The International Equity Market
In the second quarter of 2010, international indices were hurt by investor concerns regarding the strength of the European Union and its ability to stave off debt issues within the member countries such as Greece, Spain, and Portugal. As a result, international indices posted lower results than their domestic counterparts over the second quarter, year-to-date, and one year time periods. In May, the European Union and the International Monetary Fund (IMF) pledged $1 trillion to fight off sovereign debt contagion risk.

Even though the United States continues to have the largest GDP as compared to other developed and emerging countries, our GDP had remained consistently larger per capita as compared to these other countries. Globally, the unemployment rate has remained high and inflation was mixed. Emerging countries continued to post large gains during the recovery as investors sought cheaper labor and goods.

Source: JPMorgan
The U.S. Dollar weakened against major foreign currencies in 2009 as investors came back to the market and domestic and foreign indices posted strong gains during the calendar year, but the dollar strengthened in the first half of 2010 reversing the recent trend of strong relative international equity returns. During the global recession, investors sought the safety of the U.S. Dollar in order to protect assets as the U.S. Government took drastic steps to strengthen domestic financial markets. As market conditions have improved, the U.S. Dollar weakened as investors diversified their currency exposure to levels to close to, but still above pre-recession levels.

Source: JPMorgan
The Bond Market
During the second quarter of 2010, Treasuries and mortgages reversed the recent trend and outperformed their credit related index counterparts as investors sought the safety of government backed issues during the quarter as equity losses effected corporate debt. For the first time in over a year, high yield indices did not post the largest gain during the quarter as option adjusted spreads on credits edged upward, but remain well off of all-time highs. TIPS issuance has increased as demand has risen due to future inflation concerns even though the Fed has signaled deflation is more likely to be prevalent over the near-term.

The Federal Reserve kept the Fed Funds Rate at an all time low of a range between 0 to 25 basis points since December 2008. Interest rates along the entire curve continued to remain low as investors attempted to unload riskier assets and buy Treasuries, but to a far lesser extent than in 2009. The Federal Reserve stated concerns over continued recovery and possible deflation even though there has been massive stimulus and bailout dollars are being spent by an already deficit plagued federal system in a hope to spur the economy.

Credit spreads widened slightly in the second quarter of 2010, but were still off from at all-time highs as investors sought the large yield currently existent in investment grade and below investment grade credits. Although high yield indices were aided by high coupon payments and asset flows into the asset class, credit fundamentals generally improved and market conditions appear to have eased worries from anxious investors.

The Real Estate Market
The NCRIEF second quarter return was 4.4%, 5.2% year-to-date, and -5.9% over the twelve months ending June 30, 2010. While real estate fundamentals are under pressure due to economic weakness and a rising unemployment rate, the most important factors affecting the real estate market have been rising cap rates and soft credit markets. Cap rates have risen sharply by 100-200 bps, which has lowered valuations. The lack of CMBS issuance and a restrictive lending environment significantly impacted transaction volume and appraisers have a very limited pool of comparable sales. The combination of these factors led to an unfriendly appraisal environment. However, the correction has likely occurred as managers revalue 100% of the portfolio on a quarterly basis. Furthermore, cap rates appear to have stabilized and may even be under slight upward pressure for quality properties. Most commingled real estate funds have already eliminated or will have eliminated there withdrawal queues in the next quarter or two. Real estate manager consensus has been improved property valuations and continued income streams from existing property holdings through the end of the year.
UNLEVERAGED CAP RATE IMPACT

