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Third Quarter 2014 Review

Exceptional...for all the wrong reasons.

While the summer months often mark a lull in the markets, the third quarter provided plenty of excitement, for better or for worse. Geopolitical concerns again were to blame for a great deal of the uncertainty seen in markets, as issues both old and new loomed. Mixed global economic data also added to the turmoil, as many speculate on the next moves of central banks around the world. Doubt appears to be creeping in, as many begin to question the continued strength of this global recovery.

Worries over several conflicts across the globe continued to weigh on investors’ minds as this summer progressed. Tensions between Russia and Ukraine ran hot and cold, as the threat of further escalation stoked fears over the potential implications for the European economy. Though the situation has cooled somewhat as of late, it is far from resolved and a serious overhang remains.

What’s more, other crises have more recently commanded the attention of the international community. Conflict continues to rage in the Middle East, involving a multitude of factions and spilling across borders. The U.S., along with its allies, initiated airstrikes in Syria and Iraq in September, as leaders from around the globe consider further action to stem the advance of the Islamic State. At the same time, the outbreak of Ebola in Africa has proven to be a massive challenge for global health workers. As they work to contain the virus, its subsequent spread to Europe and the US has made it an increasing cause for concern.

As if all of this wasn’t enough, signs of slowing global growth, especially coming out of Europe, made themselves apparent. While the economic implications of the Ukrainian conflict and Russian sanctions weighed enough on European markets, so too did dismal economic data: the Eurozone saw stagnant GDP growth for the second quarter, with Italy falling into its third recession since 2008. Even Germany, until now Europe’s financial stalwart, showed signs of weakness with a slump in manufacturing and downward revisions to forward GDP. Emerging markets didn’t fare much better, with continued signs of a Chinese slowdown, as well as weakness in Latin America. The only real bright spot to speak of this quarter was here in the US. Real GDP growth came in at 4.6% in the second quarter, proving that weaker data earlier in the year was indeed the result of poor weather and not a sign of an anemic economy. Consumer and housing data throughout the quarter further reinforced this notion, reflecting a continued slow and steady recovery.

Naturally, these divergent paths have led to contrasting policy stances amongst the world’s central banks. The Federal Reserve indicated that its quantitative easing program will end in October as scheduled. With that said, it has maintained that rates would stay low for a “considerable time” following the end of quantitative easing. While general consensus remains that the Fed will raise short term interest rates at some point next year, the exact timing of that rate hike remains to be seen. In a similar fashion, the Bank of England has also indicated plans to raise rates in the not too distant future. By comparison, the European Central Bank has taken steps to boost the feeble Eurozone economy through more accommodative policy, lowering rates and announcing a program to purchase asset backed securities. Japan is also continuing on course with expansionary monetary policy, in line with Prime Minister Abe’s regimen for stimulating the economy. Overall, it’s clear that, while beginning incrementally, the global normalization of interest rates is still sometime away.

Though there was plenty of uncertainty to go around, investor sentiment for the most part remained intact this quarter. US equity indices hit record highs, while M&A and equity issuance activity was strong, as evidenced by the Alibaba IPO in September, the largest in US history. Even with increased selling in September, US equity markets logged gains for the quarter, albeit modest ones.

However, in the short time since the quarter’s end, the landscape has changed rather drastically. Volatility has returned to markets as many of the concerns about economic and geopolitical risk continue to beleaguer sentiment. While it has been over three years since we have last seen market instability like this, this has not made us complacent. In line with the emphasis we place on risk management, we have already begun to examine steps to protect your portfolio. As always, we have looked from a number of perspectives at the potential scenarios that could adversely impact our investments, especially if conditions should deteriorate further. Doing so has provided a measure of readiness for such events, and allowed us to quickly identify areas where it might be prudent to reduce risk.

No one can predict the future, especially when it comes to markets, but as we say frequently, there are always good reasons to be optimistic when it comes to investing for the long term. Though there are undoubtedly plenty of causes for concern in an environment like this, this often leads many to doubt or even ignore tomorrow’s bright spots. Whether it is the prospect of US energy independence, the global economic impact of disruptive technologies, or the growth trajectory of emerging and frontier markets, we feel there remain a number of trends at play that will be major engines of growth for the global economy.

In all, while we believe there may be storm clouds on the short term horizon, we remain confident in our ability to manage these potential risks while identifying the opportunities they may create going into the balance of the year and onward into 2015. We greatly appreciate your business and thank you again for your support and trust.

Legal Information and Disclosures

This memorandum expresses the views of the authors as of the date indicated and such views are subject to change without notice. Drum Hill Capital, LLC (“Drum Hill Capital”) has no duty or obligation to update the information contained herein. Further, Drum Hill Capital makes no representation, and it should not be assumed, that past investment performance is an indication of future results. Moreover, wherever there is the potential for profit there is also the possibility of loss. This memorandum is being made available for educational purposes only and should not be used for any other purpose. The information contained herein does not constitute and should not be construed as an offering of advisory services or an offer to sell or solicitation to buy any securities or related financial instruments in any jurisdiction. Certain information contained herein concerning economic trends and performance is based on or derived from information provided by independent third-party sources. Drum Hill Capital believes that the sources from which such information has been obtained are reliable; however, it cannot guarantee the accuracy of such information and has not independently verified the accuracy or completeness of such information or the assumptions on which such information is based. This memorandum, including the information contained herein, may not be copied, reproduced, republished, or posted in whole or in part, in any form without the prior written consent of Drum Hill Capital, LLC.


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