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The Stable Value Market Environment
First Quarter 2008

First quarter 2008 was an historic period as investors faced unprecedented volatility culminating with the near bankruptcy and subsequent bailout of Bear Stearns, the fourth largest US investment bank. Flight to quality buying sent Treasury yields lower as investors reacted to troubling news including large subprime related write-downs, agency downgrades of bond insurers, and failures in the auction rate securities markets. Credit spreads continued to gap wider as institutional investors deleveraged their balance sheets and sold securities to meet liquidity needs. By mid-March, credit spreads widened significantly beyond their historic highs as rumors about the condition of Bear Stearns and other investment banks intensified risk aversion and further constrained liquidity. The Federal Reserve took unprecedented actions to provide liquidity and stabilize the market including $30 billion to facilitate the sale of Bear Stearns to JP Morgan, along with a 75 bps cut in the FF rate and the injection of billions through special liquidity facilities including the opening of the Discount Window to investment banks. Treasury yields were down sharply across most maturities, with yields on 2, 5, and 10 yr notes declining by 146, 100, and 61bps, respectively. The Treasury curve steepened with the spread between two and ten-year Treasuries ending the quarter at 183 bps, compared to a positive slope of 97 bps last quarter. GIC yields, based on the average compound rate for a $5 million contract, also declined during the quarter, but to a lesser degree than Treasuries as credit spreads widened to levels well above historic norms. GIC yields declined around 80 bps in shorter maturities, while yields on intermediate and longer maturities declined around 40 to 50bps. The difference between three and 10-year GIC contracts ended the quarter at a positive spread of 144bps, up from 100 bps at the end of last quarter. Despite a more intense re-pricing of risk within other investment grade sectors, GICs continued to demonstrate solid relative value characteristics when compared to high-investment grade alternatives. GIC spreads widened significantly with the average five-year contract offering around 200 bps over Treasuries at the end of March, up approximately 70 bps since December. Moreover, the high contract offering, based on FCM's weekly GIC statistics, yielded approximately 250 bps over the corresponding Treasury, which is very favorable when compared to spreads in the 200 bps range, before wrap fees and commissions, on similar corporate bonds. The equity markets ended the quarter much lower led by weakness in financial shares with the DJIA, S&P 500, and Nasdaq reporting total returns of -7.0%, -9.4%, and -13.9%, respectively. On the contrary, investment grade bond funds reported solid performance with the Lehman Aggregate Index returning 2.2%, as the effect of lower interest rates on asset values more than offset wider credit spreads for non-Treasury sectors.

Economic News: Recent data points to a weakening economy and the possibility of recession. The current consensus is for slightly positive GDP growth in the first quarter of around 0.5%, down from the 0.6% growth experienced in the fourth quarter 2007. The housing market continued to weaken with housing starts falling 12% in March to a 17-year low, while sales of existing homes remained near multi-year lows. The consumer confidence index fell to its lowest level in five years in March as declining home values, tighter lending standards, and softer labor market continued to depress consumer optimism. This was reflected in weaker retail sales, with sales excluding automobiles increasing by only 0.1% in March, after a 0.1% decline in February. Business investment also showed signs of weakening as orders for durable goods, ex transportation, declined by 2.6% in February, after a decline of 1.0% in January. After rebounding in January, the manufacturing sector contracted in February and March with factory activity, as measured by the ISM Index, remaining near five year lows. The labor market continued to weaken as the economy lost jobs for a third consecutive month in March, resulting in payrolls declining by over 200,000 jobs during the quarter. The unemployment rate increased from 4.9% in January to 5.1% in March, the highest level since September 2005. Headline inflation crept higher during the quarter, driven by higher commodity prices, with the consumer price index (CPI) increasing 0.3% in March, after no change in February. The more closely watched Core CPI, excluding volatile food and energy prices, grew at a more controlled rate of 2.4% in March, on a year over year basis, up slightly from a 2.3% growth rate in February. The FOMC cut its Fed Funds rate target by an unprecedented 200 bps during the quarter, bringing the rate down to 2.25%. In its March policy statement the committee acknowledged the difficult market conditions: "Financial markets remain under considerable stress, and the tightening of credit conditions and the deepening of the housing contraction are likely to weigh on economic growth over the next few quarters".

David J. Molin, CFA

The following chart illustrates GIC spreads for $5.0 million, five year investment only, compound interest contracts.
The rates are net of expenses, with no commission payable.

Fiduciary Capital Management, Inc.

Illustrative GIC Statistics
("Bullet", net of expense, no commissions)
$5 Million Compound Contracts

High
Avg.
Low
Three Year
4.63%
3.68%
2.86%
Five Year
5.04%
4.39%
3.49%
Seven Year
5.50%
4.85%
3.94%
Ten Year
5.95%
5.29%
4.39%

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Updated 6/26/08