Winter 2014

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Market Overview


2013 started with numerous concerns, including worries about the European debt crisis, continued gridlock in Washington, fears about the economy in general, and worries about inflation. But in the end, 2013 ended up being a positive year for investing despite all the negative press. Most asset classes performed well, with some even outperforming their historical averages.

U.S. Stocks led the way returning over 30%. After beating U.S. stocks in 2012, International equities failed to keep up this year, but still performed well returning over 20%. Emerging market returns varied significantly for the year, but this sector left investors disappointed.

Homeowners and investors welcomed a strong rebound in real estate. On average, home prices rose over 10% during the year, resulting in significant increases in equity. It’s estimated that home prices are still about 30% below 2006 highs in most markets. The increase in home prices triggered the homebuilders to aggressively re-enter primary markets and start buying inventory in the secondary and tertiary markets. We were able to start selling some of our finished lot inventory at significant profits.

Multi-family apartments also performed well as supply continues to catch up to demand in most major metropolitan cities. It became much more of a seller’s market with rising values and declining cap rates. We were able to sell out of several legacy assets realizing sizable returns that we then reinvested in new opportunities.

Although we did not experience inflation in 2013, everyone’s fear of rising interest rates finally came to fruition in the 2nd Quarter causing the stock market to sputter and creating serious headwind for fixed income investments. The yield on 10-year Treasuries is now at approximately 3% (the highest level in more than two years). This steep rise in interest rates left most investment grade bond funds down about 2%.

Commodities, and managed futures, were the big disappointment for the year. Energy funds realized acceptable returns, but broad basket funds and especially precious metal and mining funds suffered significant losses due to slumping demand. Trend followers again failed to find sustainable trends amongst choppy futures markets.

In the latter part of the year, investors worried that the Fed might start tapering their monetary policy. But it wasn’t until the very end of the year that tapering was finally implemented at a nominal rate. Tapering signaled that the Feds are cautiously optimistic about the economic outlook for the U.S. but remain committed to supporting the slowly improving economy.

So far, poor economic data from the 4th quarter of last year has caused a pullback in the stock market in early 2014. But most analysts seem to remain cautiously bullish and expect the market to continue to go up in 2014. They expect another positive year with a slowly improving economy worldwide, low inflation, and slowly rising interest rates.

Despite the positive outlook, we continue to hedge our clients’ portfolios against possible downturns by properly diversifying into various asset classes.


Investment Strategies

We continue to maintain a diversified investment strategy that attempts to protect portfolios against the known and unknown risks facing investors. Below are a few thoughts on different asset classes based on the current environment.

Bonds - Although interest rates are expected to go up, we expect the increase to be gradual over the next one to three years. As such, we continue to maintain exposure to bonds, but have moved into unrestrained and multi-sector strategies to grant the managers any needed flexibility to shorten their maturity and even short bonds if they feel strongly compelled. These funds will also increase their credit risk where they feel the reward is warranted.

Enhanced-Yield Strategies - Our strategy for this asset class has not changed. We continue to maintain exposure to higher yielding bonds that are driven by the economy and not as much by fluctuations in interested rates. We also continue to invest in private debt transactions as small companies struggle to find banks willing to lend. In the private debt area, we continue to seek deals with strong collateral and expect low to mid-teen returns.

Stocks - It appears the Federal Reserve continues to be motivated to support the economy and thereby the stock market. A study by J.P. Morgan showed that historically, when 10-year Treasury yields are below 5% and rising, stock prices tend to rise as well. For 2014, we don’t expect nearly the same returns experienced in 2013, but believe the stock market will end the year positive. We’ve carved off some of the profits and reallocated the cash to other asset classes.

Real Estate - We continue to maintain our real estate targets with a focus on income producing properties, particularly in the multi-family and commercial sectors. We are certainly not finding the same opportunities that were available from 2008 through 2010, but we are still finding attractive deals with strong fundamentals and strong cash flows. In fact, in 2014, we expect to sell much of the real estate that was acquired after the Sub-Prime Meltdown in 2008. As assets are selling, we are redeploying the cash into new opportunities. Some of these new deals are equity ownership in new properties whereas some deals are being done with mezzanine debt and preferred equity to improve our security and shorten our investment time horizon in case we do see a spike in interest rates.

Commodities/Managed Futures - Last year, Commodities and Managed Futures presented the biggest drag on clients’ portfolios. We continue to use these asset classes to mitigate the risks of increased inflation expectations and a weakening dollar, as well as provide investments that are uncorrelated to other asset classes.


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.

Cornerstone Team Notes