Review and Outlook

Fall 2014

Investor's Update

Closing Prices 09/30/2014
DJIA.................................................
17,042.90
S&P 500 INDEX.................................................
1972.29
US TREASURY BOND
Current Yield - 10 year bond.................................................
2.52%
Current Yield - 30 year bond.................................................
3.21%
Past performance is no guarantee of future results and investing involves risk, including the possible loss of principle.

Geopolitical tensions and slowing global growth reintroduced some volatility into the markets over the course of the third quarter. However, large cap U.S stocks continued their momentum with a further advancement of this aging bull market. In total, the S&P, with income, advanced 1.1%, while the DJIA and Nasdaq rose 1.9% and 2.2%, respectively during the quarter. Outside of large capitalization securities, the rest of the market ran into some difficult times. The Russell 2000, a small cap index, posted a loss of 7.4% during the quarter. This continued its trend from the start of the year. Technology led the way from a sector standpoint, advancing 4.8%. Energy was the worst performing sector as oil declined 13.2%.

A combination of the Russia/Ukraine conflict, Middle East unrest, an Argentina default and a multitude of disappointments with respect to GDP reports were too many headwinds for international investors. The Dow Jones Global (ex-U.S.) Index was down 5.1% for the quarter. Dispersion like this typically results in more turmoil ahead. Having only one strong economy is not enough in the intertwined global landscape we now operate in.

On the global front, declining growth and inflation reports have many Central Banks shifting to pro-growth initiatives, just as our Federal Reserve is finally exiting its Quantitative Easing program. Short-term rates are expected to be raised next year, although the timing of those increases is a guessing game at this point. Low rates internationally and rising rates in the U.S. created a wave of liquidity entering the domestic marketplace. The 2-year and 5-year Treasury gained 11 and 16 basis points to end at 0.58% and 1.78%, respectively. A stronger dollar may create more headwinds for our globally diversified corporate arena going forward. It should also keep a lid on energy and commodity prices, thus helping consumer wallets. This wave of inflows also helped push down longer-term interest rates even as our GDP reports came in quite strong, alleviating the first quarter, weather-induced decline. The 30-year Treasury yield fell 13 basis points to end at 3.21%. The Barclays Capital Intermediate Government / Credit Index was basically flat during the quarter. Municipal bond investors generally fared better than most with the Barclays Municipal Index up 1.5%.

Economic Outlook

A rosy economic scenario has unfolded for the Federal Reserve, and therefore investors. Inflation statistics, as Fed Chair Yellen predicted, have come down. Job growth has remained steady, albeit not overly robust. Wage inflation is helping consumers, but not at an accelerating pace that would crimp corporate profits. Long-term interest rates have stayed low as international pressures create minimal alternatives. Consumer and corporate balance sheets have been repaired since the debt induced recession. U.S. energy independence is coming. This will allow the Fed to be accommodative as long as possible and promote the pro-growth environment. A sudden rise in inflation, commodity prices or interest rates would change the picture. We do not envision this occurring anytime soon.

Global concerns are real. Geopolitical events can wreak havoc on global growth initiatives. Any surge in attacks that affect the flow of energy could put more of Europe back into a deeper recession. The European Central Bank lacks the political synergies amongst the European Nations to fully get their economies operating at maximum capacity. For instance, what is good for Germany may have the opposite effect for Italy. The winners this year have mainly come from the Large Cap sector, with an emphasis on companies that show diversified earnings streams, a catalyst for future revenue enhancements and higher free cash flow than their peers. However, many mid and small cap companies are already in bear markets. The easy money has been made. As index correlations continue their move lower, stock selection will become more paramount.

As noted, the weather induced first quarter decline in GDP proved to be an aberration. Second quarter GDP has been revised to a robust 4.6%. We expect a more normalized trend going forward, likely in the 2.5% - 3.0% range. If the “rosy economic scenario” discussed continues, there exists a possible upward revision. If the geopolitical concerns expand, we could see further, below trend reports.

Capital Market Analysis

Many market measures point to overvaluation, overbought and overly bullish conditions. When this is coupled with poor market breadth, lack of leadership and expanding credit spreads, more volatility typically ensues. In fact, nearly half of the Nasdaq stocks are already down 20%! However, that does not mean the market is necessarily headed for a crash. A pause that refreshes would be welcome news. Many stocks have gotten ahead of themselves, but still boast profit measures that should continue.

The other major concern many pundits are discussing is the timing of the Fed’s interest rate increases. Fed tightening does not mean disaster and an end to this bull market. For instance, since 1980, two years after the first Fed rate hike the stock market was higher 90% of the time. We do not envision the Fed raising rates in a less-than-stellar environment and will likely only occur in strong market conditions. Even with a new Chairperson, their mantra remains full employment and stable prices. Deflation is of primary concern at this juncture.

Summary

The market is finally starting to experience some volatility which should create new opportunities down the road. Mixed global economic conditions and lackluster participation in this recent advance leads to a cautious approach. We remain focused on high quality companies, which have clean balance sheets and stable dividends. A better buying opportunity could present itself over the coming weeks and months. 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 Municipal Bond Index
A broad-based, total return index. The index is comprised of 8,000 actual bonds. The bonds are all investment-grade, fixed-rate, long-term maturities (greater than two years) and are selected from issues larger than $50 million dated since January 1984. Bonds are added to the Index and weighted and updated monthly, with one-month lag.
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.

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