Commentary

Equity Market Overview

Jagged movements in the stock market during the second quarter revealed a confused market and nervous investors. The release of higher-than-expected core inflation data in April followed by suggestions from Federal Reserve Chairman Ben Bernanke that interest rate hikes may continue kept investors scrambling through the end of the second quarter. For the quarter, broad equity performance, as measured by the S&P 500 Index¹, was down 1.44%. The markets are testing the new Fed Chairman's resolve and trying to determine what this powerful man's guiding principles will be.

There has been a seesaw pattern in the stock market during the first and second quarter. The first quarter suggested the continuation of the mid-cycle growth economy, and our portfolios performed consistent with that view. However, the seesaw went the other way during the second quarter as the Fed comments seemed to cause the market to question growth's prospects and lean towards the likelihood of recession. The seesaw seems to be shifting nearly on a daily basis as the market struggles for direction.

Despite the recent downturn in the markets, we believe the economic backdrop remains positive. First-quarter earning reports were stronger than forecasted. President Bush signed a tax bill extending lower rates on dividends and capital gains through 2010, a move that favors capital formation and access while lowering capital costs. Corporate cash flows and balance sheets are at the best levels we've seen in a generation. GDP growth remains above average while unemployment is below average. The market trades at about 15 times earnings—so is reasonably valued—while interest rates are still relatively low. All these factors are positive for the equity markets. In our opinion, a small uptick in inflation should not derail the economy.

Within the Calamos portfolios, we have positioned our strategies to benefit from the long-term economic and business investment themes that we feel will drive global market opportunities well into the future. The recent market volatility only serves to reduce leverage or shake out the weaker-stomached investors; it has no impact on longer-term investment opportunities. Our portfolio construction continues to focus on opportunities that are aligned with investment themes such as:

• the surging global need to outsource or significantly enhance productivity
• global connectivity
• global media and entertainment
• supply-side business models
• global demographic and wealth shifts
• energy and commodity dislocations
• the global march towards democracy and global trade

Because the market is questioning growth in global markets, our portfolios declined more than the general market for the quarter. While our growth-oriented stance was beneficial to performance during the first quarter, our weighting in growth securities did hurt us in the second quarter as a "flight to quality" drove investors to securities with more defensive characteristics. As a result, in the broad market, large-cap outperformed small- and mid-cap, value beat growth and developed markets came out ahead of emerging markets.

Nonetheless, we are confident in the positioning of our equity holdings. We remain positioned for an economy in the mid-phase of the economic cycle. Valuations of growth-oriented companies are compelling as earnings continue to be strong and global economies are on a solid footing. In our opinion, this phase has the potential to produce a double positive: increasing earnings can lead to higher stock prices and some PE expansion, which could increase stock prices even further.

We believe a halt to the Fed's interest rate hikes will serve as a catalyst for positive stock market action. Our strategy has always been to position the portfolio before an event rather than to wait for an event and chase after it. Since we know it is impossible to time the upside breakout, we will maintain our positioning, letting the current volatility run its course. Our outlook remains positive and we believe our patience during this difficult period will benefit us in the long term.