Winter 2013

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the argument lost its leverage by the recent negotiations. It was clear that taxes were the main focus of the recent gridlock. We believe that spending will have to be the main focus of the next round of negotiations. This probably means meaningful spending cuts in governmental and entitlement programs. Although we agree spending cuts are essential to the long-term viability of the U.S., there will be short-term economic consequences. However, as we have believed that uncertainty has been one of the biggest impediments to economic growth, we believe that the U.S. market place can deal with whatever changes may come as long as the companies and individuals have certainty and can plan for it. This includes higher taxes and smaller government.

Market Outlook:

Below are a few bullet points from our outlook heading into 2013. Overall, they have not changed much from the last newsletter, but we have added a few additional comments.

  • Ben Bernanke will continue to backstop the equity markets. The printing of easy money will continue, but it will be less effective than previous attempts at stimulating the economy. Just last week, it was noted in the notes of the last Federal Reserve Board meeting that several members are worried about keeping interest rates too low for too long. We believe the expectations of inflation could drive asset class performance in 2013 even more than if inflation actually occurs.
  • U.S. GDP will continue to stall around 2% into 2013 which means unemployment will not drop significantly. When the job market begins to gain steam, we would actually look for an increase in the unemployment rate as prospective employees reenter the market. The main driver of the decreasing rate in 2012 was participants in the job market who stopped looking for a job, and therefore no longer counted as unemployed. So if the unemployment rate goes back in 2013, it could be good news if it’s because more people are looking for a job.
  • Bernanke stated he plans to keep interest rates low through 2015. Negative real returns for investors should bode well for hard assets such as precious metals and real estate.
  • Currencies will play a bigger role as the Fed wants to weaken the dollar, but the crisis in Europe could maintain the Dollar as a safe haven investment. A strong dollar will also have negative effects on U.S. companies because it will lower reported revenues from foreign countries.
  • Housing has bottomed in many areas which will be a positive for the economy. The housing sector has also seen many improvements over the last six months. We expect a saucer recovery in most areas, but some areas that currently only have 1 or 2 month supply will recover much quicker. We believe housing could be the biggest story of 2013 if it continues to improve as it could positively affect the unemployment rate, increase consumer spending, and increase sentiment as fewer homes would be underwater.

Investment Outlook and Strategy:

Using the above as our backdrop, below are a few thoughts on different asset classes that affect our current allocation strategies. In the current environment there are significant headwinds as well as potential catalysts we feel could improve the economy if Congress would act responsibly. We continue to maintain a diversified investment strategy that attempts to protect portfolios against the known and unknown risks facing investors.

Bonds - As we noted in the last newsletter, the upside of bonds has decreased substantially in the last year (how much lower can rates go, right?). However, we still believe in most regards that it’s useless to fight the Fed. In this environment, we also see advantages of using managers which have the ability to go where the opportunities are. In many portfolios we have moved to a multi-sector bond fund which offers more of the flexibility the current environment demands, rather than a core bond fund. Specific to California, in 2012 investors felt the risk of owning State of California bonds has diminished. Len Templeton, one of our bond managers, believes, “…this trend is likely to continue this year. We like to buy good local school district G.O. bonds, essential service revenue bonds, sales tax revenue bonds, and some good quality hospital bonds for our California clients.We avoid most city bonds and

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Disclosures: This commentary is submitted for the general information of Cornerstone Wealth Management, LLC clients and may not be distributed to other individuals. This commentary is not deemed to be investment advice and information contained herein may not be current. An investor should consider the investment objectives, risks, charges, and expenses of each investment carefully before investing. For more complete information, you may contact us at 858-676-1000. Past performance is no guarantee of future results. Individual performance may vary and investment performance numbers may not be audited.