Winter 2013

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pension bonds, because we are concerned about credits with exposure to unfunded pension liabilities.”

High-yield Bonds - This asset class continued to be an outperformer in 2012, up almost 16%. As companies have piles of cash sitting on their balance sheets, default risk remains low. This asset class has seen an increase in inflows, but continues to perform well. Yields on many income-producing investments including utilities, high-yield bonds, MLPs and REITs have decreased as values have soared from investor demand. We see high-yield bonds as a good diversifier to stocks in the current environment. If a client wants to take on more risk, but remain out of the stock market, we still believe high-yield remains a good area. We also believe this is a great opportunity in the private market. Last year we started working with Keystone, whose strategy is to replace banks that are no longer willing to lend. With opportunities of strong cash flow backed by great collateral, we feel there is a great risk/reward investment.

High-yield Bonds - Managed and active funds lagged in 2012 as “risk on” and “risk off” days made managers cautious. As we look to 2013, we believe the first quarter could be sideways or have a small correction if corporate earnings fail to impress or if gridlock consumes Washington. We are more optimistic for the second half of the year. We hope that Congress will provide more certainty which will allow businesses to plan and invest for the future. However, any corrections in the first half of the year may be an opportunity to buy in for a long-term investment horizon. The stock market is not expensive in historic context, and with emerging markets playing a larger role, growth potential is there although there are headwinds. We believe that emerging markets may be an area of opportunity for 2013 as developing countries continue to have better fiscal policies. Emerging markets should also benefit from a more stable Europe and U.S. As well, if bonds become less desirable due to rates inching up, stocks should benefit from money moving away from bonds.

Real Estate - The multi-family housing sector saw a lot of investor money come in to acquire assets in 2012. This bodes well for us, as many clients have invested with Virtu over the last two years in the space. Virtu was able to sell one property this summer, is selling one in January, and we hope that the continued recovery in this space will allow them to sell other properties that they managed during the downturn. Virtu expects to sell individual properties that it acquired before it launched it fund, but also a few assets in its first fund. With another investment that we started last year, Omninet, an improved economy will help increase rents and distributions to owners. We still think real estate presents a great investment opportunity as well as diversification from the stock market. Specifically, we think the opportunity to generate cash flow favors this real estate sector in particular. As inflation expectations increase, this asset class could do well if property values increase and rentsmove upward.

Commodities/Managed Futures - Over the last twelve months these asset classes have been the biggest drag on clients’ portfolios. The “risk on/risk off” mentality of the markets is not conducive to great performance in managed futures which wants to follow trends whether up or down. The last six months has been a great example, as commodities were the best performer for the third quarter, but quickly reversed to the worst performer in the fourth quarter of all the asset classes. Although the managed futures and commodity exposure has decreased a little, mostly due to negative performance in 2012, we continue to use these asset classes to mitigate the risks of increased inflation expectations and a weakening dollar while the Federal Reserve continues printing money at historic rates.

Overall, if the economy stays weak, we expect bonds and other income investments to remain desirable and overvalued in 2013. Borrowers gain the benefit of low interest rates, but those living off fixed income face challenges in the current environment. If the economy begins to gain steam in 2013, these same investments will have lower valuations and assets such as stocks and commodities should benefit.

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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.