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Third Quarter 2014 Financial Market Review

The U.S. economy solidified its dominance within the world’s developed economies as the primary engine for global growth in the third quarter. After a weather-induced slump in the first quarter of this year, the U.S. economic engine bounced back strongly with a 4.6% annualized growth rate in the second quarter. While some of the strength in the second quarter was a result of a snap-back from first quarter weakness, indications were that the U.S. economy shifted into stronger, above-trend growth during the third quarter and may be poised to finally move above the subdued 2.2% average growth rate it has been stuck in since the economic expansion began in 2009. During the third quarter measures of consumer confidence, industrial production, auto sales and new homes sales all posted multi-year highs and showed the greatest strength we have seen since the financial crisis. Furthermore, the labor market continues to improve, as the unemployment rate fell to a six-year low of 5.9% in September as the economy steadily added jobs.

With economic strength in the U.S. taking hold, the theme of de-synchronization of monetary policies around the globe took center stage. Investors grappled with the implications of the Federal Reserve ending its quantitative easing program in October and beginning to raise interest rates sometime next year. The markets struggled to understand the timing and magnitude of future rate hikes amidst mixed messages from a dovish Federal Reserve Chair Yellen and a more hawkish picture of future interest rates born out in the “dot projections” of FOMC members. This uncertainty translated into a notable uptick in market volatility during the third quarter after a prolonged period of unusual tranquility. Despite drawing closer to the end of quantitative easing, the 10-year U.S. Treasury yield actually fell during the quarter, as investors judged the relative attractiveness of this yield as still favorable in the global context. The U.S. dollar witnessed remarkable strength during the quarter, rising 7.67% against a basket of foreign currencies, a seemingly overdue correction given increased awareness of the likelihood of how divergent monetary policies are set to become.

In contrast to the improving U.S. economy and shift towards tightening of monetary policy, the Eurozone recovery has been faltering. During the third quarter, the ECB took material steps towards additional quantitative easing in addition to cutting its deposit rate below zero, a historic first for a major developed economy. Likewise for Japan, while “Abenomics” has been achieving some results, consumption tax hikes hit growth and consumer spending, and the central bank has been poised for “some time” to continue its aggressive monetary easing. Lastly, even China, in struggling to hit its targeted 7.5% GDP growth rate, has been taking targeted measures, including looser lending standards, to prop up its economy amid weakness--particularly in the real estate sector and a softening trend in manufacturing and investment.

The quarter was marked by many geopolitical events, most of which were already simmering or apparent during the first half of the year. Many investors moved back and forth from risk-on to risk-off as headlines grabbed their attention from places such as Syria, Gaza, Russia and Ukraine. Ultimately, the U.S. markets and the broad markets seemed to ride through the turbulence largely unaffected by such news. Investors should learn from these situations that it is wise to stay with their strategic investment program, predicated on appropriate diversification pursuant to their investment objectives, and not be influenced by media hype to make rash decisions and ad-hock changes to their asset allocations.

Against this economic backdrop, financial market returns for the third quarter ended relatively flat for both U.S. stocks and bonds, while U.S.- based investors witnessed significant losses in both international equities and real assets. The Russell 3000® Index, a broad measure of U.S. stock performance, returned just 0.01% for the quarter and the Barclays U.S. Aggregate Bond Index was up only 0.17%. The roughly flat results for U.S. equities masked, however, significant divergence in returns for various capitalizations, in particular large cap stocks which materially outperformed small cap stocks. While the S&P 500® Index, a broad measure of large-cap stock performance, rose 1.13% for the quarter bringing YTD gains to 8.34%, small cap stocks, as measured by the Russell 2000® Index, sold off 7.36% with YTD losses of 4.41%. The strengthening U.S. dollar hurt unhedged investments overseas, with the MSCI ACWI Ex-U.S. Index falling 5.27% in dollar terms for the quarter.

Meanwhile, real assets had dismal performance results for the quarter, suffering from a stronger U.S. dollar, falling inflation, a weakening China that could stifle demand and an overhang of expected surpluses relative to demand in various sectors of the commodity markets. The Bloomberg Commodity Index fell 11.83% for the quarter, with significant declines in the futures markets for energy, agricultural products and precious metals. Global Natural Resource equities, whose revenues are directly tied to the commodity markets, suffered similar double-digit declines. Lastly, declining inflation expectations also drove down prices for Treasury Inflation Protected Securities (TIPS), with this sector leading fixed income declines with a 2.04% loss for the quarter.

As we move into the fourth quarter and close out the year, we believe the fundamental underpinnings for continued economic growth in the U.S. remain in place. While markets expect the Fed to begin to transition from an easy to tighter monetary policy, continued low inflation is permitting them to take a gradual course so as to ensure the economic recovery is not derailed too early from its expansionary pace. Particularly in light of the uncertain geopolitical climate and economic woes in other parts of the world, the stronger economic picture in the U.S. should be welcome news for investors.

However, investors should bear in mind how far we have come. Since the equity market recovery began in March of 2009, the S&P 500® Index is up 192% and hovering near all-time highs reached in the third quarter. Stock markets appear pretty fully valued based on historical averages and interest rates are near historical lows. In part thanks to extraordinary monetary accommodation, risk premiums continued to compress further in many market segments and investors, still searching for yield, should be cautious and mindful of their risk tolerances. Investors can expect to see periods of higher volatility and need to have a more realistic picture of capital market returns in the coming years, which are expected to be subdued relative to recent experience and reflective of a slower world economic growth picture.

As investors face market uncertainties, we believe that global diversification across asset classes, a long investment time horizon and a consistent and robust savings plan are the best ways to build confidence and achieve your investment objectives.


You should carefully consider the investment objectives, risks, charges and expenses of GuideStone Funds before investing. For a copy of the prospectus with this and other information about the funds, please call 1-888-98-GUIDE (1-888-984-8433) or download a prospectus. You should read the prospectus carefully before investing.

S&P 500® is a trademark of The McGraw-Hill Companies and has been licensed for use by GuideStone Funds. The Equity Index Fund is not sponsored, endorsed, sold or promoted by Standard & Poor’s and Standard & Poor’s makes no representation regarding the advisability of purchasing the Equity Index Fund.

All indices are unmanaged and not available for direct investment. Index performance assumes no taxes, transaction costs, fees or expenses. This update is prepared for general information only and it is not to be reproduced.

GuideStone Capital Management, a controlled affiliate of GuideStone Financial Resources, serves as the investment adviser to GuideStone Funds.