Review and Outlook

Spring 2015

Investor's Update

Closing Prices 03/31/2015
S&P 500 INDEX.................................................
Current Yield - 10 year bond.................................................
Current Yield - 30 year bond.................................................
Past performance is no guarantee of future results and investing involves risk, including the possible loss of principle.

A consolidative, range-bound market resulted in minimal movement for the major U.S. equity indices. However, accommodative global central bank actions, coupled with the hint of higher short-term rates at home, resulted in another sizeable shift in currency markets. Many international indices responded with money flows accelerating to equity and fixed income markets. The strong dollar is wreaking havoc on globally diverse corporations as earnings translations to our home currency are likely to take a big bite out of reported earnings. For the quarter, The Russell 2000, whose smaller capitalization constituents have less international revenues, outpaced their larger brethren with the index advancing 4.3% compared to the S&P, including dividends, returning 1%. The DJIA and Nasdaq rose 0.3% and 3.9%, respectively, during the quarter. As noted, global markets led the way with China’s Shanghai Stock Exchange Composite realizing a sizeable gain of 16%. The consistent, albeit slow, expansion in the U.S. along with higher yielding sovereign bonds has led to a continued attraction of foreign capital as the U.S. Dollar Index rallied 9% during the quarter. This is now the third quarter in a row of 5%+ returns relative to a basket of currencies, with the Euro leading to the downside. This rare occurrence should lead to further disintermediation amongst those who have significant currency exposure and those who do not.

Digging deeper into sector performance, Healthcare and Consumer Cyclicals led the way with 6.6% and 4.8% returns. Utilities and Energy were laggards with losses of 5.2% and 2.9%, respectively. Growth stocks posted their largest quarterly gain relative to value stocks as investors reached for beta and shunned dividends. Oil prices slowed their descent but still dropped another 13.4% and are now off 54.24% from last year’s highs. The unemployment rate improved significantly over the past year, moving from 6.7% to 5.5% as of February. Gold ended essentially unchanged at $1,183.l0 but had a $153 trading range throughout the quarter.

With the Federal Reserve ending its Quantitative Easing program last year and recently altering their projections to lower growth for longer, investors are now left playing a guessing game as to when rate hikes will begin. More importantly, the trajectory and speed of those rate hikes will determine how equity and fixed income markets perform over the coming quarters. Incoming data is already showing signs of a slowing U.S. economy. The aforementioned currency effects are taking a bite out of our export market and keeping a lid on inflation statistics, even after taking out the sudden drop in energy prices. As was the case last year, most economists have called for higher long-term rates prior to the start of the year. The 10-year Treasury yield has, yet again, proved fickle as yields dropped from 2.17% to 1.92% over the past three months. Most fixed income benchmarks provided positive returns as the Barclays Capital Intermediate Government/Credit Index and the Barclays Capital Intermediate Aggregate Index gained 1.5% and 1.6%, respectively.

Economic Outlook

Industrial production, durable goods and a multitude of economic reports are showing an abrupt slowdown in our current export market. We have now seen core orders decline for six straight months after February’s report. Exports were a major source of growth coming out of the recession, but the strong rebound in the dollar has resulted in our goods becoming too expensive on an international scale. This should take a bite out of expected GDP estimates.

In January of this year, analysts on average expected profits in the first quarter to increase by a modest 3.6%. With the huge spike in the U.S. dollar and lower energy prices, estimates are now calling for a 5.3% decline in profits. This nearly 9% reduction is the largest quarterly drop in 5 years. It will be tough to see the overall market continuing to post considerable gains if final reported earnings show a decline this year. International growth will have to markedly perk up in order to see profit expansion in the near future

The final update to the 2014 GDP report showed a modest 2.4% advancement. We expect a more normalized trend going forward, likely in the 2.5% - 3.0% range with an upward bias if the currency market begins to normalize. However, first quarter GDP should come in under this range as the impact of softer earnings, slowing wage growth, an increased saving’s rate, West Coast port issues, historically bad weather for a large portion of the East Coast and a lagging export market take the rate closer to 1%, with risk to the downside. Interest rates should remain range bound, with a slight bias towards the lower end if oil prices continue to keep inflation metrics depressed in the near-term and earnings come in line with the currently reduced estimates.

Capital Market Analysis

On the International side, the London FTSE 100 posted a new all-time high during the quarter. The Frankfurt DAX also made new all-time highs after their recent 41% advance. Japan’s Nikkei is breaking out of a 15 year base while numerous other developed nations' equity indices are showing signs of strength. Global interest rates remain extremely competitive as Germany, Japan, Italy, and United Kingdom 10 year yields are at 0.18%, 0.40%, 1.28% and 1.58%, respectively, while the U.S. comparable closed at 1.92%. Several European five-year sovereign debt rates are actually negative! This should keep yields tame locally and may even cause a further drop in the trading range. It’s hard to argue against owning equities when the largest stock markets in the world are all breaking out together and the alternatives are underwhelming.

Fed Fund futures market is now pricing an initial rate hike late in the second half of this year, but the timing could certainly be altered. More important for investors is the pace, frequency and size of those rates hikes, not the absolute timing. It is clear the Federal Reserve would like to normalize policy; however it is unlikely they will do this in the face of slowing wages, tame inflation and sub-par growth. These areas will have to show improvement over the coming months for the “data dependent” Fed to start raising short-term rates. Winning sectors and companies are quite different in these scenarios. Rising long-term rates would be a boon to banks’ net interest margins, while lower rates would continue to keep capital cheap, therefore benefitting consumers and corporations dependent upon debt issuance.


We have executed some minor pruning of the portfolio as we transition to an eventual attempt at normalizing interest rates could take longer than expected. The substantial moves in currency markets are throwing a wrench into economic data and have resulted in a hesitant Federal Reserve. Global economic conditions are slowly improving and need to continue if we are to collectively benefit. A focus on global macroeconomic conditions should allow us to book profits in a more volatile investment environment. We remain focused on high quality companies, which have clean balance sheets and stable dividends. Stock selection will remain paramount. Fixed income investors will continue to benefit from exposure to high quality securities with a neutral duration.

We appreciate your confidence and business. Please do not hesitate to call us if you have any questions or if we can be of assistance.

Barclays Capital Intermediate Government/Credit Index:
An unmanaged index based on all publicly issued intermediate government and corporate debt securities with maturities of 1-10 years. This index represents asset types which are subject to risk, including loss of principal.
Barclays Capital Intermediate Aggregate Index:
An unmanaged index that consists of 1-10 year Governments, 1-10 year Corporates, all Mortgages, and all Asset-Backed securities within the Aggregate Index (i.e. the Aggregate Index less the Long Government/Corporate Index).
Dow Jones Industrial Average:
The most widely used indicator of the overall condition of the stock market, a price-weighted average of 30 actively traded blue chip stocks, primarily industrials
NASDAQ Composite Index:
Measures all NASDAQ domestic and international based common type stocks listed on The Nasdaq Stock Market. The NASDAQ Composite is calculated under a market capitalization weighted methodology index.
Standard and Poor's 500 Index:
Capitalization-weighted index of 500 stocks, including the reinvestment of dividends and other distributions, designed to measure performance of the broad domestic economy through changes in the aggregate market value of 500 stocks representing all major industries.
London FTSE 100:
The FTSE 100 is a market-capitalisation weighted index of UK-listed blue chip companies. The index is part of the FTSE UK Series and is designed to measure the performance of the 100 largest companies traded on the London Stock Exchange that pass screening for size and liquidity. FTSE 100 constituents are all traded on the London Stock Exchange’s SETS trading system.
Frankfurt DAX:
The DAX® Index tracks the segment of the largest and most important companies – known as blue chips – on the German equities market. It contains the shares of the 30 largest and most liquid companies admitted to the FWB® Frankfurt Stock Exchange in the Prime Standard segment. The DAX® represents about 80% of the aggregated prime standard’s market cap. The DAX® is primarily calculated as a performance index. It is one of the few major country indices that also takes dividend yield into account, thus fully reflecting the actual performance of an investment in the index portfolio.
The Nikkei 225 is comprised of 225 stocks selected from domestic common stocks in the 1st section of the Tokyo Stock Exchange, excluding ETFs, REITs, preferred equity contribution securities, tracking stocks (on subsidiary dividend) etc other than common stocks. Shanghai Stock Exchange Composite: Constituents for SSE Composite Index are all listed stocks (A shares and B shares) at Shanghai Stock Exchange. The index was launched on July 15, 1991.
Russell 2000®:
The Russell 2000® Index measures the performance of the small-cap segment of the U.S. equity universe. The Russell 2000 Index is a subset of the Russell 3000® Index representing approximately 10% of the total market capitalization of that index. It includes approximately 2000 of the smallest securities based on a combination of their market cap and current index membership. The Russell 2000® is constructed to provide a comprehensive and unbiased small-cap barometer and is completely reconstituted annually to ensure larger stocks do not distort the performance and characteristics of the true small-cap opportunity set.

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