While the financial markets are off to a strong start this year, driven by infusions of liquidity and encouraging economic news, we don't expect the "Bull Moose" to continue climbing much higher completely unchallenged. (The Bull Moose represents a jagged market uptrend, similar in shape to a moose's antlers.) As we move into the summer months and the U.S. presidential election shifts into high gear, we expect the still-unresolved policy issues to increasingly overshadow positive economic trends and get in the moose's way. In fact, we think the markets could see a 6% to 8% decline in this period, before picking up once again as we head toward year end. Longer term, the outlook becomes more encouraging, as we expect global rebalancing to continue unabated, along with a renaissance of manufacturing and improvement in jobs and housing here at home.

For now, our portfolio positioning remains unchanged. We are neutral equities versus fixed income, and would continue to emphasize a yield-oriented "get paid to wait" investment strategy. In other words, we would use rallies to take some profits where appropriate and rebalance toward lower beta or cash-flow-driven themes. We are not married to any one asset class. In this low-yield world, we are finding potential opportunities across all asset classes.

In fixed income, the mix should be tilted toward credit, high-yield managers, select sovereign bonds, high quality municipal securities, and specific mortgage-backed securities in a crossover (non-benchmark) custom strategy. In equities, risk management and the protection of capital in the summer months is our primary goal, but we continue to emphasize a collection of investments that should be major long-term beneficiaries of the global rebalancing theme.

LIQUIDITY DRIVES THE MARKETS HIGHER

The recent bank stress test results were the latest catalyst to push the markets higher — this time, to the 1400 level for S&P 500 and over 13,100 for the Dow Industrials. This is about a 10% to12% gain so far this year with less than three months on the books.

The positive catalysts this year have all been about liquidity — Europe's Long Term Refinancing Operation 1 (LTRO) and LTRO2, Bank of Japan, Bank of England, the Federal Reserve's Operation Twist — and now the enthusiasm over the stress test results. Emerging markets and other reflationary investments (tangible assets, materials, technology, etc.) have all been responding positively, as they have outperformed so far this year. And the liquidity spigot is likely to remain open for at least a few more months, given a very active and liquid European Central Bank and Fed chatter about potential additional liquidity programs such as Twist 2 (also known as Oliver Twist, as the market says "more liquidity please!"). The liquidity programs in Europe have helped bring down financing yields in places like Italy and Spain.

Helping the markets further, these substantial liquidity catalysts have all been accompanied by solid economic developments, particularly on the job front. Recent non-farm payroll numbers were better than expected, for instance, and the unemployment rate has fallen to 8.3% (its lowest in three years). Importantly, the drop was based in large part on job increases — not necessarily all due to a lower participation rate. These numbers tend to jump around a bit, but the trend (just like the first four months of last year) is for continued good job growth.

POLICY CLOUDS AND POTENTIAL PULLBACK AHEAD

While liquidity, profits and solid economic progress have so far outweighed policy issues for the markets this year, we don't expect this trend to continue. Starting in April/May, with the Greek and French elections, and increasingly as we enter the summer months, we expect investor focus to shift to the policy front and the pressure from rising gasoline prices. As the liquidity spigots gradually close, and the policy focus increases, we expect the markets to enter a consolidation phase.

The pullback could be in the 6% to 8% range if all of these concerns hit at the same time. If this were to occur, equities would likely pull back to 1285 to1295 on EPS of close to $100 for 2012. We still feel 1350 is the appropriate target given everything, both positive and negative, which is why we are neutral on the asset class. If stocks do in fact pull back as we're expecting, we would look for a resumption of the positive uptrend heading into the final months of the year, based on resolution of some of the overhanging policy issues. This, of course, assumes the geopolitical equation remains relatively stable as well. At this time, we are looking to further position portfolios for the next three years as a new business cycle develops and the world continues to re-balance.

GET READY: THE NEXT FEW YEARS

In the quest for the next growth cycle, many fall into the trap of thinking about "how it used to be" or believe the only way back is to reignite the old catalysts that drove the prior cycle (think residential real estate, housing, the U.S. consumer, etc , supported by "shadow" financing). This line of thinking ultimately leads to two paths: reentry into the old catalysts with an expectation of the prior returns, or ultraconservatism and the belief that a new growth cycle is not possible given the collateral damage and repair of the former growth levers.

This thinking is natural and is precisely what leads to a rather wide opportunity set as the economy repairs itself. Put another way, more fruitful opportunities arise at the least visible times and in environments in which most investors are second-guessing the opportunities or simply believe the next great growth cycle cannot happen anytime soon, given all of the visible concerns. Right now, it's true, the concerns are fully visible, but the underlying new growth trends are not.

We are clearly stuck in the middle of this mood, although we are witnessing signs every day that the contrary is occurring. As you travel across the country you can see tangible evidence of manufacturing coming back home; new technologies being developed in many cities (not just Silicon Valley); hydraulic fracturing activity securing new sources of oil and natural gas; energy infrastructure activity plowing ahead; railroads full of car loads; the farm belt and the nation's timberland alive and well; commodity input companies, ball-bearing manufacturers, heating and control systems firms all hiring; auto and automotive parts manufacturers becoming technological leaders and building cutting edge machines from the tires to the engine to the driving experience; and hospitals utilizing robots to transport materials, medicines and the like — and the list goes on. These catalysts are very different than those of the prior cycle, and if you are not involved in these industries, it can be difficult to see these changes unfolding.

This is happening across the country in companies of all sizes, but most importantly in small and mid-sized companies, where most of the job growth is. It is important to know that "capital" designated for investment will always search out and find an eventual home in the greatest risk-adjusted-return entity — wherever this may be in the world. In our view, this means coming back home to the U.S. It may be hard to see right now and the policy cloud may be obscuring a lot of this activity, but we believe it is coming quickly and will soon be very visible. This is all part of global rebalancing and, in our view, the next great growth cycle for the United States.

This not to say, however, that there are not interesting trends in other countries. We are particularly favorable on the demographics of many emerging market countries. We prefer a country-by-country approach when investing in this part of the equity asset class. In this case, we are searching for demographics that can allow the consumer base and their businesses and governments to spend and "upgrade their society" just as we did in the U.S. in the past few decades.

So, although we are concerned about the next few months and believe asset prices (namely equity markets and commodities) have gotten ahead of themselves, we are optimistic about the next three years. We think in terms of three years because that is generally a half of a business cycle and tends to be the amount of time it takes for return on capital to hit its stride. This holds true, in our view, for individuals, families, institutions, and even businesses, though perhaps not for governments.

Managing investments in this environment requires a much deeper understanding of the real reasons why capital flows from one opportunity set to another — even in times of concern. Get ready, it's coming — and in some ways it's already here.

PORTFOLIO CONSIDERATIONS

We would continue to take advantage of rallies to remove some market risk and lower cyclicality in portfolios across asset classes, awaiting more attractive prices in the coming months.

We are neutral on equities relative to fixed income overall. Within equities, we remain overweight large caps due to their greater exposure to the higher growth areas of the world and the benefits derived from global rebalancing. For sector investors, we are still finding attractive ideas in technology, industrials and certain consumer areas. We favor "cash flow driven" and global growth companies with strong brand names.

Within fixed income, we would emphasize corporate bonds and further emphasize high-yield. In the tax-exempt space, we prefer high-quality municipals (essential-service revenue bonds and general obligations of states and high-quality local governments). We continue to recommend the use of a crossover strategy in this environment. The crossover strategy incorporates opportunities in both the taxable and tax-exempt markets used together to help optimize both the after-tax yield and total return.

As for currencies, increased investor appetite for risk over the last few months has pushed the U.S. dollar lower versus most other non-euro and non-yen currencies. Overall, the currency markets have remained quite volatile so far this year in response to this change in demand. In addition, improving investor sentiment has already lifted the value of some local currencies back towards their 2011 highs. Whenever significant moves in the currency markets occur, concerns about intervention typically arise, especially for countries that rely on exports as a major source of growth. Despite the strong rally, we think wide scale intervention is unlikely at this time.

Within hedge funds, we would reduce market risk by focusing on managers of diversified strategies and "all-asset" managers as a replacement for equity-only managers.

In private equity, we would pay close attention to vintage year diversification among managers who have strong track records in the full private equity cycle. We favor managers that have expertise in distressed assets and others that have strong track records in the energy and technology arena.

We recently reduced the commodity asset class to neutral as they have rallied significantly since October 2011. We will revisit our position as we approach a consolidation phase in this asset class in the coming months. Gold should still be considered a "hedge" in portfolios particularly as the geopolitical landscape remains volatile.

Overall, we see more attractive opportunities at better prices in the reflationary asset classes (including equities) during the expected spring/summer consolidation phase. At this time, we will look to reposition portfolios for the next growth cycle over the coming three years.

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