Advisor Commentary

Monthly Economic and Financial Market Outlook
September 30, 2002

Economic Review: “Mixed Signals”

While we acknowledge a weakening in the domestic economy’s rate of recovery, spanning both the manufacturing and service sectors, we nevertheless remain convinced that the massive fiscal and monetary policy initiatives currently in place will eventually result in a sustained and moderately robust economic expansion. We do not anticipate a “double dip” recession. As in the past, we expect consumer spending will continue to function as the primary driver of economic recovery. We anticipate corporate profit growth will remain strained, yet nevertheless modestly positive, as the benefits of advancing productivity growth and modest economic growth are balanced with a brutally competitive global business environment. Coupled with increased levels of spending from the federal government, we believe Gross Domestic Product growth will approximate 2.0% in year 2002’s closing months.

Economic Quote of the Month

"I am confident that we will return to 3.0% to 3.5% growth rates by the end of this year and that growth will create jobs and renew our prosperity."

Paul O’Neill
U. S. Treasury Secretary

September Economic Highlights

Inflation

While the producer price index for finished goods remained unchanged for the latest reporting period, intermediate goods advanced 0.4%; the sixth consecutive monthly advance. Prices for unprocessed commodities surged 1.6%. The Consumer Price Index advanced an unexpected 0.3% for the period, as rising oil prices took a heavy toll. Despite the presence of these pricing pressures during the period, the Federal Reserve Board continued to see economic weakness as a greater threat than inflation. We continue to anticipate muted inflationary pressures throughout the remainder of year 2002, driven by strong productivity gains, intense global competition, and production overcapacity.

Interest Rates

Interest rates again fell dramatically in September as evidence of an increasingly more muted economic recovery, coupled with the equity market’s flight to safety, drove bond prices higher and yield levels lower. We now anticipate Federal Reserve Policy makers to ease interest rate levels by 25 to 50 basis points before the close of year 2002, responding to a post-recession economic recovery that seems to be losing momentum. However, we remain convinced that the current level of monetary stimulus is sufficient to eventually spur a re-acceleration of economic growth trends. As economic growth advances in year 2003, we anticipate a slightly less accommodating monetary policy, reflected in Federal Reserve initiated interest rate increases in excess of 100 basis points.

Equity Market Review and Outlook

The stock market, as measured by the Standard and Poor’s 500 Equity Index, generated a negative 10.86% rate of total return for the month of September, as continued economic anxiety and less than inspiring corporate earnings news served to send equity prices dramatically lower. While every sector of the equity market posted negative returns in excess of 6.0% for the month, technology stocks once again bore the brunt of an increasingly negative equity market sentiment, posting a dismal 17.57% negative return for the month of September alone.

Throughout the month, uninspired corporate profit growth also weighed heavily on September’s equity markets, as industry leaders JP Morgan Chase, Intel, JDS Uniphase, Philip Morris, McDonalds, and Oracle all suggested profit and revenue growth would be less than expected for the latest quarter. Perhaps most discouraging was the revelation by technology services giant EDS that Wall Street’s profitability and revenue growth estimates needed a significant downward revision. Additionally, and more disturbing, EDS announced the firm would borrow $225 million to unwind obligations to buy its own stock, sparking concerns about the firm’s liquidity, management, and abilities to secure new business. This unanticipated announcement from EDS helped ignite a 280 point mid-month stock market sell-off that took the Dow Jones Industrial Average below the 8000 level.

Fortunately, not all economic and financial market headlines were negative during September. FedEx reported a 45% advance in profits, benefiting from the bankruptcy of rival Consolidated Freightways. Auto sales surged 13%, fueled by 0% financing. Additionally, corporate insiders were reported to have stepped up purchases of their own stocks through the latest reporting period, especially in the much maligned technology, communication, and financial services sectors.

Stock Market Sector Performance: September 2002

Equity Market Recommendation: Neutral

While we remain encouraged with good liquidity and valuation characteristics across the equity markets, we remain cautious with respect to investor sentiment measures. Coupled with heightened geopolitical risks and corporate governance concerns, we believe a normal equity allocation is warranted.

We retain our recommendation to overweight small capitalization stocks, reflective of their better performance potential during the early stages of an economic recovery. While we retain our overweight to international stocks, we recommend a 5% lessening of the exposure, with assets re-allocated to large capitalization growth stocks, reflective of their improving valuation characteristics.

Fixed Income Market Review and Outlook

The fixed income markets, as measured by the Lehman Aggregate Bond Index, generated a sixth consecutive month of positive performance during September, posting an impressive 1.62% rate of total return. The month’s strong performance was again driven by uncertainty with respect to the economy’s rate of post-recession recovery and a continuing “flight to safety” resulting from dramatically volatile equity prices.

U. S. Treasury Securities: U. S. Treasury securities generated some of the fixed income market’s most dramatically positive performance during the month, as longer maturity U. S. Treasury Bonds posted total returns in excess of 4.0%. Significantly, ten year maturity U. S. Treasury notes posted yield levels not seen since 1963, as strong demand pushed yields below 4.0%. Further fueling the powerful Treasury sector’s September performance was mortgage giant Fannie Mae’s unsettling announcement that rapidly refinancing home mortgages were driving an asset/liability mismatch within its multi-billion dollar bond portfolio. This announcement implied a potential massive treasury security purchase program, as Fannie Mae portfolio managers maneuvered to more closely align the agency’s assets and liabilities.

Corporate Securities: The corporate bond sector posted impressive total returns for the month of September, with longer maturities generating performance in excess of 1.90%. Despite continued anxiety with respect to the resilience of the post-recession economic recovery, and the uncertain implication for corporate profits, the industrial company segment within the corporate bond sector posted the most dramatically positive performance. The month’s low interest rate levels fueled a healthy level of new security issuance as blue chip icons IBM, Bank of America, and Gillette came to market with significant offerings. Reflecting the fixed income market’s passion and near insatiable demand for high quality bonds, Chevron Texaco offered a $2.0 billion five-year maturity note at the lowest yield level ever recorded for a new corporate issue with a five-year maturity.

Fixed Income Sector Performance: September 2002

Fixed Income Market Recommendation: Neutral

We are currently recommending a neutral allocation to the fixed income markets, as we believe the expected 25 to 50 basis point Federal Reserve interest rate easing is already priced into the fixed income markets. Given our expectation of moderate economic growth into year 2003, and the corresponding expectation for interest rate upward pressure, we believe a neutral position to the fixed income markets is now warranted.

The opinions expressed in this report are those of the National City Investment Management Company and are based on information that the National City Investment Management Company believes to be accurate and reliable, but are opinions and do not constitute a guarantee of present or future financial market conditions.