Market Perspectives - January 2015

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Overview: As we reflect on 2014 and the themes about which we’ve written,we wanted to review our monthly commentary and provide an update. Someof our core themes have played out as we expected, while others appear tostill be in the early stages.

ONWARDS & IN 2014…MOSTLY UPWARDS

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Small Cap Valuations

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• Over the past year, we have repeatedly discussed our concerns about the extreme valuations seen in the small-cap domestic equity universe.

• The performance disparity began to take shape in 2014 with the Russell 2000 small-cap index underperforming the S&P 500 by roughly 8 percent.

• In our view, the valuation disparity still appears excessive.

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High Yield

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• In May, we wrote about concerns regarding high yield credit spreads. We did not feel investors were being appropriately compensated for risk levels.

• Since then, spreads have widened, in large part due to oil price declines and fears over potential energy sector liquidity, as well as profitability concerns with the lower commodity price.

• The decline has yielded almost 2 percent of spread widening since we wrote about this asset class.

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Corporate Earnings & Profit Margins

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• Several times during the year, we discussed profit margins in conjunction with improving labor markets (which could ultimately pressure margins with wage inflation).

• We also discussed the need to see economic demand pick up if earnings growth were to hold up.

• For now, both look to be steady as low energy prices appear to be benefiting the consumer and companies which consume oil.

• We will be watching to determine if this trend is sustainable.

• The expectations for earnings growth over the coming quarters appears reasonable, although we expect earnings growth could become more volatile in 2015.

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Interest Rate Environment

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• In July, we discussed how several tailwinds supporting low interest rates would become headwinds over time. This process is still in the early stages.

• In January, we discussed our preference for alternative strategies offering volatility controls while still providing investors with the potential for a positive outcome. We currently see an inevitable rising interest rate environment, albeit potentially further down the road than some have expected.

• We continue to believe the 30 year bull market in bonds is entering the final phases.

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Other Notable Commentary

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• In February, we discussed Emerging Markets and expressed caution, despite seemingly inexpensive valuations due to concerns about capital flows (amongst other reasons). The MSCI Emerging Markets ETF was down approximately 4% in 2014.

• In August, we gave an update on the Labor Markets. We have seen dramatic improvements and the question now on many investors’ minds is when we will see the development of wage inflation. This will ultimately be the likely lever that moves the Fed to start raising rates. We are seeing some initial signs that this process of rising wage inflation may be beginning, but it is very early and we will be closely monitoring the next few data points.

• In October, we reviewed the dynamic of narrow market leadership. The trend was quite pronounced this year with mega-cap stocks in the S&P accounting for a significant amount of 2014 performance. This trend has continued, and the main large-cap indices have not given a true picture of the difficulties and challenges which faced global investors in 2014.

• November’s commentary reviewed the official end of Quantitative Easing and the impact on currency exchange rates across the globe. We continue to see strong moves (especially dollar strength) as our Fed pulls back, while other central banks enter (or continue) the efforts of adding liquidity to the system.

• Finally, in December we discussed the various impacts on oil price movements. We have previously discussed our concerns regarding oil prices given the rapid expansion of domestic supply due to new technologies. Accordingly, we have been underweight the energy sector.

Market Perspectives – January 2015

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Conclusion: As we leave 2014 to the history books, we acknowledge thatsome of our investment views are still in the process of playing out. That said,our underlying valuation discipline helped us avoid certain pitfalls. We expectthat these same disciplines will serve as a valuable guide in the year ahead.Finally, we will note that while 2014 may look like a strong performance yearat the mega-cap level, broader market performance is somewhat masked bythese indices as the global investing environment was challenging for many.We wish all of our clients and friends a very happy, healthy and prosperousNew Year.

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Opinions expressed in this commentary may change as conditions warrant and is for informational purposes only. Information contained herein is not intended to be personal investment advice for any specific person for any particular purpose. We utilize information sources believed to be reliable, but cannot guarantee the accuracy of those sources. Past performance is no guarantee of future performance; investing involves risk and may result in loss of capital. Consider seeking advice from a professional before implementing any investing strategy.

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Disclaimer

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