Review & Outlook

Winter 2012

Investor's Update
Amid faster economic growth, the roller coaster ride of 2011 finished with a renewed increase in risk taking. A possible U.S. recession, which became a concern for investors during the European debt crisis, has subsided for the moment. Pent-up consumer demand, improved business confidence and an infusion of capital into the European banking system appears to have reduced investor concerns about a global financial crisis. The most beaten down sectors attracted the most momentum with the Financial and Energy sectors advancing the most. Most major averages advanced 10% or more during the quarter.

On a total return basis, the Dow Jones Industrial Average recorded a positive 8.4% in 2011, while the S&P 500 advanced 2.1% and the technology heavy, lower dividend paying NASDAQ lagged with a decrease of 0.8%. The bulk of these returns came during the fourth quarter as the DJIA, S&P 500 and NASDAQ bounced 12.8%, 11.8% and 8.2%, respectively. Smaller capitalization stocks outpaced their larger brethren with the Russell 2000 index up 15.5% during the quarter, but lagged for the full year with a -4.2% return. Global central bank tightening policies from earlier in the year led to a decline in most industrial commodities, however, gold extended its impressive run with an eleventh straight annual gain, advancing 10.2%. Geopolitical concerns and Middle East fears of supply disruptions helped crude oil advance 25.7% during the quarter resulting in an 8.3% advance for the year. Luckily, prices at the pump are nowhere near the record highs consumers were witnessing last December.

Even after an impressive run earlier in the year, fixed income investors were able to eke out positive returns with the Barclays Capital Aggregate Bond Index and Barclays Capital Intermediate Government/Credit Bond Index advancing 1.1% and 0.8%, respectively during the final quarter. Yearly returns were impressive, especially in longer issues such as the 30-year Citigroup Treasury Benchmark Index which advanced 35.5%. Refinancing concerns on county and municipal levels proved to be overblown as the Barclays Capital Municipal Bond Index gained 2.4% during the quarter, finishing with a 10.7% gain for the year. Again, deficit concerns and the ability to cover lopsided balance sheets in the public fund arena could be a concern in the future. Research during the selection process and ongoing due diligence are paramount in today’s fixed income world.

Last year was filled with many concerns including possible Eurozone credit defaults, a popping Chinese property bubble, dictatorship overhauls in unsafe regions, gridlock in Washington, continued structural unemployment concerns across the states and increased volatility in capital markets. After all of these concerns and wide gyrations in equities (the S&P 500 had a range from low to high of 27%), equity markets actually ended the year with minimal movement. Quality outpaced junk by 12% and mega cap stocks, which have been suffering through a 12 year consolidation phase, bested small caps by nearly 540 basis points. Within the S&P 500, 246 stocks ended the year down while 254 ended with positive returns, further showcasing a truly flat market.

Economic Outlook
The Federal Reserve and private sector have been legitimately effective in assisting particular aspects of the economy. Balance sheets have been repaired with free cash flow increasing, debt levels have been reduced, interest rates have remained near all-time lows and many corporations have returned to record profitability. Emerging markets continue to unwind the restrictive monetary policies of the past eighteen months in an effort to restart their growth engines as inflation concerns subside. Employment data has also turned the corner with job growth finally nearing the 200,000 jobs per month level that is needed to assist the beaten down middle class. While these are lower paying jobs, they are a necessary ingredient to GDP growth going forward. Inflation is expected to ease back to the 2% level after a likely 3.3% rise in 2011.

The recent European progress on fiscal policies should reduce the notion of another credit disaster. Their slow response to the ongoing issues was not encouraging. However, the short-term funding decisions are promising. Holding the bullish case back include the continued housing weakness, expected austerity measures by Europe and the U.S., possible interest rate increases that could lead to refinancing troubles and contagion from a recession in Europe.

Capital Market Analysis
The resulting conclusion is that volatility is here to stay but growth will remain positive within the U.S. economy, albeit at a slower pace than typical recoveries. A globally coordinated central bank accommodative position goes a long way in fixing the credit issues across the developed nations. Aided by inventory restocking, we believe the economy grew by 3.0% - 3.5% in the fourth quarter of 2011. The scenario described above should be able to deliver 1.5% to 2.0% in growth in 2012. Any hiccup in the economy is expected to be followed by a response from the Federal Reserve, leading to more monetary stimulus or, simply put, QE3. Although the macro conditions remain positive, a lot of the good news may have been priced in during the fourth quarter with these generous gains.

Slowing emerging market growth became prevalent during 2011 and is expected to continue into 2012. China and some of the high flying growth stories of the past several years need time to digest and their fast paced gains are hard to duplicate. This has certainly been a major ingredient for the decline in industrial commodity prices and, although their central banks are leaning more towards growth, they have to be careful to not let inflation seep back into their economies. A cautious global economic position seems paramount to preserving investable assets.

We continue to believe interest rates may be at or near generational lows. Assuming there are no unforeseen geopolitical events or major European credit defaults, fixed income investors would be prudent to increase quality and decrease maturity length. Collecting coupons may be the only compensation. The ballooning balance sheet of the U.S. cannot go on forever

Summary
We have preserved Investors should be rewarded by focusing on dividends, globally diversified franchises, high quality balance sheet companies and reducing risk when the market advances. We will continue to position the portfolios to take advantage of long-term growth opportunities that benefit from the ongoing global rebalancing. 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.