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The Stable Value Market Environment
Second Quarter 2010

David J. Molin, CFA

During the quarter, volatility returned to the fixed income markets as contagion fears resulting from the sovereign debt crisis in Southern Europe and concerns over the health of the global economy drove investors out of riskier asset classes and back into the safety of US government securities. As a result, Treasuries rallied throughout the quarter, sending yields lower, and credit spreads on risk assets widened with investment grade corporate spreads moving out by around 40 bps. By quarter's end, Treasury yields were significantly lower across most maturities with the largest moves focused in the mid to long end of the curve as yields on 2, 5, and 10 yr notes decreased by 41, 77, and 89 bps, respectively. As a result, the Treasury curve flattened, but remained historically steep, with the spread between two and 10-year Treasuries ending the quarter at 233 bps, compared to 281 bps last quarter. Following suit, GIC yields, based on the average compound rate for a $5 million contract, ended the quarter lower, but to a somewhat lesser degree as credit spreads over Treasuries widened. In the end, GIC yields declined around 50 to 60 bps across intermediate to long maturities and the GIC yield curve flattened with the difference between three and 10-year contracts ending the quarter at a positive spread of 234 bps. GICs continued to demonstrate solid relative value characteristics when compared to high-investment grade alternatives with the average five-year contract offering around 85 bps over Treasuries at the end of June. Moreover, the high contract offering based on FCM's weekly GIC statistics yielded approximately 120 bps over the corresponding Treasury, which is considered to be favorable when compared to spreads in the 100 bps range, before wrap fees and commissions, on similar corporate bonds. During the quarter, the broad equity markets experienced sizable losses with the DJIA, S&P 500, and Nasdaq reporting negative total returns of 9.4%, 11.4%, and 11.8%, respectively. The Barclays Capital Aggregate Bond Index reported a strong total return of 3.5% for the quarter as index performance benefited from the sizable drop in yields, which more than offset spread widening in non-Treasury sectors.

Economic News: The economic recovery appeared to lose some steam during the quarter with most economists projecting more modest near-term growth as the economy transitions away from the short term benefits of inventory builds and government stimulus. Going forward, the sustainability of growth remains the big question given the significant headwinds still facing the economy including historically high levels of unemployment, reduced household wealth, and lower availability of credit. In addition, higher tax rates in 2011 and state and local government budget cuts could further dampen growth prospects. Current consensus is for GDP growth of 2.5% in the second quarter, down slightly from the 2.7% growth experienced in the first quarter. During the quarter, the recovery of the housing market showed signs of faltering with declines in sales of existing homes and housing starts reported in May and June, which was largely blamed on the expiration of the government tax credit. The manufacturing sector continued to expand during the quarter; however, the pace of growth appeared to slow, with factory activity, as measured by the ISM Index, falling more than expected in June. The consumer confidence index declined in June to its lowest level since March, largely due to more pessimism regarding the outlook for the labor market and economy. The lower sentiment was reflected in tepid consumer spending with retail sales falling more than expected in both May and June. During the quarter, the deterioration of the labor market continued to abate as the economy added 621,000 jobs, a significant improvement from the 261,000 jobs gained in the first quarter. However, a large portion of the job gains was related to the hiring of temporary government census workers as private employers added a more modest 357,000 jobs during the quarter. The unemployment rate declined modestly from 9.7% in March to 9.5% in June. During the quarter, inflation growth at the consumer level turned negative raising concerns over deflation with the consumer price index (CPI) decreasing by 0.1% in June, after a 0.2% decline in May. At its June meeting, the FOMC maintained its Fed Funds target at a range of 0%-0.25%. The committee continues to anticipate that economic conditions are likely to warrant exceptionally low levels of the federal funds rate for an extended period.

The following chart illustrates GIC yields 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
2.75%
2.14%
1.25%
Five Year
3.79%
3.06%
2.25%
Seven Year
4.63%
3.82%
3.12%
Ten Year
5.28%
4.43%
3.87%

Any questions or feedback is appreciated. Please feel free to contact us at 1-203-269-0440.



Updated 8/17/10