May 2008 Investment Performance

US equities regained some ground in May, led by a 4.6% rise in small cap stocks (Russell 2000) and a 1.8% rise in large cap stocks (Russell 1000). Energy, materials and technology stocks led performance across the capitalization spectrum. The continued commodities boom contributed to a rally of over 16% in small cap energy stocks in May. This rally, coupled with a 7% rebound in small cap tech stocks, resulted in a 5.7% rise in the small cap growth index (Russell 2000 Growth).

In May, large cap financial stocks (down 4.5%) held back the Russell 1000, while small cap financials declined less than 1%. Year to date, large cap financials have declined 11.9%, which is the primary reason that the Russell 1000 is down 3.2% while the Russell 2000 is down only 1.8%. These declines have also contributed to the continued weakness of large cap value compared to growth.

With 99% of the large cap stocks having reported first quarter results, the S&P 500 saw a 17.5% earnings decline in the first three months of 2008. This is the third consecutive decline in earnings, which has not occurred since the end of the last bear market in 2002. Financials experienced an 80% decline in earnings in the first quarter from $59.6 billion to $12.2 billion in the first quarter 2007. Ex-financials, the S&P would have had 7% earnings growth. Consumer discretionary earnings declined 23%, primarily impacted by losses in homebuilding stocks.

All eyes will soon be on second quarter earnings, which are now expected to decline by 7.3% (They were expected to drop only 2% at the beginning of April), again impacted by an expected 44% decline in financial sector earnings. In this environment, it is extremely difficult to tell whether this is going to be anywhere close to accurate. The same can be said of the expected sharp rise in second half earnings.

According to Thomson Financial, the forward P/E for the S&P 500 is 14.1x (seemingly reasonable), yet the poor track record of Wall Street analysts makes this figure of questionable use at this juncture. The more conservative trailing P/E of 17.1x may be more useful for those using this as a general gauge for market valuation. This is not exceedingly “cheap”, so the timing of earnings rebound will be the ultimate driver of market recovery.

International developed markets gained once again, despite the horrific human tolls caused by Cyclone Nargis inMyanmar and a massive earthquake in China. The MSCI EAFE index gained 1.2%, and the MSCI Emerging Markets added 1.9% in May. Small caps outperformed their larger counterparts with the S&P Citigroup EMI ex-US index rising 2.5% during the month. Within EAFE the best performing sectors were again energy and materials, which gained 5.8% and 4.5%, respectively. The financials sector lagged, losing 3.9% during May.

Kanaly Trust Investment Performance

Kanaly’s actively managed investment models posted solid performance in May and continue to significantly outperform the broader equity markets in 2008.  Holdings in energy, technology, health care and consumer staples provided the largest contribution to performance, while financial and consumer discretionary stocks detracted from returns.  The introduction of alternative investment strategies has helped to preserve capital during this time of market volatility.

While we are encouraged by the performance of global equity markets in May, investors should remain cognizant of several headwinds for global equities, including higher energy and food prices, slowing housing markets and the yet unfinished cleansing of bank and financial firms’ balance sheets. We believe that volatility and increased divergence between countries and sectors will continue.

Disclosures

This material represents an assessment of the market environment at a specific point in time and is not intended to be a forecast of future events, or a guarantee of future results. This information should not be relied upon by the reader as research or investment advice regarding the Funds or any stock in particular, nor should it be construed as a recommendation to purchase or sell a security, including futures contracts.

There are risks involved with investing, including loss of principal. Current and future portfolio holdings are subject to risks as well. International investments may involve risk of capital loss from unfavorable fluctuation in currency values, from differences in generally accepted accounting principles or from economic or political instability in other nations. Narrowly focused investments and smaller companies typically exhibit higher volatility. Bonds and bond funds will decrease in value as interest rates rise. High-yield bonds involve greater risks of default or downgrade and are more volatile than investment-grade securities, due to the speculative nature of their investments. Emerging markets involve heightened risks related to the same factors as well as increased volatility and lower trading volume.

Diversification may not protect against market risk. There is no assurance the objectives discussed will be met. Past performance does not guarantee future results Index returns are for illustrative purposes only and do not represent actual portfolio performance. Index returns do not reflect any management fees, transaction costs or expenses. One cannot invest directly in an index.