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The Stable Value Market Environment
Fourth Quarter 2009

David J. Molin, CFA

2009 will be remembered as a year of recovery for the fixed income markets highlighted by an unprecedented rally in risk assets as investor confidence returned in the wake of massive government stimulus/liquidity programs and an improving economic outlook. This renewed confidence emboldened investors to move money out of low yielding cash and government securities into higher yielding, riskier asset classes. As a result, liquidity returned to non-Government related sectors and credit spreads contracted significantly from historic wides to end the year well below peak-crisis levels. After rallying on strong demand earlier in the quarter, Treasury prices fell in December as improving economic indicators and record levels of supply pushed yields higher. By quarter's end, Treasury yields were higher across all maturities, with the largest moves focused in the mid to long end of the curve as yields on 2, 5, and 10 yr notes increased by 19, 37, and 53 bps, respectively. As a result, the Treasury curve steepened with the spread between two and 10-year Treasuries ending the quarter at a historically wide 270 bps, compared to 236 bps last quarter. In contrast, GIC yields, based on the average compound rate for a $5 million contract, ended the quarter slightly lower for most maturities as credit spreads over Treasuries continued to tighten. In the end, GIC yields declined around 5 bps across short to intermediate maturities, while yields on long maturities increased around 20 bps. As a result, the GIC yield curve steepened with the difference between three and 10-year contracts ending the quarter at a positive spread of 246 bps, up from 222 bps last quarter. GICs continued to demonstrate solid relative value characteristics when compared to high-investment grade alternatives with the average five-year contract offering 90 bps over Treasuries at the end of December. Moreover, the high contract offering based on FCM's weekly GIC statistics yielded approximately 122 bps over the corresponding Treasury, which is considered to be very favorable when compared to spreads in the 80 bps range, before wrap fees and commissions, on similar corporate bonds. During the quarter, the broad equity markets continued to move higher with the DJIA, S&P 500, and Nasdaq reporting strong total returns of 8.1%, 6.0%, and 7.2%, respectively. The Barclays Capital Aggregate Bond Index reported a modest total return of 0.20% for the quarter as negative returns from the Treasury/Agency sector offset solid performance from the Corporate sector, which continued to benefit from tighter credit spreads.

Economic News: The economic picture has transitioned from a historically deep recession to the beginning of a recovery with most economists projecting solid near-term economic growth driven by inventory builds and government stimulus. However, the strength of the recovery will continue to be challenged by high levels of unemployment, reduced household wealth, and tepid consumer spending. Moreover, the sustainability of growth remains the big question given that the economy will need to find new growth engines once the effect of stimulus efforts begin to fade. Current consensus is for GDP to improve to an annual rate of 4.0% in the fourth quarter, up from the 2.2% in the third quarter. During the quarter, the housing market continued to show signs of improvement with some stabilization in home prices and better than expected gains in existing home sales as buyers continued to take advantage of low mortgage rates, foreclosure sales, and government incentives. To meet increased global demand for new orders, the manufacturing sector continued to expand during the quarter, with factory activity, as measured by the ISM Index, rising to its highest level since 2006. The consumer confidence index improved in December; however, index readings remain historically weak as concerns over labor market conditions continue to depress consumer optimism. That said, retail sales continued to show signs of life with better than expected gains reported for October and November. During the quarter, the labor market continued to deteriorate, but at a slower pace, as payrolls declined by 208,000 jobs, down from the nearly 600,000 jobs lost in the third quarter. For all of 2009, payrolls declined by 4.2 million jobs, compared to 3.0 million jobs lost in 2008. The unemployment rate increased from 9.8% in September to 10.0% in December, the highest level since 1983. Inflation growth at the consumer level remained well contained with the consumer price index (CPI) increasing by 0.1% in December, after an increase of 0.4% in November. At its December meeting, the FOMC maintained its Fed Funds target at 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
3.07%
2.35%
1.60%
Five Year
4.80%
3.40%
2.75%
Seven Year
5.25%
4.13%
3.18%
Ten Year
5.86%
4.75%
3.91%

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Updated 2/28/10