Download Click here to read the full report.

The S&P 500 Index – Seven Quarters of Gains and Counting
Market Overview
U.S. large cap companies continued to show strength in the 3rd quarter with the S&P 500 index increasing
0.66%, extending its string of quarterly gains to seven and pushing the year-to-date gain for the index to
6.68% as shown in Exhibit 1. During the quarter, the index hit its 34th record close on September 18th but
declined over the last several days of the quarter. The Nasdaq index also saw strength in the quarter,
gaining 5.20% and 12.78% year-to-date with investors favoring the growth opportunities of the technology
sector.
Exhibit 1
Source: WSJ
But as shown in Exhibit 2 below, many other asset classes saw weakness in the quarter including U. S. small
caps equities which were down 7.96%, emerging markets equities which were down 3.86% and the U.S.
aggregate bond index which was down 0.27%. With weak global demand and a strong U.S. dollar as shown
in Exhibit 1 above, commodity prices saw a dramatic decline of 12.64% for the quarter.
Exhibit 2
September
3rd QTR
YTD
-1.84%
0.66%
6.68%
-6.19%
-7.96%
-5.21%
-3.88%
-6.22%
-4.43%
International Emerging Market Equity Index 4
Bond & Commodity Markets
-7.77%
September
-3.86%
3rd QTR
-0.56%
YTD
US Bonds Index 5
-0.79%
-0.27%
2.52%
Commodity Index6
-7.23%
-12.64%
-9.51%
Stock Markets
Domestic Large Cap Equity Index
1
Domestic Small Cap Equity Index 2
International Developed Equity Index
1
S&P 500 Index, 2 Russell 2000 Index,
Q 3 |2 0 1 4
3
3
MSCI EAFE Index, 4 MSCI Emerging Markets Index, 5 Barclays Capital U.S. Aggregate Bond Index, 6 PowerShares DB Commodity Index
1| P a g e
Domestic Insight
The U.S. economy continues to demonstrate slow but steady growth across most sectors. The biggest story
line of the quarter is the continued improvement in the labor markets with the unemployment rate
dropping to 5.9% in September and with 248,000 jobs being added in the month, an improvement over the
12 month average gain of 218,000 jobs. With such strong job numbers, the expectation would be that the
Federal Reserve would be raising rates very soon but with inflation running below 2% the Fed indicated in
their last meeting that they would be keeping rates low for a “considerable time”. Our expectation is that
the Federal Reserve will begin raising rates in the 2nd or 3rd quarter of 2015. As we have stated previously,
having the economy become strong enough to grow without the support of the Federal Reserve is a positive
and even with higher rates, the economy and the markets can continue to grow.
Another factor that has benefited both consumers and businesses over the past quarter is the continued
decline in commodity prices as shown in Exhibit 3. Lower commodity prices help businesses trim their cost
of production and allow consumers to increase their consumption of more retail goods. This tail wind was
witnessed in August with consumer spending rising 0.6% over the previous year.
Exhibit 3
Source:Factset
The one area that has continued to show mixed signals all year is the housing sector. August building
permits and housing starts came in below expectations and demand remains weak in many areas due in part
to strict lending requirements still in place with most banks.
A positive that continues this year and is a change from previous years is the federal government is not
creating an artificial crisis situation and government spending and taxes have remained primarily unchanged
over the past year.
One of the more compelling stories driving growth is capital spending by businesses. Since the recession,
businesses have made every effort to increase their cash reserves. They have done this in large part by
reducing costs and delay capital investments in their business. With the large cash surpluses they had
Q 3 |2 0 1 4
2| P a g e
accumulated, they started to buy back their outstanding shares and increase their dividends but only
recently did they start increasing their capital investments in their business. As Exhibit 4 shows, business
capital spending as a percentage of GDP has been well below its average since 2009. Based on historical
data, the upward trend in capital spending could continue for a number of years and will be a strong
supporter of future GDP growth.
Exhibit 4
Source: Factset
International Economy and Markets
On the international front the third quarter continued the trend of numerous geopolitical flashpoints and
mixed economic data. The economic news from China and Japan continues to be mixed while most of Latin
America and Europe has struggled to show economic growth and there is concern over declining prices or
deflation in those areas. Outside of the U.S., the majority of central banks are becoming more aggressive
with their monetary policy in hopes of stimulating growth. The European Central Bank (ECB) released a plan
this quarter to begin purchasing bonds in the same way the Federal Reserve has purchased bonds under its
quantitative easing program over the past several years. The main issue with the release of the plan was
that it was severely lacking on specifics as far as the size of the plan.
Fixed Income
For the quarter, interest rates remained mostly flat with the 10 year U.S. Treasury ending at 2.52%. Even
with the Federal Reserve tapering its monthly bond purchases with the last bond purchase occurring in
October, interest rates remain low caused by strong global demand for U.S. bonds, low inflation and a
strong U.S. dollar. With the potential for rising interest rates in the U.S. we continue to favor international
bonds and floating rate bonds and in general we are continuing to minimize the duration (i.e. interest rates
sensitivity) of our bond allocation. As was shown this year, even with the potential for higher interest rates
over the next 1-3 years, fixed income plays a valuable role in diversification, capital preservation and
providing income for a portfolio.
Q 3 |2 0 1 4
3| P a g e
Portfolio Allocations & Economic Outlook
As we look out for the remainder of 2014 and start planning for 2015 we are still very bullish on equities as
an asset class. Although U.S. equities are at their long-term average valuation and corporate profit margins
are at all-time highs, there are a number of reasons to expect the U.S. economy and U.S. equities to perform
well. One of those areas that can continue to propel GDP growth is housing. Although housing has not been
overly strong for the year, as shown below in Exhibit 5, housing starts are well below their historical average
while housing remains very affordable from a historical perspective. These factors would indicate that
housing should be more of a positive than negative over the next 1-3 years. Another catalyst for the market
is the sizable amount of cash still on the sidelines which is currently at a record level of $11.2 trillion in cash
and cash equivalent accounts. For international equities, the compelling investment point is current
valuation versus long-term averages. Our favor towards equities is also supported very strongly by the fact
that fixed income does not look as appealing based on the potential for higher rates over the next 1-3 years.
Exhibit 5
Source: J.P. Morgan
As it has been 35 months since the last 10 percent correction in the market, there is the likelihood that we
may see one in the upcoming quarters. We would view this type of correction as more of an opportunity to
put cash to work versus a long-term trend in the market. It is valuable to note, that over the past 25 years
we have had two periods where the market went 60 months without an official 10% correction so it would
not be unprecedented if the low volatility were to continue in the market. There is usually a catalyst that
causes a market correction and it is possible that one of the catalysts for increased market volatility may be
the Federal Reserve increasing interest rates.
Q 3 |2 0 1 4
4| P a g e