Financial markets rebounded in both sentiment and pricing during March following the bailout of Bear Stearns, but weak economic data and global inflation—particularly in core commodities—now threaten to depress consumption and impede any possible housing turnaround as the quarter progressed.

Banks selling billions in new equity to offset mortgage related write-offs even as new issuance volume on the bond side reflected improving investor confidence gave more evidence as to the mixed state of the markets. Money market liquidity improved from last year's squeeze, though interest rates remained elevated due to the conservation of cash and capital by banks.  The banking recovery remains tentative as firms acknowledge additional capital needs and continually test investor support. Many bank stocks were down sharply, and credit ratings downgrades to the bond insurers and to Fannie Mae and Freddie Mac will test the limits of investor support. 

We see further interest rate moves by the Federal Reserve Board as ineffective against either inflation or the ongoing credit problem, and think the economy will have to retrench to find equilibrium. We have adopted a more defensive economic outlook, and expect a prolonged slowdown as housing restructures and the economy de-levers. Caught in an inflation/recession trap, we expect no rate action from the Fed during a difficult election year. Our investment strategy is to capture elevated spreads where possible, while maintaining a high quality portfolio. We continue to favor quality issuers and bank names, and have kept the fund's duration short in view of the heightened uncertainty. 

William R. Anderson, CFA
Portfolio Manager
Fortis Investments