By Rodric E. Cummins, CFA , Senior Vice President and Chief Investment Officer

A very active Federal Reserve took center stage during the period by providing healthy short-term remedies to a number of financial market dilemmas. As a result, bond investments rallied during the period and investors with well-diversified stock portfolios earned solid gains. While returns within the stock markets were narrow in breadth, most broad equity market indices closed the quarter with positive returns and near-record highs.

Facing sluggish economic growth and serious market reactions to concerns regarding housing weakness and mortgage financing, the Federal Reserve (“the Fed”) took aggressive steps to calm investors’ fears. Open market operations were conducted to provide liquidity while interest rates were reduced via both the Fed Funds rate and the discount rate. In doing so, the Fed’s first interest rate cut since 2003 signaled a change in monetary policy and sent a strong message that under current conditions, monetary policy will support economic growth even at the expense of the U.S. dollar.

Stocks generally do well during periods of monetary easing, and the beginning of this cycle is consistent with this historical pattern. The U.S. equity markets, as measured by the S&P 500® Index, responded with a strong rally following the August 17th discount rate cut to post a return of 2.03% for the quarter. The year-to-date total return for the S&P 500® was 9.13% as of quarter-end. Also, in classic fashion consistent with late-stage economic cycles, the equity markets were led by large capitalization stocks over the more economically sensitive small company stocks, with market leadership maintained by high-quality, large capitalization growth stocks. The performance of emerging markets and a sharply declining U.S. dollar led international stocks into positive territory for the quarter as the MSCI® ACWI Ex-U.S. Index posted a return of 4.62% for the period. Emerging markets stocks, as measured by the MSCI® Emerging Markets Index, returned 14.42% for the quarter and 34.50% year-to-date.

The fixed income markets rallied on the Federal Reserve’s change in monetary policy, resulting in lower interest rates across the U.S. Treasury yield curve. For the quarter, the Lehman Brothers Aggregate Bond Index returned 2.84%.

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All indices are unmanaged and not available for direct investment. Index performance assumes no taxes, transaction costs, fees or expenses. This update is prepared for general information only and it is not to be reproduced.