2015 Mid-Year Market Review

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1 2015 Mid-Year Market Review Cedar Hill Associates, LLC North River Road, Suite 1100, Rosemont, Illinois Phone: 312/ An Affiliate of MB Financial Bank

2 2015 Major Investment Themes U.S. Equity markets posted modest results - A host of economic uncertainties tempered investor sentiment and kept equity prices confined within a relatively narrow trading band. U.S. stocks recorded only marginal improvement. The S&P 500 Index increased 1.2% YTD with dividends driving most of the lift. International Equities outperformed U.S. markets - A significant new Quantitative Easing program announced by the European Central Bank in January, alongside signs of economic improvement, gave investors confidence in European equity markets. While some gains were given back in the last few days of June due to the threat of Greece exiting the Euro, the EAFE index posted the strongest results of the major indices. Source: Bloomberg Slow U.S. economic growth continued - A final revision to first quarter GDP figures showed slow economic growth with the economy expanding 0.6%. Even with accommodative monetary policy, growth remains well below targets and highlights the susceptibility of the economy. Fed expected to raise rates by year-end - Although economic growth has been disappointing to date, recent data points to improvement within manufacturing activity, homebuilding permits, unemployment, personal income, and consumer confidence. The cadence of any future rate hikes will likely be gradual, and monetary policy should remain accommodative. 2

3 2015 Outlook Scorecard U.S. Equities: Economic conditions, monetary policy and valuation all continue to be favorable for further equity market increases in U.S. equity markets should continue their climb higher, but at a much more modest pace and in line with corporate earnings growth. International Equities: Quantitative easing measures announced by the European Central Bank should push markets higher in While emerging markets remain out of favor, valuation levels are attractive. Equity Income: Despite fears that higher interest rates will cause a sell-off in high dividend paying stocks, Equity Income securities remain attractive and pay a hefty premium above traditional fixed income. Fixed Income: Rates are unlikely to surge from year-end levels, but limited benefit can be achieved by pursuing additional risk. High quality, intermediate to long-term municipal bonds offer the most compelling risk/return. Correct Correct Partially Correct Correct While YTD equity results have been modest, performance is trending up. International developed market and emerging market equities have outperformed U.S. markets year-to-date. Income oriented securities have underperformed in 2015, but continue to earn their dividends and pay a hefty premium above traditional fixed income. Interest rates have been range-bound in 2015, with most fixed income indices posting flat to slightly positive results. 3

4 Equity Markets Equity Market Performance 6/30/15 YTD Sector Results S&P % Russell % MSCI EAFE 5.5% Nikkei (Japan) 16.9% MSCI Emerging Markets 3.0% MSCI World Index 2.6% Source: Bloomberg, MSCI The S&P 500 Index increased 1.2% YTD with dividends driving most of the lift. Equity valuations are elevated, but not alarming. The S&P 500 ended the second quarter at a forward P/E of 17.3x a modest premium to the historical average forward P/E of 16.7x. A premium valuation to historical levels is likely justified by today s low interest rate environment. Valuation multiples usually don t expand when interest rates are rising, so earnings growth will likely drive equity returns from here. Despite giving back some gains in the last few days of June as fears increased that Greece would exit the Euro, international markets posted strong results during the first half of the year. New quantitative easing measures in Europe and Japan have stoked the rally and economic data in both countries continue to improve. Emerging markets have experienced significant volatility in 2015, led by the Chinese market, which rallied over 150% since mid-2014, only to fall by over 30% in a three-week period starting late June. Source: FactSet (as of 6/26/15) 4

5 Fixed Income Markets Interest Rates Bond Index 12/31/14 6/30/15 1 Year Treasury 0.25% 0.27% 5 Year Treasury 1.65% 1.65% 10 Year Treasury 2.17% 2.35% 30 Year Treasury 2.75% 3.12% Barclays Int. Taxable Bond Index 2.00% 2.10% Barclays 5 Year Muni Bond Index 1.42% 1.62% Barclays U.S. Corporate Credit Index 3.11% 3.36% Merrill Lynch High Yield Master II 5.96% 6.65% Source: Bloomberg, U.S. Treasury, Raymond James The benchmark 10-year U.S. Treasury finished the first half of 2015 at 2.35%, only 0.18% higher than the start of the year. At quarter-end, the yield curve was similarly aligned to its position at year-end (see bottom chart). Though all signs point to the Fed beginning to raise shortterm rates in the second half of 2015, this is not a forgone conclusion and instead will be dependent upon continued positive trends in economic data. Spreads on credit investments have begun to widen as investors seek more compensation in a less certain environment. Despite recent drama in Greece, the market does not expect similar events in other troubled European countries, as the 10-year rates on Spanish and Italian sovereign debt held at levels similar to the U.S. Treasury. Source: Bloomberg 5

6 Market Outlook 0 Shaded areas above indicate recessions. S&P 500 Stock Price Index /24/00 10/9/07 6/30/15 Forward P/E 26.3x 16.7x 17.5x Yield 1.2% 1.8% 2.0% Federal Funds Rate 6.0% 4.8% 0.1% 10 Year Treasury Yield 6.2% 4.6% 2.4% Sources: Federal Reserve Bank of St. Louis, Bloomberg With the S&P 500 continuing to set new highs, we would not be surprised to see increased volatility going forward, as stock market pullbacks (5 10% decline), or the occasional correction (10 20% decline), tend to become more likely in the back half of the business cycle. We do not believe, however, that a pullback/correction would mark the end of this secular bull market. Business cycles don t typically die of old age; they are usually killed off by high interest rates, excessive risk/debt, or other exogenous shocks that restrict demand none of which are present currently. Even though the Fed is expected to begin raising rates in the second half of 2015, any rate increases will be slow as not to disrupt the tepid pace of economic growth experienced the past few years. A sustained period of near-zero interest rates, negligible inflation, and positive corporate earnings growth and economic data is supportive of current market valuations and still leaves room for additional market upside. 6

7 Portfolio Positioning Fixed Income - Limit exposure and keep duration relatively short in order to avoid backlash from potentially higher interest rates. Little additional return can be gained by extending maturities or reducing credit quality. Opportunistically, invest in undervalued municipal bonds. U.S. and International Equities - Favor U.S. technology, industrials, and healthcare due to attractive valuations and competitive advantages. Overweight emerging markets relative to developed international markets, where growth rates and valuations remain more attractive. Equity Income - Provides attractive total return potential, strong diversification to traditional equity strategies and additional current income. Master Limited Partnership exposure will likely be increased. Alternative Investments - Where appropriate, use hedge funds, private equity and real estate to enhance returns, reduce risk, and/or provide further diversification. Remain Opportunistic and Flexible to changing market conditions. 7

8 Disclosures This Market Review may include forward-looking statements. All statements other than statements of historical fact are forwardlooking statements (including words such as believe, estimate, anticipate, may, will, should, and expect). Although we believe that the expectations reflected in such forward-looking statements are reasonable, we can give no assurance that such expectation will prove to be correct. Various factors could cause actual results or performance to differ materially from those discussed in such forward-looking statements. Inclusion of index information is not intended to suggest that its performance is equivalent or similar to that of the historical investments whose returns are presented or that investment with our firm is an absolute alternative to investments in the index (if such investment were possible). Investors should be aware that the referenced benchmark funds may have a different composition, volatility, risk, investment philosophy, holding times, and/or other investment-related factors that may affect the benchmark funds ultimate performance results. Therefore, an investor s individual results may vary significantly from the benchmark s performance. The information presented herein is intended for reference purposes only. Past performance is not necessarily indicative of any specific investment or future investment results. Views regarding the economy, securities markets or other specialized areas, like all predictors of future events, cannot be guaranteed to be accurate and may result in economic loss to the investor. This Market Review is intended to provide general information only and should not be construed as an offer of specifically tailored individualized advice. 8

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