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First Quarter 2013 - Market Update

EconomyThe first quarter of 2013 was a very strong quarter for markets as the macro risks of last year quickly became old news. Strong economic data out of the US and China fueled global growth expectations while Japan continued various measures to boost their economy. Equities in Japan (+25% for the Nikkei) and the US (+10% for the S&P 500) led the charge. Most alternative strategies were also positive for the month and the more risk oriented fixed income strategies continued to appreciate. The quarter was not without news. A last minute bailout of Cyprus occupied headlines for the better part of March and investors quickly remembered just how quickly situations in Europe can escalate. Japan continued to ease, North Korea threatened South Korea and the US with nuclear attacks, and Italy had a stalemate election.US
The Fed’s $85 billion bond buying program continued to push capital in to asset prices during the quarter. Sequester cuts went into effect on March 1st and markets didn’t even blink. Immigration reform, gun control legislation, and government spending policies all dominated the political landscape for the month. Both sides of the aisle made their positioning known in an effort to make headway prior to the summer recess. Thus far, no real progress has been made on the spending cuts and debt limit. Questions loom around how and if this will affect capital markets. Corporate America remains reluctant to invest in labor and capex and the consumer is not yet on stable ground.Overseas
The election on February 24th in Italy ended in a virtual tie between Luigi Bersani and Silvio Berlusconi meaning the previously determined austerity measures were now in jeopardy of being overturned. The Bank of England also committed to providing more stimulus if necessary.The Bank of Japan announced open ended quantitative easing to begin January 2014 in addition to the commitment of higher inflation for the region.North Korean leader Kim Jong Un threatened South Korea and the US with the use of nuclear weapons in an effort to stimulate support from his political base and instill patriotism in his people.Equity MarketsDuring the quarter, the S&P 500 joined the Dow Industrials and the Russell 2000 by reaching all-time highs. On March 31st, the S&P 500 closed at 1,569.19, the Dow Industrials closed at 14,578.54, and the Russell 2000 closed at 951.54; levels not seen since October 2007. However, the largest gainer for the quarter was Japan’s Nikkei 225 which was up over 25% for the quarter and now up over 50% for the previous five months. The US equity performance was largely driven by continued central bank easing combined with a low interest rate environment forcing capital into riskier assets as investors search for return. While the US is by no means the globe’s growth engine, it is the risk market of choice and clearly on a slow path to recovery. The story in Japan was continued fiscal and monetary measures to increase liquidity and flood the markets with capital.The following chart summarizes various equity market indices in the first quarter:Bottom Line: Equities remain an attractive, albeit reasonably valued, asset for longer term investors. The recent rally warrants caution when putting new money to work. Based on investor timelines and tolerance for volatility, equity capital should generally be staged in over time. We continue to believe that allocations to growth, value, US, emerging, and international equities are warranted as diversification and asset allocation will be critical within the equity space. 2013 could be the year for which active managers begin to outperform passive investments again as correlations break down and the good is separated from the bad and the ugly.Fixed Income MarketsMost fixed income markets sold off during the quarter as expectations for global growth improved and equity flows increased. The municipal bond market continued to experience reduced volumes and March was another down month as the tax deductibility of municipal interest was potentially at risk. CLOs and bank loans witnessed massive inflows for the quarter, especially in comparison to high yield flows. Both markets generated strong returns during the quarter as investors were hungry for yield and corporate America willingly continued to partake of record low financing costs.The following chart summarizes performance for various fixed income indices in the second quarter:Bottom Line: Maintain low allocations to fixed income with a focus on opportunistic strategies or traditional strategies where credit quality is high and duration is low.Alternative InvestmentsThe first quarter was strong for most alternative strategies as correlations between individual securities continued to decline and long and short trades were no longer entirely offsetting. Long/short equity also benefited from higher market exposures coupled with positive equity performance. Within the credit space, RMBS managers continued to generate positive performance. Global macro strategies underperformed as commodities weakened and some of the more macro oriented trades were less profitable.The following chart summarizes performance for various hedge fund indices in the first quarter:Bottom Line: Hedge fund returns are more in line with expectations and will continue to do well. The hedge fund allocation will be the most risk managed component of any portfolio and serve to dampen volatility while generating low correlated returns to traditional asset classes.Conclusion and OutlookWith central bank activity at unprecedented levels across the globe and no shortage of uncertainty in capital markets, a carefully structured investment policy with a focus on asset allocation and “emotionless” rebalancing remains paramount to generating attractive risk adjusted returns over market cycles.


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