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R  E  P  O  R  T

August 2006

Stocks Stage A Comeback

After 17 straight rate hikes, on August 8^th, the Federal Open Market Committee decided to hold the federal funds rate at 5.25%. In its minutes, the Fed stated that economic growth “has moderated from its quite strong pace earlier this year, partly reflecting a gradual cooling of the housing market and the lagged effects of increases in interest rates and energy prices.” Most investors had expected this move.

Fueled by a benign Federal Reserve message in early August, the stock market staged a steady rally in the following weeks. Large companies led the way which may be a signal to investors that the time for outperformance of small cap vs. large cap stocks might be at an end. Both the Dow Jones Industrial Average and the broader Standard & Poors 500 index have moved up in excess of 2% while the technology-laden NASDAQ Composite has surged ahead 4.2% for the month.

Signs of a slower growth economy in the second half of the year have provided the backdrop to the market’s resurgence. Growth slowed to 2.9% during the second quarter from the first quarter’s brisk 5.6% pace. This modest rate should continue the second half of the year and into the first half of 2007. Inflation should moderate as the economy cools. At RiverPoint, we believe this scenario will likely provide a catalyst for better U.S. equity performance.

There also appears to be significant improvement in the equity risk-reward ratio. Earnings have climbed 25% since January 2005, while the S&P 500 is up only 6% over the same period. This has resulted in low valuations -- the S&P 500 is trading at just 14.9 times estimated 2006 per-share earnings, despite estimated double-digit profit growth for 2006. At RiverPoint we believe the financials sector -- representing 22% of the S&P 500 -- is uniquely positioned to benefit from an end to the Fed’s tightening program. This sector also sports above-average quality rankings, a measure comprised of earnings and dividend growth over the past 10 years.

A Cooling Real Estate Market

Prospects for the U.S. housing market took a turn for the worse on August 23^rd with the release of a government report that showed existing home sales had tumbled 4.1% in July from a downwardly revised June level - a steeper decline than expected. The report followed Wednesday's unexpectedly sharp drop in existing home sales. The July figures represent the fourth straight monthly decline and leave home sales more than 11% lower than one year ago.

The housing numbers indicate the economy may be slowing faster than the Fed anticipated. "Bernanke will have to exhibit considerable courage to ride the storm out," said Peter Morici, a professor at the University of Maryland School of Business and former chief economist at the U.S. International Trade Commission. "The temptation to raise interest rates could result in a terrible bout with stagflation or a recession."

The prospect of possible material home price deflation throughout the country must be a major worry for the Bernanke Fed. Home equity extraction has been a material boost to household purchasing power and has underpinned robust consumer spending for over the past 10 years.

However, the historically low interest rate environment of 2006 makes a housing “bust” in the order of past housing recessions unlikely. In fact, the last major housing recession in the ‘80s was accompanied by a housing credit crunch – a sharp contrast to today’s still easy lending standards. Also, in contrast to the residential housing deceleration, commercial housing, albeit a much smaller segment of the overall housing market, is still expanding. At RiverPoint, we believe that the slowing housing market, while having a dampening effect on the overall economy, will not have a major recessionary impact on the economy or capital markets.

Roth 401k Here to Stay

The Pension Protection Act of 2006 was signed into law by President Bush on August 17^th. This act provides several changes to the way Americans save. One significant change was that the new law made Roth 401k’s, set to expire in 2011, permanent. This is significant for today’s workers. While the maximum amount one can contribute to a 401k remains the same at $15,000 (or $20,000 if you are 50 or older), the differences between a Roth and a traditional 401k are noteworthy.

With a traditional 401k plan, money contributed today is taxed as ordinary income upon distribution after the individual retires. Historically an investor’s tax bracket upon retirement is higher than when beginning his/her career. This scenario would lead to a greater tax burden for the retiree. On the other hand, contributions are tax deferred, minimizing the taxes paid on the front end. With a Roth 401k, however, taxes are taken out today leaving distributions during retirement untaxed. The more dollars an investor can save at a younger age in a Roth 401k, the better off the investor will be upon retiring. Whether or not a Roth 401K is the optimal investment vehicle for an individual will depend on the individual’s personal financial situation.

Market Summary	8/31/06	YTD Price Change
Dow Jones Industrial Average	11,381	+7.90%
Nasdaq Composite	2,184	-0.43%
Standard & Poor’s 500 Index	1,304	+5.79%

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