Q3 2013 Market Commentary

Summer is over and for many investors this is a time to get back to work, positioning themselves for year-end and looking at what may come next year. As such we thought wed move away from the angle of our recent Commentaries and instead discuss some trends we feel are developing in the market and how they may affect you, your investments, and your planning. US markets have shown strong growth relative to other markets over the past 3-4 years Headwinds, political and economic, have been present since the financial crisis of 2008, but US companies of all sizes have continued to show the traits that make them some of the best run businesses in the world. They are adaptive; as regulations and laws evolve, companies are figuring out how to operate in an ever-changing world and how to quickly navigate around new ways of doing business. They are innovative; creating new technologies or leveraging existing technologies, US companies are constantly pushing the discovery boundaries - from new techniques for releasing trapped oils and gas in an effort to become energy independent, to game changing technologies like 3-D printing. They are proactive; taking steps to reduce expenses in the face of the financial crisis and more quickly regaining profitability than their peers around the Globe. They are opportunistic; taking advantage of what the environment presents to them through such things as leveraging historically low interest rates to refinance their balance sheets, fund one time dividend payments to shareholders, perform massive stock buybacks to increase shareholder value or pay off higher expensed debt. American companies are now better positioned and healthier, financially, than they have been for years. Earnings per share on the S+P 500 have risen from a post financial crisis low of 59.65 in 2009 to current expectations of 110 for 2013, almost doubling after the crushing effect of the global financial meltdown. While a credit crisis is still a possibility in Europe, and many members of the EU are still in recession, there are signs that the region is beginning to stabilize. It would be our opinion that a stronger developed Europe could be the linchpin to the increase and sustainability of a Global growth rebound. Historically over 70 % of imports to the 27 member Eurozone are from Emerging Markets. They also export roughly 50 % of their production to Emerging Markets and as such their economic growth is symbiotically tied together. As EU members have introduced austerity packages and tightened their belts in response to the financial crisis, these levels of trade have been depressed. It is a classic chicken and egg story of one needing the other to get better. But it is our opinion that an increase in demand from Europe for Emerging Market products could more quickly accelerate the process as, while it might be a small bit of fuel it would be tossed in a very big fire. Greater need for production from Emerging economies would require greater amounts of workers earning more wages, thus introducing middle class living to more of a very large population and by

extension increasing demands for goods and services previously unattainable to those individuals. Greater Emerging Market consumption would lead to greater amounts of exports to Emerging Markets from Europe and the US, and the cycle of demand would pick up globally. Signs of rebound in European economies are beginning to sprout, good news for their regional companies as well as for the potential uptick in Emerging Market growth. Its all about Emerging Markets. As we have discussed in previous Market Commentaries, for stocks to continue appreciating in value you need two things. Actual progressive earnings growth, and a willingness on the part of investors to pay a higher multiple of those earnings, based on their expectation that growth will happen in the future. While companies have done a great job of increasing earnings per share through cost-cutting, stock buybacks and some increase in demand, real, long-term revenue and earnings growth will only come from a rise in consumption. At this time US stocks have become what can be described as fully priced without one or both of the above mentioned catalysts. Foreign markets, on the other hand, have already fallen quite a bit. From a fundamental pricing basis they are perhaps more attractive. When focusing in on Emerging Markets, we find that they are adjusting to both US monetary policy (unwinding excess) and their own over-heated resource markets. That said, their share of global consumption continues to grow along previously projected patterns due to continued urbanization and income growth. Demographically, Emerging Markets are getting younger as developed markets are getting older - this fact is not lost on multi-nationals looking for new customers. These economies are large with over 2.5 billion people living in China and India, ranking second and third behind the US in purchasing power according to the Economist. The creation and growth of a middle class takes time, but given their size any increase in consumption demand from these economies will have lasting effects on global growth. We are still in transition, but a gradual rotation into a greater percentage share of foreign and Emerging Markets may seem prudent at this time with US markets full in valuation. The US Story Moving forward earnings of US domiciled companies will need to work their way around continued political squabbling, existing Sequestration cuts, slow employment growth, a tapering of the Feds QE policies and any further cost-cutting created by new debt ceiling debates. For all our faith in US management, we begin to look outside of the US for a bit more growth as valuations on domestic stocks have become fairly, yet fully, priced at this time. As we continue to see a shift of large cap multi-nationals looking to Emerging Markets as the source of their new revenues, we feel that small and mid-sized companies will fill in any domestic space thats left by large multi-nationals as the latter increases their focus on foreign markets. Small and mid-sized (regional) firms are more likely to inspire trust in a culture that is increasingly distrustful of large institutions. Also, smaller firms that have survived the last credit crisis are in a much better position to weather new ones - one could argue even more so than the multi-nationals which rely on international banking and finance.

We have been slowly increasing small cap exposure for clients in the last 6 months to position for what we feel may be a brighter future ahead for them. That said, as they as smaller companies we have to be aware that their ability to survive downturns or mistakes in their business is not good and thus their upside may be higher but so too is their volatility. Economically the US continues its trudge through the push and pull effects of low interest rates, Quantitative Easing (QE), low mortgage rates (even with recent spikes), Sequestration, slow job growth, fickle consumer confidence and political debt debates. Our opinion remains the same - job growth will continue to be a very slow process with high levels of unemployment hanging around for years to come. Housing, bolstered by low mortgage rates and pent up demand, remains solid though it has slowed a bit as mortgage rates have increased back into the 4.49 % range for a 30-year fixed. It is important to keep in mind that, relative to the US economy, housing is one of the biggest drivers of growth and typically the largest household asset. The results we are seeing are directly attributable to the Fed actions of QE driving down mortgage rates to historic lows and making buying or building a new home a reality for many. This has eliminated inventory and driven up pricing and household net worth. The bond market remains pricey as Fed QE action has kept the price of Treasuries and mortgage backed securities high. Those high price levels have pushed investors seeking yield into alternative fixed income assets, thus increasing the price of high-grade corporate debt, lower-rated junk bond debt, senior loans and municipal bonds. We would anticipate rate increases in 2014 out into 2016 as the Fed begin to the process of tapering their $85 billion a month of bond purchasing. As such we continue to keep bond portfolio durations short, utilizing funds that can buy bonds wherever they see value and can even short the market. We are also holding funds that look outside of the US for quality bonds, as well as building out our own individual bond ladders. Overall our attitude of defensive optimism remains in place. Many of the structural issues that created the financial crisis have been ironed out, but 100-year events like those of 2008-2009 do not wash themselves out quickly and will continue to be a drag on growth for some time. We continue to manage in a manner that seeks responsible return without an overextension of risk as these are still unique times. But overall we are pleased with the progress being made and the corners being turned.
Should you have any questions or comments regarding this Commentary please feel free to email me or Julia Randall at steve@nstarfinco.com and julia@nstarfinco.com, respectively, or call us at (800)220-2161. Steve Steven B Girard, President
The opinions expressed are those of Northstar Financial Companies, Inc. and are based on information believed to be from reliable sources. However, the informations accuracy and completeness cannot be guaranteed. Past performan ce is no guarantee of future results.
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