MARKET OVERVIEW

The beleaguered U.S. housing market swerved toward collapse in July, rattling Wall Street and provoking the year’s second major government bailout. Although stocks recovered from a mid-month trough, investors walked away with mixed results. The S&P 500 lost ground, weakened by an excursion into bear territory, off more than 20% from its October record. The Dow Jones Industrial Average crossed below the psychologically important 11,000 mark, before recovering and ending the month with a slight gain.

Freddie Mac and Fannie Mae, the quasi-governmental agencies that back nearly half the U.S. mortgage market, sparked the inferno. Years of poor oversight, lax lending standards and falling home prices left the firms in a crisis of confidence. One report suggested they were $75 billion undercapitalized. Questions regarding their access to new funds raised doubts on their ability to finance new mortgages, a necessary ingredient for a housing recovery. As Wall Street slipped into a tailspin, the government shifted into action. The Treasury Department announced plans to increase a long-standing credit line to Freddie and Fannie and take an equity position in the firms “if needed.” The Federal Reserve offered access to cheap credit via the discount window.

The measures bolstered investor confidence and stock prices. Adding to the return of stability was a precipitous drop in oil prices and a rebound in GDP. The cost of crude fell 11.4% in July, the largest monthly slide on record. Second quarter GDP rose 1.9%, boosted by international trade and tax rebate spending.

Predicting corporate earnings remains an exercise in disappointment. Thomson Reuters' estimate of second quarter S&P 500 profits worsened from -11.5% on July 1 to -17.9% on July 28. If realized, the contraction would complete a full year of falling profits, corporate America’s longest losing streak in six years. Energy firms are expected to post the best results, with profits up 25%. The financials sector continues to be a fountain of weakness, with expected second quarter profits down 85%.

EQUITY UPDATE

STYLE AND MARKET CAPITALIZATION

Small-company stocks bucked the broader trend last month, advancing while mid- and large-sized firms lost ground. July marked the third straight month of outperformance for small caps, the longest string of wins for the asset class since a similar stretch ended in July 2005. From a style standpoint, value was the place to be. Value stocks outperformed growth stocks across the capitalization spectrum, bolstered by a recovery in the financial sector.

S&P 500 SECTORS AND INDUSTRIES

The tables turned for energy and financial companies last month. In June, the two sectors were the respective best and worst performers in the S&P 500. In July, the opposite was true. Energy stocks collapsed, burdened by a record monthly drop in the price of crude. Exxon Mobil, the world's largest public oil firm, plunged 9%, despite posting the largest-ever U.S. corporate profit during the second quarter. Financial stocks rebounded from a mid-month nine-year low, buoyed by government plans to rescue mortgage giants Fannie Mae and Freddie Mac.

INTERNATIONAL EQUITY

International equities fared poorly in July, skidding through a second month of losses. On average, emerging market shares fell harder than those in developed markets, while Asia underperformed Europe and growth underperformed value. This year’s sell-off has left few rocks unturned. According to Bloomberg, of the twenty-three industrialized countries in the MSCI World Index, only Canada has dodged the 20% decline that defines a bear market. Among the twenty-five countries in the MSCI Emerging Markets Index, only Jordan and Morocco have escaped the bears.

Assessment Of Current Economic Indicators*

POSITIVES

Monetary Policy-The Fed held rates at 2.00% on June 30; real rates are negative

Valuations-Based on expected profits, stocks are the cheapest in at least 10 years

Business Inventories-Inventories rose in May, but sales increased at a faster pace

Industrial Production-Jumped in June, bolstered by the end of an auto supplier strike

NEUTRAL

GDP-2Q08 up 1.9% (prelim) on trade and tax rebates; 4Q07 revised to -0.2%

NEGATIVES

Retail Sales-Up meager 0.1% in June, weighed down by 3.3% slump in auto sales

Inflation-CPI hit 5.0% in June, highest since 1991; Core CPI was lower at 2.4%

Investor Sentiment-Market optimism remains thin, according to Bloomberg reports

Geopolitical-Continued deadlock over Iran's controversial nuclear program

Employment-Nonfarm payrolls fell a sixth consecutive month in June

Consumer Confidence-Remained near 16-year low in July, according to the Conference Board Corporate Earnings-Fell 17.9% in 2Q08 (est.); 3Q08 predictions are positive, but deteriorating

Oil Prices-Highly volatile and still costly, despite falling a record 11.4% in July

Housing-The worst housing downturn since the Great Depression continues…

*As of 31-Jul-08