Q2 2014 Market Commentary

There are a number of ways to tell when a bull market is getting long in the tooth. You start seeing negative articles telling us the world is about to end (again), being disputed by an equal number of articles telling us that the market is only going higher. Conservative investors begin to feel compelled to increase the amount of risk they are taking feeling that the boat is leaving the harbor without them, while riskier investors feel that such newcomers will simply fuel higher gains. Speculative IPOs come to market finding all too willing buyers, and the total number of IPOs begin to pick up as underwriters look to get the issues out to market as fast as possible in a proverbial strike while the iron is hot mode. All things we are experiencing at the moment. The psychology of investing is a very interesting thing to see in action. We all want to achieve greater returns and greater asset accumulation, yet the cycle of boom and bust is perpetuated by the actions many take that is counter to fundamental long-term investing. As investors we must seek to find the facts that are scattered throughout the volume of information that inundates us from every corner. We must take unemotional data and somehow apply it to the an emotionally driven environment in order to make the most rational decisions we can about our portfolio, the risks we are exposed to, and those we are willing to assume. I speak often about the fundamentals of the market, but that is our way of trying to remain judicious in our actions when managing assets for which we are responsible. We have found ourselves in a more fluid, volatile, and shifting environment since the tech bubble burst in 2000. Since that time stocks have experienced two of the worst bear markets in history while being sandwiched amongst very aggressive bull periods. This feast and famine has many causes but two are at its heart; cheap monetary policy and a greed is good investor mentality. Prior to the 2000 tech bubble bursting the Fed had been very concerned with the impending Y2K issue, and so poured liquidity into the economy. This rise of cheap money found its way into dot.coms and fueled the subsequent rise in IPOs and stock market pricing. Concerned about that flow of money into speculative businesses and the markets irrational exuberance the Fed then raised interest rates in 2000, thus popping the cheap money driven market. After the proceeding bear market the Fed once again lowered rates, which added fuel to the housing market and has been considered one (of many) reasons for the dramatic increase in mortgages being written and securitized, the exponential increase in housing prices and the creation of the housing bubble which led to the financial crisis. Greed raised its ugly head in both of these periods. Stocks were selling at ridiculous multiples in late 1999, and some companies like Pets.com came to market and skyrocketed in price, regardless of actual earnings. This time is different became the investing community mantra, and everyone was going to become a millionaire and retire early. Yet the inevitable happened as this time was not at all different. The bottom fell out and stock indexes surrendered over 43 % in their values from 2000 to 2002, showing investors the reality of exactly how much they had overpaid for those stocks. With the Fed feeling the need to support a stumbling economy and stock market they lowered interest rates again, which led to a rise in one asset that was considered to be not only underpriced, but less risky than stocks - real estate. But like any other underpriced market when investment money comes flooding in, housing roe to fair value very quickly.
1100 East Hector Street, Suite 399, Conshohocken, PA, 19428 Tel: 800 220 2161 www.nstarfinco.com Registered Representative, Securities offerred through Cambridge Investment Research, Inc. a Broker/Dealer, member FINRA/SIPC Investment Advisor Representative,Northstar Financial Companies, Inc. a Registered Investment Advisor. Northstar Financial Companies Inc. and Cambridge are not affiliated.

But by then the investor bit was firmly in the mouth, and the bulls were running. Thus we had an overextension of the real estate market, and then of the securities backed by mortgages. The stock market, it could be argued, was not yet overpriced at that time, yet when the real estate bubble burst those securitized products became worthless and the systemic effect created a financial systems meltdown. The effect on economic growth and earnings was swift and severe, so companies needed to account for a sudden drop in expected earnings and thus the market needed to reprice. When the dust settled large company stocks had shed more than 60 % of their value before rebounding. So as we begin to hit the multiples of earnings in todays markets that equal the valuations in 2007 the question becomes where are we now and are we setting ourselves up for another decline? The answer to that is not as clear as we would like it to be, as there are both similarities and dissimilarities between 1999 and 2007 and 2014. The Fed Once again the Fed is playing a key role in the market environment. After the financial crisis the Fed proceeded to infuse liquidity into the economy by effectively reducing interest rates to zero. When that did not produce the necessary or desired results the Fed enacted a policy of Quantitative Easing (QE) where they bought assets directly from the large banks. In effect they helped solidify the economic stability of those companies by cleaning up their balance sheets, as well as getting even more liquidity into the economy. As previously discussed this accomplished a couple of separate agendas. One, it lowered the borrowing costs of mortgages and propped up the housing market, which had been crushed during the financial crisis. And two, it pushed conservative investors farther out on the risk spectrum searching for yield, as the traditional interest instruments (bank accounts, CDs, Treasuries) no longer produced the needed returns. This helped bolster the lower quality bond market, and ultimately the stock market. All told the Fed has infused an additional estimated $3.5 trillion dollars of liquidity into the economy through this program which is currently being tapered off and is expected to end this year. But just like in 1999 or 2007, when the Fed had been providing cheap liquidity, there has been an asset appreciation effect that has occurred. While you cannot point to any one asset that has been disproportionately bloated due to the infusion (like tech stocks in 1999 and housing in 2007) it can be argued that Fed action is the reason numerous assets have risen in price, from commodities to emerging markets, to housing (again), to bonds and stocks. Commodities and emerging markets have already suffered their sell off period, the question is will the others follow as QE is ended and all that liquidity is ultimately siphoned back out of the economy in the future? Equity Markets At Northstar one of the things we keep close eye on is the current metrics of the market relative to historical norms. By this I mean we watch things like the price of stocks relative to earnings being made (PE ratio), the price of stocks relative to earnings growth (PEG ratio), the price of stocks relative to sales (price to sales), etc. What we want to get an idea of is, at any time, is the market undervalued relative to what is being produced by corporate America or overpriced. At this time all the metrics of the S+P 500 are at 15 year averages. This says to us that the markets are currently fully priced and to justify further appreciation, we need to see an expansion of sales, or earnings growth and realized earnings. Otherwise, only a drop in the price being paid for stocks will make further investment more attractive. The metrics are similar to 2007, but still far below the levels seen in 1999 (a period of abnormally high valuations by all historical measures).
1100 East Hector Street, Suite 399, Conshohocken, PA, 19428 Tel: 800 220 2161 www.nstarfinco.com Registered Representative, Securities offerred through Cambridge Investment Research, Inc. a Broker/Dealer, member FINRA/SIPC Investment Advisor Representative,Northstar Financial Companies, Inc. a Registered Investment Advisor. Northstar Financial Companies Inc. and Cambridge are not affiliated.

There is no doubt that some sector earnings have risen since 2007. Not only have they increased from the nadir of the financial crisis but they are also higher than before the crisis. But those increases are not across all sectors. Things like Materials, Energy, Utilities and Financials are all lower than in 2007. But in balance we have seen increases in the likes of Consumer Discretionary, Industrials, Consumer Staples, Information Technology, Telecom and Healthcare. More importantly revenue per share have followed suit, rising in these same sectors but not in the others. So it is a mixed bag with some parts of the economy producing and others not. But when looking at current earnings we cannot discount the effects of low interest rates. Low rates provide companies with the ability to strengthen their balances sheets by refinancing high cost debt at much lower rates. This has helped greatly reduce the amount of leverage that US companies are carrying, bringing their debt to equity ratios down to decades lows. It has also helped to bring their profitability back to where it was pre-financial crisis. And with that added profitability, companies have been able to enact aggressive stock buy backs increasing the per share earnings by lowering the amount of outstanding shares. The question is, now how do earnings go up? It has been our contention for some time that the increase in earnings through such things as stock buybacks will come to an end and companies will once again need to focus on increasing sales more rapidly. Companies will need to do so in the face of less liquidity from the Fed. Likewise, as interest rates begin to rise we will see borrowing and operating costs begin to increase which could have an effect on profitability and bottom line earnings. All difficult headwinds which may only be overcome by greater amounts of global consumption. But Europe remains in the doldrums slowly working their way through their issues and Emerging Markets, such as China, have also shown signs of slowing rather than accelerating. The wildcard in all of this may well rest in the European Unions use of QE themselves. There is plenty of exploratory news about the EU looking at turning on their printing machines and beginning their own asset buying spree. Just like the US version of QE, this could have both some marginal positive effect as well as pose additional long-term risks. A growing developed Europe would create greater amounts of demand from a heavy importer of emerging markets goods. A growing emerging markets could be good for a US economy looking to export goods and services to them. But a global double down on liquidity floating in the system could also have currency implications (and subsequently commodity pricing effects) as well as implications for global inflation that would be hard to reign in. At this point we would be far more comfortable with a lower priced market that was paying more attention to the fundamentals of global economic growth, how that growth has been supported and the outlook for that growth to continue, than one that was focused on how close the S+P 500 was to a psychological benchmark of 2000. Bull markets can run for a long time, often longer than they should. But investors not having experienced a correction (a 10% or more decline) since 2012 and our opinion is that the longer this bull runs without fundamentals getting better, the deeper the correction will need to be to get pricing back in line with actual earnings. So while there are some similarities to 2007 we do not feel we are on the verge of another financial crisis period. Granted we have yet to see the long term implications of the unprecedented QE program and how the Fed will manage to cease the program and efficiently remove the excess liquidity from the economy. Neither do we know if enough momentum has been achieved to propel the US economy further without artificial aid, aid that cannot go on forever.

1100 East Hector Street, Suite 399, Conshohocken, PA, 19428 Tel: 800 220 2161 www.nstarfinco.com Registered Representative, Securities offerred through Cambridge Investment Research, Inc. a Broker/Dealer, member FINRA/SIPC Investment Advisor Representative,Northstar Financial Companies, Inc. a Registered Investment Advisor. Northstar Financial Companies Inc. and Cambridge are not affiliated.

What we do know is that our slow and steady wins the race philosophy, one that has served long term investors for decades, will continue to be the strategy for Northstar and its clients. Risk adjusted asset allocation, based on fundamentals and not emotion and equally focused on client financial planning goals, rather than investing for the sake of investing, will remain the game plan. Cash implementation will continue to be slow and methodical looking for proper entry points into stocks and bonds, avoiding the rush of the herd mentality. Since 2009 our outlook has remained the same, that for a lengthy period of time we will experience the fits and starts of exiting a 100 year flood event like the financial crisis. That it will take years to return to a more normalized global growth pattern and that prudent conservatism will help us ride through periods of volatility like the ones we expect in the near future. Should you have any thoughts or questions regarding this commentary please do not hesitate to call or email me. Take Care

Steven B Girard

1100 East Hector Street, Suite 399, Conshohocken, PA, 19428 Tel: 800 220 2161 www.nstarfinco.com Registered Representative, Securities offerred through Cambridge Investment Research, Inc. a Broker/Dealer, member FINRA/SIPC Investment Advisor Representative,Northstar Financial Companies, Inc. a Registered Investment Advisor. Northstar Financial Companies Inc. and Cambridge are not affiliated.