Market Conditions

Manager Commentary

Equity market conditions continued to be challenging with the S&P 500 falling (5.04%) in January after falling (1.78%) in December. Intraday trading on January 20th pushed the S&P 500 significantly below the August 2015 lows, suggesting that a more serious breakdown was in progress; given the S&P 500's inability to hold any rally for more than a day or two, we continue to be cautious on a short, intermediate, and even long-term basis at this point. While we are cautious on the equity markets, we think it is premature to conclude that the bull market is over and that a bear market is around the corner. Most importantly, we continue to find sectors and stocks that are both outperforming the index and that are showing gains even in this environment, as money is still flowing into more defensive sectors and value stocks.

Fixed income markets rallied in January, providing both underlying returns and interest income for the more conservative allocations. Based on price action in the fixed income markets, expectations for substantial rate hikes from the Federal Reserve and a steepening of the yield curve have clearly fallen. 10-year rates have dropped precipitously from around 2.3% in December to under 1.9%. We believe these expectations will continue, even if the Fed does decide to raise rates again in March 2016 as has been discussed. This environment provides investing opportunities in the fixed income space that may be less correlated to the equity markets.

It has become clear over the past 6 months that turnover in the equity portfolio components must increase in order to keep up with market volatility and changing sector and stock relative strengths. In addition, in order to buffer the equity portfolios against volatility, we will be managing cash levels very aggressively. For the income-oriented portfolios, we continue to see lower volatility and investing opportunities, so cash levels in those components will be lower. Finally, in all portfolios, we will be exploring a higher number of positions for each portfolio component in order to buffer against the flash selloffs we have been seeing move through the markets.

We remain cautiously optimistic that the equity markets will find a foothold over the coming weeks and provide some upside opportunities in the short-term.

Portfolio Update

The leading sectors in 2015 were Cyclicals, Technology, Consumer Staples and Health Care; the laggards were Energy, Materials, Utilities, and Industrials. This leadership started to change in August 2015 and has continued through January. Since the short-term top in the markets on November 3rd, Utilities is now the best performing sector, followed by Consumer Staples. Financials have joined Energy and Materials as the worst three sectors since November; Technology, Healthcare and Cyclicals are flat. This rotation clearly demonstrates the ongoing stress in the equity markets, and the tendency towards late-cycle and defensive stocks. Here are some highlights of what we have been doing with several of the portfolio components:

• In Core Equity, we currently hold 42% cash. We have rotated out of Financials (e.g. Mastercard, Verisgn), out of Healthcare (e.g. Regeneron), out of Technology (e.g. Apple), and out of Consumer Discretionary (e.g. Amazon) in favor of the sectors and stocks that have shown relative strength. We have recently added more defensive names that are showing relative strength, including Hormel, Campbells Soup, Public Storage, JM Smucker, and Activision.
• In Growth and Income, we also currently hold 42% cash. We have rotated out of Financials (e.g. First American Financial, Wells Fargo, Chicago Mercantile) and out of generally underperforming positions (e.g. Conagra, Cintas, General Electric) in favor of stocks with solid yields and relative strength. We have recently added Extra Space Storage, Equinix, Xilinx, and Coach.
• In Sector Focus, we currently hold 50% cash. We have rotated out of Technology (e.g. Nasdaq Technology, Nasdaq Ex-Technology and Internet) and Consumer Discretionary sectors in favor of Utilities and REITs.
• In Tactical ETF, we currently hold 40% cash. We have rotated out of Technology (e.g. Nasdaq Technology, Nasdaq Ex-Technology, and Internet), Industrials, Biotech and Consumer Discretionary sectors in favor of Utilities and long-duration Treasuries (TLT).
• In Income and Growth, we currently hold 25% cash. We have rotated out of Financials (e.g. New York Community Bank, People's United Financial) and out of generally underperforming positions (e.g. Fly Leasing, Ship Finance). We have recently added Blackstone Kelso Capital and Sovran Self Storage.
• In Fixed Income Rotation ETF, we are currently fully invested. We have rotated out of high yield and floating rate senior loans in favor of long duration treasuries, Build America Bonds, and intermediate term corporate bonds.