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Investment Commentary Quarter Ended March 31, 2014 After a rip-roaring 2013, US stocks ended the first quarter generally flat. While this might suggest a dull market environment, the underlying currents were anything but boring. A minor early year correction reversed course in February, and geopolitical tension (i.e. Russia/Ukraine) injected uncertainty and contributed to increased day-to-day volatility. Time will tell if this is the ‘pause that refreshes’ or the ‘calm before the storm’. Fundamental, technical and seasonal factors continue to suggest that a meaningful correction should occur this year; based on historical precedent, the May – October time frame would seem most likely. As for bond investments, despite the overwhelming unanimity of opinion that interest rates would be headed higher, intermediate to longer term yields actually fell a bit, resulting in slightly positive returns for the quarter. When 2014 began, the overall consensus was for US economic growth to accelerate, and for the stock market to put in another good year. Of course, economists have predicted strong growth for years, and those expectations have fallen short in most every case. The “recovery”, now in its 6th year, remains muted, with total jobs, labor force participation, real income, and wage growth all near or below 2007 levels. Economic indicators continue to be confusing and sometimes contradictory. There may be some validity to the argument that bad weather hampered first quarter activity but there seems little reason to expect robust economic and/or corporate earnings growth in 2014. While there should be pent-up demand for business spending, the latest data remains sluggish. Add all this together and it should be no surprise that expectations for first quarter earnings growth have dropped to 2%, from 8% when the year commenced. A kind of stalemate appears to have developed between the lackluster fundamental backdrop, and the positive investor sentiment that centers on low interest rates making Investments offered by Lodestar Investment Counsel, LLC are not insured are not obligations of, or guaranteed by Lodestar Investment Counsel, LLC. Investments are subject to risk, including possible loss of the principal amount invested. stocks the only game in town. Indeed, the current bull market has stretched over 1,800 days, ranking as the seventh longest since 1928. Stock market bulls argue the following: valuations, while elevated, are not in the stratosphere, state and federal government deficits are shrinking, consumer balance sheets are on the mend, and the nation is on the road to energy independence. Bears counter that there is more than enough to be concerned about, particularly if you have a sense of market history and are more focused on potential downside than upside. Irrespective of one’s market outlook, it seems evident that there is a growing gap between the financial markets and the real economy. With stocks near In this issue: Commentary Manager Profile Market Snapshot 1 4 4 “ Irrespective of one’s market outlook, it seems evident that there is a growing gap between the financial markets and the real economy.” all-time highs and earnings growth minimal, several valuation measures suggest that the market is quite fully priced. Moreover, signs of excess are abundant. Investor surveys reflect extremely bullish sentiment, and record margin debt (investors borrowing to buy stocks) is consistent with levels at the two most recent market peaks. In addition, corporate insiders, those who should know their businesses best, are selling at a furious pace. Also worrisome are the valuations being paid for ‘momentum’ stocks, as well as the merger and takeover activity in the social media industry. Reminiscent of the Internet bubble of 19982000, we are again seeing acquisitions of companies with little or no revenue, never mind earnings, such as Facebook’s recent $19 billion acquisition of a messaging service company. “The recovery still feels like a recession to many Americans, and it also looks that way in some economic statistics.” Janet Yellen (3/31/14) One can debate the underpinnings of this bull market, but there is no doubt as to who has engineered the plan. As we have previously noted, all that seems to matter is Federal Reserve commentary and activity. These days, the markets react to every utterance about quantitative easing and the direction of interest rates, but little else. The chart above illustrates the stock market’s dependence on Fed money printing activities, with every peak and valley over the past five years coinciding with a central bank stimulus program. US monetary authorities understand that quantitative easing is not sustainable, and they have attempted to stop on two occasions. These periods resulted in average stock market losses of 17%. The current “taper” is a more measured attempt to wean investors off the liquidity bottle. Based on a couple of off the cuff comments earlier this year, some market observers posited that new Fed Chairperson Yellen might be less beholden to Wall Street, and more interested in policies that help the economy and reinforce the credibility of the financial system. By keeping interest rates low, many believe that Congress has been able to avoid dealing with the debt and entitlement issues that will eventually have Lodestar Investment Counsel, LLC 150 South Wacker Drive, Chicago, Illinois 312.630.9666 “ One can debate the underpinnings of this bull market, but there is no doubt as to who has engineered the plan . . . all that seems to matter is Federal Reserve commentary and activity.” serious economic repercussions. Unfortunately, Yellen’s initial comments were met with disdain by some investors, causing her tone to change. Her quote above is important for two reasons: (i) we find it remarkable that a Fed Chairperson would admit that the 5-year old recovery “still feels like a recession” in some respects, and (ii) more important than confirming that the economy remains weak, her ‘dovish’ speech provided support, once again, for those who believe that ‘free money’ will continue to be available should the economy sputter. Things to Watch Asset prices will be influenced in coming months by the answers to a number of questions, including the following: Will the sharp pull-back in last year’s high flying momentum stocks spill over to the rest of the market? Will the US economy gain traction once the weather improves, with any strength flowing through to corporate earnings? Will the Federal Reserve finish tapering its bond purchases by this fall, as expected. What tool(s) will be utilized if the economy does not improve and/or if stock prices correct meaningfully? Will the severe drought in the western US, together with crop damage from the harsh winter, cause significant food inflation? With economic growth and spending cuts less effective these days in driving stocks higher, will ‘deconglomeration’ (where large companies sell assets or split into separate entities) become an increasingly popular means of driving shareholder value? market is throwing curveballs and we prefer to swing at fastballs. During these periods, experience suggests that relative inactivity is often an asset. Chasing ‘story’ stocks may be exciting, but it is usually not profitable. To the contrary, we strongly believe in the virtues of owning solid companies with the objectives being to preserve and enhance capital over time, generate safe and growing income, and avoid undue risk. While the value of these investments will fluctuate with swings in the markets, we, and our clients, take comfort in this rational, conservative and prudent investment philosophy. Our concluding thoughts involve peace of mind, and how this can be best accomplished within the context of an investment portfolio. Over time, the strategy of owning quality, buying when assets offer compelling long-term value, and adopting the mindset of ‘slow and steady wins the race’ has historically provided excellent risk adjusted returns. There are times when patience is required because the For more information about Lodestar, please visit our website at www.ldstr.com. Managing Director Profile Peter W. Flanzer Managing Director Peter joined Lodestar in 2002 after serving as a Principal with another Chicago-based investment advisory firm. For over 25 years, his focus has been on working with private clients in the management of their investment portfolios. Peter earned his bachelor of arts degree from Kenyon College, and received his law degree from the John Marshall Law School in Chicago. In addition to spending time with his family and participating in civic and charitable affairs, Peter is an avid golfer in the warmer months and enjoys playing paddle tennis in the winter. Peter can be reached at 312.630.9666 or at [email protected]. Market Snapshot - March 31, 2014 Equity Indices Quarter Interest Rates 3/31/14 3/31/13 S&P 500 1.82% 5-Year Tax-Exempt AA 1.45% 0.85% Dow Industrials (0.15)% 5-Year US Treasury Notes 1.73% 0.77% NASDAQ 0.81% Russell 2000 Index 1.07% $1,291.70 $1,598.20 $101.58 $97.23 Commodities Gold Oil - WTI ($/Barrel) “Lodestar”: 1 A guiding principle, interest, or ambition. 2. A star, especially Polaris, that is used as a point of reference. Lodestar Investment Counsel was formed in 1989, as an independent registered investment advisor, with the above definitions firmly in mind. All of our principals have extensive experience working with wealthy individuals, families, corporate and individual retirement plans, and charitable organizations, like those who make up our client base today. We recognize and respect the need to grow and preserve our clients’ core assets. Our services are designed to provide a risk-averse approach to longterm capital appreciation, that is tailored to the unique financial circumstances and needs of each specific investor. We provide discretionary account management for taxable, tax-exempt, balanced and fixed-income portfolios. business, we strive to adhere to the guiding principles of focus, consistency and service. We would welcome the opportunity to meet with you, or others you know who might benefit from our services. To assure that all our clients receive a high level of personal service, our minimum account is $1 million in investable assets. In all aspects of our Lodestar Investment Counsel, LLC 150 South Wacker Drive, Chicago, Illinois 312.630.9666 www.ldstr.com