October 2007

FED EASING: A WELCOME DEVELOPMENT

The financial market outlook can be summarized thus – mixed signals make for an uncertain future. Strong corporate balance sheets are acting as a cushion that allows companies to execute business strategies without having to worry about small missteps. Overlooking the risks associated with shady – sometimes even illegal – practices in the sub-prime mortgage sector has taken a toll on the financial markets. The key question is whether all of those risks are now recognized or whether there are more crises looming on the horizon. Having survived the initial fallout from the sub-prime market collapse, financial markets have rebounded sharply with the S&P 500 Index returning over 6% in September.

More negative sub-prime headlines are almost certain to pop up over the next few months; the market’s reactions to these will probably not be as severe as they have been over the past few months. For example, Citigroup reported on October 1^st that third-quarter profits fell about 60% year-over-year because of sub-prime related issues; during the conference call, CEO Charles Prince said that the company will “return to a normal earnings environment” in the current quarter. Similarly, Samuel Molinaro, CFO of Bear Stearns, stated on September 20^th that “the worst is definitely behind us” after the Wall Street firm reported its biggest profit decline in more than a decade.

The Federal Reserve Board’s recent rate cut - from 5.25% to 4.75% on the federal funds rate - provided an exogenous shock that seemed to brighten market prospects. What is unclear yet is whether the Fed will continue to assume an accommodative posture or whether this cut represents a one-time incident. There is certainly ample historical data to support that the stock market will perform well if the Fed continues to cut rates. The table below details S&P 500 performance following the past eight Fed rate cutting cycles:

Period of Fed Easing	Total Rate Cut	S&P Return, Next 12 Mo.
Sep ’84 – Dec ‘84	3.31%	9.6%
Mar ’85 – Jul ‘85	0.75%	32.2%
Dec ’85 – Aug ‘86	2.12%	14.6%
Oct ’87 – Feb ‘88	0.81%	10.8%
Jun ’89 – Sep ‘92	6.81%	12.6%
Jul ’95 – Jan ‘96	0.75%	13.9%
Sep ’98 – Nov ‘98	0.75%	26.1%
Jan ’01 – Nov ‘02	5.25%	-17.3%

Source: Federal Reserve, UBS U.S. Equity St

We expect the U.S. economy to narrowly avoid a recession and that further Fed rate cuts will continue to provide a boost to the market. Fed fund futures contracts are currently pricing in more cuts before the end of 2007. In fact, in its most recent monetary policy statement, the Fed states that tightness in the credit markets may “intensify the housing correction” and “restrain economic growth”, suggesting that further cuts may be necessary to preclude a recession. Lower interest rates translate into cheaper money, which will allow corporations to pursue expansion and consumers to spend more freely. Both of these outcomes would be positive for the stock market.

During recessionary times, the performance of the S&P 500 has historically been mixed following Fed rate cuts. The key to a successful end to 2007 and a strong beginning to 2008 will be whether the Fed can keep the United States economy out of a recession. While we do not anticipate the economy to slog its way into a full-fledged recession, at RiverPoint we have taken a proactive stance throughout the year by trimming our clients’ exposure to equities and lowering risk in their portfolios by diversifying into assets that have a low correlation to domestic stock performance.

Through the first three quarters of 2007, the global economy has continued to grow at a robust pace even while financial market turmoil and the fading housing market have slowed growth in the U.S. Sectors that stand to benefit most from such strong growth have turned in the best performances to date: broadly spanning sectors such as Energy, Technology and Industrials have all outperformed more domestically-focused sectors. Financials and Consumer Discretionary have been the sectors most punished by the troubles at home, as these are the sectors most exposed to the deteriorating U.S. housing market and troubled credit markets. At RiverPoint, we have positioned portfolios to take advantage of these shifts in investor tastes by lightening allocations to the Energy and Materials sectors, while adding stocks in the Financials and Technology sectors based on their attractive valuations and strong prospects going forward.

These trends have also affected the relative appeal of large capitalization stocks vis-à-vis their smaller-cap rivals. For the last five quarters, large caps have grown earnings at a faster clip than small caps, but small caps posted better returns due to merger and acquisition activity and a greater appetite for risk in the market. As a result of the recent credit market slowdown, M&A activity has slowed and investors have become more risk averse. This has led to more stable globally-oriented large-cap stocks outperforming their smaller counterparts. In addition, and for the first time in four or five years, investors are beginning to favor growth oriented stocks versus their value-oriented brethren. It appears that investors have finally recovered from the tech bubble hangover and are beginning to realize that many of these once shunned tech firms have strong prospects. We have positioned our clients’ portfolios to take advantage of these shifts to large cap stocks and growth oriented stocks by concentrating on those sectors and high quality individual stocks with reasonable valuations that we believe will perform well into the coming year.

Market Summary	09/30/07	YTD Price Change
Dow Jones Industrial Average	13,896	11.5%
Nasdaq Composite	2,702	11.8%
Standard & Poor’s 500 Index	1,527	7.6%

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