December 1, 2014

Dear Friends,
Several macro-economic measures indicate that things are going well in the economy. The rate
of unemployment fell last month to 5.8 percent, the lowest rate since 2008. Corporate profits are
at an all-time high. Consumer spending and business investment capped the strongest six
months of growth in a decade. Short term interest rates are at near zero levels and mortgage
rates are very affordable. In addition, both the Dow Jones and S&P indexes seem to reach new
highs on a regular basis.
But if the economy and the market are so strong, why is there still a sense of discontent amongst
so many of us? Everyone has their own answer to this question. My response is that big picture
statistics often conceal the sharp differences that exist within different parts of the economy and
different sectors of the current stock market.
Investors were willing to pay a high premium for liquidity this year. The securities of large and
widely traded companies commanded a higher price than those of smaller and more volatile
companies. As a result, the average returns of large actively traded companies increased by
double digit amounts, while the returns earned by the many investors who held their money in
smaller cap companies lagged behind.
Why was a premium placed on the stocks of large, liquid companies? One reason was that
fighting in the Ukraine and the Middle East, as well as political uncertainty in Brazil, and
Mexico gave rise to a concern by foreigners about the safety of their local currencies. Many
began to send money to America. Some bought real estate and contributed the rising prices of
both residential and commercial property in New York, Florida, and California. Others began
to invest their money in the shares of large and liquid American companies. As a result of the
increased investment outlays by both foreign and American investors, the prices of both real
estate properties and equities rose sharply.
The increase in values, however, was not uniform for all market size companies. The stock
prices of small companies lagged those of the larger ones, just as rural real estate values did not
increase as much as land and building values in many urban areas. From the start of this year
through today, the price increase of both the large company S&P and the Russell index of the
1000 largest companies are in the 12.5 percent range. In contrast to these double digit returns,
the return of the smaller cap Russell 2000 index is only in the 2 percent range.

This price pattern is different than it was in the past. Over the last three years, the returns of the
S&P, both the Russell 1000 and 2000 were comparable: the annualized returns were in the range
of 18.4, 21.0 and 18.4 percent respectively. Over the past five years, the average return of the
smaller company index was marginally higher than the returns of the larger S&P and Russell
1000 indexes. The returns of these series were 13.6, 16.3 and 16.7 percent respectively. By
historical standards, the large premium investors now are paying for size and liquidity is
unusually high. The question all of us face is when will a return to normalcy take place?
John Maynard Keynes was asked a similar question when he was the bursar at Cambridge. He
responded: The market can remain irrational longer that you can stay solvent. My reaction to
Keynes famous market insight is that we should to continue to manage your portfolio with
thought and care.
We therefore plan to continue holding your large liquid assets so long as investors continue to
pay a large premium for liquidity. Once the liquidity premium starts to fall, smaller and more
volatile companies could begin to earn comparable or higher returns. We will then change your
asset allocation because our goal will continue to be to preserve and enhance your wealth.
Be assured that we carefully watch market developments on a daily basis. You should also
know that we review all of your positions every two weeks and ask ourselves if each holding
should continue to be held or whether it should be sold. Trust me when I say we are highly
motivated in this effort. We do not like to lose money, and we own in our personal portfolios
almost every security you hold in yours.
Sincerely,

Eugene Lerner
Managing Director, Partner