U.S. equities continued their steep ascent amid growing evidence of an economic recovery and stronger than expected corporate profits. The S&P 500 Index gained during the third quarter. Risk tolerances increased during the quarter. Investors continued to move money out of cash and low yielding money market mutual funds into higher-yielding, riskier investments in the equity, debt, and currency markets.

Stocks climbed higher despite doubts surrounding the rally. Many investors had anticipated a correction given the magnitude and speed of the market recovery that began in March. However, the S&P 500 Index ended the quarter near its highest level for the year.

Broad based gains extended across all sectors in the S&P 500 Index. Financial stocks led the third quarter rally one year after the collapse of Lehman Brothers. Some of the biggest decliners during the financial crisis posted the largest third quarter gains, including American International Group. Industrials, materials, consumer discretionary, and technology sectors were also among the best performing sectors. Defensive utilities, health care, and consumer staples segments joined energy and telecommunication services as the relative laggards. Emerging market equities outperformed developed markets and in the U.S., small caps outperformed large caps and value outperformed growth.

Stocks appreciated as the economy showed broad signs of improvement. The majority of economic data released during the quarter came in above expectations. Manufacturing reports were largely positive, a slew of housing reports showed signs of stabilization, and consumer confidence improved overall. While the global recession appears to be over, the labor market is still weak and a disappointing manufacturing report and a consumer confidence report led to modest market declines during the last two trading days of the month.

Companies cut costs aggressively during the economic downturn. These efforts helped over 70% of companies in the S&P 500 Index report second quarter profits that beat consensus earnings estimates. Analysts’ expectations were low going into the quarter and have been steadily revised higher. Following a two year streak of profit declines, analysts are now expecting a steep earnings recovery.

Mergers and acquisitions picked up after a two year decline in activity with low interest rates, improving credit markets, and high levels of corporate cash provided a favorable environment for deal making.

The Allianz RCM Disciplined Equity Fund out performed the S&P 500 Index benchmark. Successful stock selection drove the outperformance.

Starbucks was the leading contributor to performance during the quarter. Its shares moved sharply higher surrounding a significant upside earnings surprise on the company’s fiscal 3rd quarter earnings report. Caterpillar and Apple were also top contributors to relative returns, as was the decision to not own Exxon Mobile which is a heavy benchmark position.

Corning was the leading detractor from relative performance during the quarter as the stock traded somewhat flat for the quarter, consolidating sharp gains from earlier in the year. Lockheed Martin and Intuit were also leading detractors during the quarter.

Sector allocation was a slight detractor from relative performance during the quarter. Our underweight in financials had the largest negative impact on performance, while our underweight in utilities had the biggest positive impact.

The Allianz RCM Disciplined Equity Fund out performed the S&P 500 Index benchmark. Successful stock selection drove the outperformance.

Starbucks was the leading contributor to performance during the quarter. Its shares moved sharply higher surrounding a significant upside earnings surprise on the company’s fiscal 3rd quarter earnings report. Caterpillar and Apple were also top contributors to relative returns, as was the decision to not own Exxon Mobile which is a heavy benchmark position.

Corning was the leading detractor from relative performance during the quarter as the stock traded somewhat flat for the quarter, consolidating sharp gains from earlier in the year. Lockheed Martin and Intuit were also leading detractors during the quarter.

Sector allocation was a slight detractor from relative performance during the quarter. Our underweight in financials had the largest negative impact on performance, while our underweight in utilities had the biggest positive impact.

We believe the economy will modestly expand over the near-term, aided by government spending, the delayed impact of monetary stimulus and a recovery in housing sales from depressed levels. Corporate profits exceeded analysts’ expectations for the last 2 quarters as aggressive cost cutting efforts helped offset weakening top line growth, and inventories for many companies are now at extremely low levels following destocking in the first half of the year. Going forward, corporate profits should benefit from leaner cost structures and inventory restocking needed to keep pace with demand.

Given significant stock price appreciation in recent months, the market does appear fairly valued. Nevertheless, while we would not be surprised for the market to pullback in the near-term, we believe the overall positive momentum should continue over the longer-term as innovation and strong competitiveness in the US marketplace drive the stock market forward.

In the coming months, we will continue to adhere to our investment process and remain focused on identifying undervalued companies undergoing positive change.