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Quarterly Commentary – December 2014

During the last quarter of 2014, US equities went into all-time high territory. The S&P 500 Index had a fairly steady run up until mid-September when it took a nosedive of about 7.5%. In October, it recovered nicely and reached new highs toward the end of the month. It then dropped about 5% in December and recovered again to reach new highs in late December, bringing back some degree of volatility that we had not seen in a while. The S&P 500 reflected an increase of 13.7% for 2014. The Dow Jones Industrial Average was up 10.0% for the year. Small company stocks represented by the Russell 2000 Index, after going nowhere for a year, finally broke new highs but only closed up 4.9% for the year. International equities as represented by the MSCI World Ex U.S. Index were down -6.8% which created a drag on any properly diversified portfolios in 2014. Fixed Income as represented by the Barclays Aggregate Bond Index closed at 6% for the year.

In 2014 we saw fairly robust growth in global corporate profits which provided support for nice returns on US Equities. The Fed’s stance toward more paced and measured future interest rate moves was also a big positive. GDP numbers came significantly stronger than expected, with third quarter growth coming in at an annualized 5% rate relative to an expected 4.3% and a prior quarter reading of 3.9%. The US Economy has experienced an annualized growth exceeding 3.5% in the past four quarters which had not happened since 1999. What is interesting about this is the timing. This kind of growth usually tends to happen earlier in the recovery cycle and it is unusual to see it pick up this kind of steam at this later stage. A surge in consumption was a major contributor as well as business fixed investment which was revised up. This was despite a sluggish contribution from housing. If housing were back to par, we probably would have added another percentage of growth to GDP.

A few surprises this past year included strong US Government Bond performance with rates continuing to drop on the long end just as everyone thought they could not get any lower. Certainly, the big surprise this past quarter was the continued plunge in oil which had begun in late June after more than three years of relatively stable prices in the $100/barrel range. It is about supply and demand. The North America’s energy boom has increased supply, which added to the strong production in the Middle East and North Africa combined with reduced demand from slowing economies around the globe, particularly China and much of Europe and the bottom pretty much fell out by about 50% from the recent high. The positives will be the benefit to the consumers as it will provide higher disposable household income and lower industry input costs for all sorts of goods as well as help contribute to lower inflation. The potential negatives will be the impact on energy producers which make up a significant portion of the economy and the market index, potentially bringing down S&P 500 earnings. Failure for supply and demand factors to stabilize could have the geopolitical consequences of increasing tensions with countries that are highly dependent on energy exports.

Although this will vary from sector to sector, overall the US equity market appears fairly valued with corporate earnings having kept pace with equity returns. Given the recent run-up however, one should remain cautious. We may have pulled some of 2015’s growth into 2014. The continued growth in the US Economy, inflation, interest rates, Fed activity and Geopolitical concerns will remain part of the landscape as we look to 2015. Barring any major surprises, we remain optimistic with the equity market going into the New Year.

Thank you for the opportunity to serve you. We wish you a happy, healthy and prosperous New Year.