Review and Outlook

Spring 2014

Investor's Update

Closing Prices 03/31/2014
DJIA.................................................
16,457.66
S&P 500 INDEX.................................................
1,872.34
US TREASURY BOND
Current Yield - 10 year bond.................................................
2.73%
Current Yield - 30 year bond.................................................
3.56%
Past performance is no guarantee of future results and investing involves risk, including the possible loss of principle.

The first quarter finally yielded some volatility but ended on a high note as many major averages reached near record highs. After seeing returns over 25% for many equity indexes in 2013 while economic growth was anemic, one should expect a consolidation of these gains. The S&P 500 started the year off with a quick 6.1% drop from its peak but bounced back with an 8.4% rise from its lows. In total, the S&P with income advanced 1.8%, while the Nasdaq rose 0.8% and the DJIA actually declined 0.2%. Performance varied widely from sector to sector as Utilities led the way with a 9.9% return while the Consumer Discretionary sector performed the worst, declining 2.8%. Healthcare was also a strong performer, returning 5.8%.

Value typically outperformed growth and Mid-Caps outperformed their counterparts. The S&P Mid-Cap 400 advanced 3.0%, while the Russell 2000 posted a 1.1% total return. Participation and stock picking rose to the forefront as only 18% of stocks are above their twenty day moving averages even though many benchmarks are making new highs. A return to normalcy where reasonable valuations, high free cash flow, top-line growth and shareholder friendly management comes back to favor as opposed to the momentum driven market of sky-high valuations and IPO's with no earnings being rewarded would be a welcome sight. Gold rebounded 6.7% following its first down year since 2000. Most commodities posted generous advances, primarily tied to the food industry. Coffee, lean hogs, corn and wheat were up 60.7%, 47.5%, 19.0% and 15.2%, respectively. However, the economic sensitive copper and lumber were down 11.5% and 6.8%, respectively, for the quarter.

Fixed income investors were also a tale of two stories. As the Federal Reserve continues down the taper path, short-term rates are expected to continue their rise. Two-year Treasury rates bounced from a low of 29 basis points to close the quarter at 42 basis points; a rise of 45%! However, the ten year Treasury yield dropped from 3.0% to 2.7%. This flattening of the yield curve could wreak havoc on companies who have relied upon short-term rates to fund their operations. In total, the Barclays U.S Government Credit Intermediate Index returned 1.0% during the quarter as the Long-term Index advanced 6.5%. Municipal investors generally fared better than taxable bonds as the Barclays Muni Bond Index rose 3.3%.

Economic Outlook

A healthy consolidation of the generous gains over the past five years is constructive. Investors now have to weigh differing economic numbers and headline risk. Some of the froth in this market has been taken out as many of the favored momentum stocks are down over 20% in a short period. This has caused a rotation into safer areas with higher dividends and lower valuations. The bullish case is consistent. A tame gasoline price, even with geopolitical risk stemming from Russia and the ever unsteady Middle East, speaks volumes to our expanding ability to selfsupply oil and gas. Manufacturing is making a comeback on the home front due to lower input costs related to energy. Housing remains supportive with mortgage rates well below historic norms. Household net worth is on a steady ramp upwards. Corporate and consumer balance sheets continue to strengthen. Wages are finally perking up while job gains remain positive. Reduced political bickering on budget and debt ceiling issues, however short-term it may be, is always beneficial. Consumer sentiment is steadily improving as incomes rise and job prospects improve.

International markets are showing signs of less stress from inflationary pressures which will allow their central banks to focus on growth initiatives. Europe is slowly coming out of their recession, while Japan's new regime is on a similar money printing path that the U.S. was on a few years ago. Expansion is expected, how much is the question. Aside from the weather related slowdown this winter, all signs point to positive GDP growth with a possibility of 3+% later in the year. We are expecting sub-2.0% growth during the first quarter due to the short-term impact from weather across the country.

Capital Market Analysis

These are all great signs, but after a 170% advance in the past 5 years, how much good news is priced in? Since 2008, S&P earnings per share are up 118% but revenues per share are only up 7%. A large portion of the earnings gains are attributed to easy monetary policies and low financing rates. Corporations have been able to issue debt at low levels and buy back stock. Now that the Federal Reserve is on the path to tightening, the market must discount higher rates. That's a major concern, but not our only one. Corporate insiders are selling stocks at 25-year highs. Rising wages are great for employees, but are also the first major sign that inflation could be forthcoming. Rising healthcare costs and taxes could put a dent in the consumer's wallet and corporate profits. China and emerging markets are attempting to rebound but nothing is certain. Europe is barely growing at all and any unexpected event could flip them back to recession. Any further hiccup in their markets could eventually hit the U.S.

Valuations are reasonable with respect to growth prospects. Any consolidative period would be welcome news as healthy markets do not go up in straight lines. Corporate balance sheets are much improved. Companies raised their dividends during the first quarter at a record pace. Dividend payout ratios have historically averaged 52%, while we are currently at only 36%. The trend should continue, which will reward long-term investors. A correction could be a great buying opportunity.

Summary

We continue to participate in this market, booking profits along the way and collecting income. Paying strict attention to support levels and macro-economic conditions should allow us to preserve principal should any correction occur. Investors should be rewarded by focusing on dividends, franchises with broad economic moat, high quality balance sheets and reducing risk as the market advances. Increasing credit quality while emphasizing shorter maturities in the corporate bond market will remain our strategy for fixed income investors. Protecting principal in the short-term, while identifying positive, long-term stories over the coming months, should yield positive results.

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

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).
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.
S&P MidCap 400
Designed to measure the performance of 400 mid-sized companies in the U.S., reflecting this market segment's distinctive risk and return characteristics.
Barclays Capital Long Government/Credit Index
Measures the investment return of all medium and larger public issues of U.S. Treasury, agency, investment-grade corporate, and investment-grade international dollar-denominated bonds with maturities longer than 10 years. The average maturity is approximately 20 years.

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