Fall 2014

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Market Overview


It’s been an interesting year so far for the investment world with growth in many areas and noteworthy dips. Equities, for example, had a relatively strong first half of the year but with several drastic dips. October continued that theme with a large dip at the beginning followed by a rally. We sent out a Market Update at the bottom of the dip explaining that we felt the drop was temporary and simply caused by headlines. The following weeks confirmed our sentiment.

Headlines at the beginning of October included weaker economic reports (particularly slowing growth in foreign countries), decrease in oil prices, the Ebola outbreak, the ISIS threat, sanctions against Russia, political turmoil, and regulatory uncertainties.

We’ve also seen a drastic drop in oil prices, largely caused by increased supply and diminished demand. The strong dollar isn’t helping either and has caused commodity returns to drop as well. Energy and Infra-structure Master Limited Partnerships (MLPs) have seen a surge for most of the year. But a rapid drop in oil prices triggered a sell-off in the energy market, which included MLPs. In September and beginning of October, MLPs experienced a large drop, but have since recovered much of the losses. Historically, MLP’s have not been closely correlated to oil prices. That may explain why the drop in prices was short-lived.

The strong dollar is cutting into profits of American companies as several firms fell short of their revenue forecast for the third quarter. Although profit reports were largely positive, revenue numbers didn’t look as good. When the dollar is strong, American goods are more expensive abroad which could decrease demand. In addition, the goods that are sold abroad generate lower revenue when the money is converted back into U.S. dollars. A 1% move in the U.S. dollar could result in a 2% move in S&P 500 earnings.

Going forward, we expect opportunities in every asset class to be harder to find, but they are still out there. Growth will most likely be subdued, but a well-managed portfolio should continue to do well. With quantitative easing about to expire, we could experience another dip—to stick with this year’s theme—but it will most likely be short-lived.


Investment Strategies

The following are a few thoughts on different asset classes based on the current environment.

Fixed Income - The biggest headline in the bond world this last quarter was the departure of PIMCO’s Bill Gross from the firm he started and from managing the world’s largest fixed income strategy, the PIMCO Total Return Fund. In reaction to the announcement, we immediately moved clients’ assets to the Doubleline Total Return Fund, managed by Jeffrey Gundlach. Bill Gross has such an influence on the bond markets that we did not want to risk getting caught in a mass exodus, albeit unlikely to occur. We have maintained our position in the PIMCO Income Fund which is not managed by Gross, and where performance and asset balances have remained steady.

Investment grade bonds continue to perform well. Despite many calls to exit bonds out of fear of rising interest rates, we maintained our fixed income exposure and are glad we did. Barclay’s Aggregate U.S. Bond Index is up over 5% year-to-date. Several of our core bond managers, Loomis Sayles, Templeton Financial, and PIMCO have all performed very well during this period. The announced end of quantitative easing could cause a rise in interest rates. Such a rise would hurt bond prices. That’s why we continue to favor fixed income strategies that have the flexibility to shorten maturities, to short bonds, and to increase credit risks if the reward warrants the risk. Several of our managers have also increased their international and emerging market debt exposure. But because of continued slow economic growth, we expect interest rates to stay relatively low for the foreseeable future.

Enhanced-Yield Strategies - Higher yielding investments, such as corporate debt and MLPs, make up this asset class. Most MLP indices were up around 24% through August this year. But in September and particularly the first half of October, MLPs saw a drop of around 15%. But over the next week already, MLPs rose by over 10%. We feel MLPs continue to offer upside potential that is not closely correlated to oil prices in the long run. We expect the outcome of the recent election will bode well for energy related investments. Enhanced yield in general should continue to do well.

Equities - Even after an over 7% drop in September and October, the S&P 500 is up close to 10% on the year. The Dow Jones, on the other hand, is only up 5.9%. We still believe that the stock market has room to grow and do not expect an extended downturn in the near future, but we expect volatility to remain higher than normal as the rest of the world follows the United States’ lead to stimulate the economic growth and ward off deflation through various methods of stimulus such as quantitative easing.

Real Estate - Low interest rates continue to benefit the real estate market and generate activity. Although the consensus from our managers is that we have not reached a peak (and no one is willing to predict how far we are from the peak), we have seen more selling than buying in the portfolio over the last quarter. Virtu and Landsmith continue to maintain a steady pace of selling into the rising market, which includes some legacy properties purchased before the sub-prime real estate meltdown of 2008.

The acquisitions that have occurred in the last quarter by our managers have been very strategic. For instance, JCR Captial has been placing more debt than equity in newly originated investments in an effort to have more control over their/our investment capital for the next 2-3 years. Also, we purchased residential lots in the Reno, Nevada, market based on their lagging residential rebound yet improving employment data. We purchased the lots all cash in order to avoid any interest rate risk in case we decide to move forward with any development activity. Lastly, Brixton Capital, one of our newest managers, tactically bought an abandoned retail building to renovate and lease. Brixton also bought a note on a multi-family complex at a significant discount and is now in the process of foreclosing on the property before selling it on the open market.

Opportunities such as these are why we feel owning real estate is so important in a diversified portfolio. The real estate markets are much less efficient than public markets and allow more opportunities to find and create value.

Commodities - After a strong first two quarters, U.S. oil prices dropped over 13% during the third quarter and continue to drop. The first two weeks in October alone, prices dropped another 10%. Gold and precious metal prices have also receded with gold being down almost 3% year to date, and down 11% over the last 12 months. With the dollar growing stronger, commodity prices in general could continue to decline. Therefore, we’ve allocated more to MLPs, energy related investments we discussed earlier, which currently provide a 5% - 6% yield while we wait out the slide in the price of oil.

Managed Futures - After a prolonged period of stagnant performance, managed futures have finally kicked into gear during the third quarter. The Princeton Managed Futures Mutual Fund was up almost 10% over the past 6 months. A popular explanation for this asset class’ struggles over the past few years has been the effects of government meddling. Now that quantitative easing is expected to end, managed futures may experience positive performance again. Regardless, we continue to believe that proper exposure to this non-correlated asset class is beneficial for a portfolio.


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. The information provided herein from third parties is obtained from sources believed by Cornerstone to be reliable, but no reservation or warranty is made as to its accuracy or completeness.

Cornerstone Team Notes