Stocks worldwide advanced during the third quarter as investors rushed to participate in one of the strongest rallies in decades. Reports showed Japan, Singapore, Hong Kong, Thailand, Germany, France, Norway, Brazil and Israel officially exiting recession. Investor fear, as measured by the Chicago Board Options Exchange Volatility Index, receded to a 52-week low. The MSCI All Country World Index (ACWI) surged its second consecutive double-digit advance. Since crashing to a six-year low in March, the benchmark has rebounded 66%.

• The Allianz NACM Global Equity 130/30 Fund was up for the third quarter, although it lagged the MSCI ACWI.
• The Fund operated with approximately 12% additional leverage on the long side and 12% short-side exposure. On the long side, the fund’s portfolio consists of stock selections based upon the team’s bottom-up ideas from across the globe. On the short side, the fund currently has exposure to Continental Europe and the U.S. via short index futures as well as individual stock swaps. The fund plans to continue progressing towards typical exposure level of 130/30. The fund maintains operation with 100% net exposure.
• From a country perspective, longs in China and Korea were the two biggest winners for the month, both driven by strong relative performance versus the benchmark. Offsetting performance were stock picks in Japan, where modest underperformance coupled with a portfolio overweight in this country, a poor performer within the MSCI ACWI, hampered shares.
• Looking at sectors for the quarter, Energy and Telecommunications were the two top performers, both with relative returns that trumped the index. On the flip side, performance in Financials lagged, with both relative underperformance and a portfolio underweight in this sector, a top performer for the benchmark.

Stock Stories

• A solid quarterly performer for the fund was Massey Energy. Shares of the fourth-largest coal producer in the United States rose in part due to a positive quarterly report which beat analyst expectations, as well as a bullish Street view on coal companies and higher metallurgical coal prices. The company has a well capitalized infrastructure with solid operating margins and a favorable product mix. Massey also recently announced an asset purchase from a bankrupt competitor at rock bottom prices, which increases their coal reserves. We made the decision to sell shares at the end of September, and replace them with a better investment candidate, following the recent run-up in stock price.
• Shares of Oracle, the leading vendor of database, middleware, and enterprise software applications, slumped last quarter. The company recently reported expanded operating margins and earnings in line with guidance, but lighter-than-expected revenues helped drive the pullback. The integration of BEA and the recent Sun acquisition allow for market share increases and vertical growth potential beyond the current business mix. However, the market is looking for more clarity around the Sun deal, which will likely happen near year-end. Oracle’s strong recurring revenue stream and growing product offerings allow the company to potentially increase market share even during a challenging environment. We continue to hold Oracle shares given these long-term growth opportunities, coupled with high visibility and a dominant position in the enterprise software market.

Despite this summer’s bull market rally, equities don’t appear overly expensive. The MSCI All Country World Index was priced at 14.8 times expected earnings in September (twelve-month; IBES). That compares with an average of 16.1 over the past ten years and a peak of 24.4 in January 2000. From an economic standpoint, the global economy continues to recover, with leading indicators rising in Europe and Asia the past six months (source: Organisation for Economic and Co-operative Development). U.S. indicators are on a five-month roll. Still, the road ahead won’t likely be smooth, particularly for export-dependent economies. The jobs-related downturn in U.S. consumer confidence in September highlights challenges facing U.S. retailers entering the holiday shopping season. The greenback’s decline is a second point of weakness. Since March, the U.S. dollar has lost 14% of its value against a trade-weighted basket of currencies. This buoys American businesses at the expense of foreign competitors, a factor that may be evident in forthcoming earnings reports. If the rest of the world recovers faster than the U.S. and the Federal Reserve lags global peers in monetary tightening, the drop in the dollar could accelerate. At Nicholas-Applegate, we believe our products are well positioned to capitalize on the changing market environment.