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. Major deals were announced including Walt Disney’s purchase of Marvel Entertainment and Dell’s acquisition of Perot Systems. Low interest rates, improving credit markets, and high levels of corporate cash provided a favorable environment for deal making.

The Allianz RCM Large-Cap Growth Fund delivered a strong absolute return during the third quarter, but underperformed the Russell I000 Growth Index’s gain. While the Fund has some good stock picks in technology, the sector was an area that detracted from relative returns overall. Stock selection in the consumer discretionary sector also contributed to the relative shortfall.

FedEx was among the best performers in the Fund. Freight volumes have started to improve along with the global economy, after plummeting at the end of 2008. Strong shipping volumes overseas and cost cutting efforts helped FedEx report a solid quarter that topped the company’s initial guidance. We believe the stock will continue to benefit from a recovery in shipping volumes, especially in the International Priority segment. Deep operating costs and capital spending cuts set the stage for strong operating leverage as demand returns.

In technology, Apple was a strong performer, benefiting from strong sales of Macs and iPhones. The company sold 2.6 million Macs and 5.2 million iPhones during the June quarter, more than analysts expected. Additionally, the company introduced new models and price cuts across the iPod line. Information storage company EMC was also a positive contributor to relative returns, rising amid a strong earnings report and a successful takeover battle.

Conversely, Qualcomm declined amid some mixed data points out of China and a more conservative tone from the mobile phone chipmaker’s management. While the shares may be volatile in the short-term, we maintain our longer-term conviction in Qualcomm as we believe it is well positioned to benefit from secular growth in wireless handset sales and the shift towards handsets with 3G technology.

Consumer discretionary holding Activision Blizzard held back relative returns. The video game maker’s shares also declined in July amid concerns about a delay in its Starcraft 2 title and weak industry sales data. The stock recovered some lost ground after reporting a better than expected second quarter.

The top detractors also included futures exchange operator IntercontinentalExchange. The company’s shares declined in July after the Commodity Futures Exchange Commission (CFTC) announced it would investigate the need for tougher government regulations on energy trading. The proposed rules seek to curb the influence speculative investors have on commodity prices. We materially trimmed this position during the quarter on concerns regulatory headlines would continue to weight on the shares.

Major equity indices retreated at the end of September and into early October, highlighting investors’ uncertainty about the stock market rally following the steep and swift recovery experienced since March. The S&P 500 Index has gained since reaching a multi-year low on March 9.

However, we believe the market will continue to move moderately higher in the intermediate-term as the economy modestly expands over the next four quarters. Government spending, low interest rates, high levels of cash on the sidelines, and positive earnings revisions help support our positive outlook. Over 60% of the government’s $787 billion fiscal stimulus package is unspent and a surge of spending expected in 2010 should help the economy grow.

Corporate profits have exceeded analysts’ expectations for the last 2 quarters, lifted by aggressive cost cutting efforts. We believe profits will continue to top expectations as demand returns and companies benefit from the high leverage in their cost structure.