Market Commentary as of 3/31/08

Equity markets got off to a rough start to 2008 as most of the major indices dropped 10% or more during the first quarter. As the credit freeze in the United States and around the world takes its toll on the mortgage-backed securities market people are starting to ask, "What will be next?" It's obvious that banks and investment banks will need to reduce the leverage on their balance sheets. That begs the question as to what impact this will have on the capacity for borrowing and the ability of the overall economy to grow in the future. To the typical American, the size of Goldman Sachs’ balance sheet is of no consequence. The fact that the price of gasoline is approaching $4 a gallon and the job market is softening, however, is of more than just passing interest. Taken together it isn't difficult to see why consumer confidence is at its lowest levels since 1993, as calculated by the University of Michigan Consumer Confidence survey.

Fuel for a Rebound
The reality, however, is that things are not as bad as they appear. In our opinion, inflation will wane as the Federal Reserve Board tackles the problem aggressively. The US stock market is, by many measures, as cheap as it has been since the early 1980s. That said, the market is unlikely to rebound without a catalyst—and the fuel to keep it going. The catalyst could come in any number of forms, but most likely through a stabilization of the current situation or the belief that the global growth engine is still strong enough to weather this storm. The fuel is the interesting side of the story—cash sitting on the sidelines. In the US alone, there is currently $4.3 trillion dollars invested in money markets and small certificates of deposits earning annual returns of 3% or less.

To put this in perspective, the aggregate market value of the S&P 500 Index is less than $12 trillion. During the first quarter of the year, Federated Investors, a major money market fund provider, added $40 billion in assets to its money market products. That was nearly triple the $15 billion of expected growth for the period. Although consumer confidence is taking its toll on the market at present, perception and reality should soon converge.

We suspect that there will be more surges in volatility as the market reacts to bad news and value buyers attempt to shift to "early-cycle" stocks. In the end, we still expect growth to outperform, despite the doubts created by the market correction. Value investing styles have not provided a safe haven during the recent turmoil nor do we think it will provide leadership as the market finds its footing, rebuilds, and moves forward over the next several quarters. As we have said before, the scarcity of growth makes it much more important as an asset class. This is a situation we have seen before and one with which we are comfortable. Our process of identifying companies able to exceed consensus expectations and generate positive earnings surprises is still finding stocks with characteristics that we like. Over time, we believe the market will reward that growth with higher stock prices.

Winners and Losers
The Fund lagged the Russell 1000 Growth Index during this tough environment for stocks. The largest positive contributors to the fund were Nike, a new addition in the Consumer Discretionary sector, and Healthcare names Illumina and Intuitive Surgical. Each of these stocks benefited from excellent earnings reports. Laggards included trading platform Intercontinental Exchange, which suffered from the overall malaise in the Financial sector as well as speculation over potential acquisitions. Garmin, a maker of portable navigation devices, and Google were other notable detractors from performance.

Charles P. McCurdy, Jr. CFA
Charles F. Mercer, Jr. CFA
B. Anthony Weber