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Quarterly Investment Briefing February 6, 2013

Quarterly Investment Briefing February 6, 2013. Clayton T. Bill, CFA . Stephen J. Nilles, CFP. 2012 Year in Review Equity markets posted double-digit returns amidst the noise of policy and politics.

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Quarterly Investment Briefing February 6, 2013

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  1. QuarterlyInvestment BriefingFebruary 6, 2013 Clayton T. Bill, CFA Stephen J. Nilles, CFP

  2. 2012 Year in ReviewEquity markets posted double-digit returns amidst the noise of policy and politics JAN-MAR: Equity markets posted a strong start led by Apple which became the largest holding in the Russell 3000® Index DEC:The fiscal cliff debate in the U.S. took center stage JUL:President of the European Central Bank (ECB) Mario Draghi said the ECB will do “whatever it takes to preserve the Euro” Growth of a Portfolio JAN-JUL: Eurozone nations struggled to balance austerity with growth and non-U.S. markets bounced with news (or lack thereof) NOV-DEC: Political transitions in the U.S., China and Japan SEPT:Fed announced Quantitative Easing III (QE3), ECB began unlimited bond-buying program

  3. Capital Market Returns Current and Annualized: 12-31-2012 Source: Russell

  4. What Worked and What Didn’t in 2012 • What Worked • Equities • Financial Services +27% • Developed Europe +21% • Fixed Income • European High Yield +30% • Global Emerging Mkt Debt +18% • U.S. Aggregate 10+ Years +9% • Alternatives/Real Assets • Grains +18% / Precious Metals +6% • REITS Asia +45% • Infrastructure: Transportation +22% What Didn’t Work • Equities • Energy +4% / Utilities +8% • Israel +3% / Spain +4% • Fixed Income • U.S. Treasuries +2% • U.S. Aggregate 1-3 Years +1% • Alternatives/Real Assets • Coffee -42% / Natural Gas -31% • Infrastructure: Utilities +1% • 4Q2012: • Equities: Financial Services +5% / Greece +12% / Technology -6% • Fixed Income: European High Yield +9% / U.S. Treasuries -0.1% • Real Assets: Livestock +5% / REITs Europe +10% / Grains -12% Source: Russell

  5. Muted Volatility in 2012By almost any measure, stock volatility declined markedly in 2012, reflecting a surprisingly calm market environment for much of the year. As a measure of daily price movements, the percentage of trading days up or down by more than 2% plunged to a six-year low, while the calendar-year trading range for the S&P 500 Index was in the tightest quartile since 1928. Source: Fidelity

  6. Bond Yields Low, Credit Categories More Fully ValuedExceptionally low interest rates have pushed yields in many fixed-income categories to near-record lows. After a year of significant spread tightening, yield spreads on most categories are now below historical average levels. During the fourth quarter, mortgage-backed security spreads widened back to levels seen prior to the Fed’s third round of quantitative easing. Source: Fidelity

  7. Fixed Income: Impact of Rising Interest Rates • Fixed income’s primary role in a portfolio is to help diversify equity risk • Rising interest rates can be a headwind for fixed income • Remember, bond total return is a combination of price changes and coupon payments • Rising interest rate environments have typically been strong for equities, real assets, and extended fixed income sectors ShortTsy IntermediateTsy LongTsy AggBonds GlobalHigh Yield Corporates EMD Price impact of rate increase Average current coupon Total return

  8. Muni Fundamentals Steady, Tax Advantage IncreasedAlthough fiscal challenges still exist for many municipalities, state revenues have improved for 11 straight quarters, and the recent uptick in property tax revenues is a positive sign for localities. Recent tax changes for 2013 enhance the after-tax yield advantage of municipals for high-income investors, though muni income could still be affected by future tax initiatives.

  9. Fiscal Cliff AftermathDeferred choices, tax impacts Estimated revenue over 10 years from fiscal cliff deal $55bnCapitalgains / Dividends $150bnPhase out ofcertain deductions $20bnInheritances $395bn Income tax rates Positive: Negative: Clarity into individual tax rates / removal of policy uncertainty Deferral on spending cut decisions and loomingdebt ceiling debate

  10. Global Outlook: Three steps forward, one step back UNITED STATESSlow progress EUROPEThe key risk EMERGING MARKETSAsia • Expect 2.1% GDP growth • Inflation < 2% • Stabilization of housing • Modest employment growth (+160k / mo.) • Recession to continue in 2013, but will avoid collapse • Northern Europe ~0% GDP • Southern Europe ~-1% GDP • Continued volatility in response to political indecision • Low equity valuations caused by uncertainty • Source of restrained global growth will benefit from return-to-risk appetite • China: successful soft landing that should drive global growth • 7-8% GDP growth likely

  11. Fed Boosts New Easing, Money VelocityRemains MutedThe pace of the Federal Reserve’s latest quantitative easing would add $85 billion of new securities per month and raise the Fed’s balance sheet to nearly $5 trillion if continued through 2014. While the aggressive posture boosts liquidity and investor risk sentiment, money velocity remains low, implying little inflationary pressure is transmitting through bank lending.

  12. Historical U.S. Debt & Equity Issuance-To-GDPLeading up to the financial crisis in 2008, debt levels of the household and financial sectors grew to be quite excessive. This eventually became problematic for the economy because reducing debt back to normal levels cuts into consumer spending (with respect to the household sector) and access to credit (with respect to the financial sector).

  13. Historical Deleveraging ExamplesThe last 5 years in the U.S. have closely traced the Swedish and Finnish deleveraging episodes from the 1990’s, which offer a useful historical analog that shows the private sector must deleverage first and that the government sector can follow once GDP growth reaccelerates. The flow is logical given the government’s capacity to deficit-spend and control monetary policy.

  14. How Does This Recovery Compare? Coming off the 2009 market bottom Current market recovery has been in line with historical averages • Based upon prior recoveries, market shows potential for additional upside

  15. Global Investing: Diversification Across Markets and Objectives GLOBAL MARKET CAP Non-U.S. Equity40% U.S. Equity46% EmergingMarkets14%

  16. Conclusions • Economic stabilization in 2012 translated into strong equity market performance amidst uncertainty • In 2013: Expect low but differentiated returns across asset classes and regions • Event driven volatility will continue Considerations for investors: • Have reasonable return expectations • Don’t let volatility drive knee-jerk investment decisions • Remain focused on investment process and insuring that asset allocation is appropriate for attaining goals

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