A year ago we wrote: "Anyone who scans the investment landscape beyond the S&P 500 should be anxious." Market signals were flashing caution and most financial markets disappointed investors in 2015.

The biggest stock market story for 2015 is divergence of returns. The year 2015 is looking a lot like 1999 where performance was driven by a narrow group of stocks while most stocks did poorly. In 1999, technology stocks seemed to suck money from every other part of the stock market in what in hindsight was clearly a bubble.

The US stock market finally succumbed to selling pressure that has been affecting financial markets across the globe. For over a year volatility has been a feature of the world's currency, credit and commodity markets. In addition, many world stock markets have been in correction mode, especially emerging markets. Financial markets are interconnected so as poor economic news piled up last quarter all stock markets headed lower.

Is it time for a correction? That is the question that has been on the mind of many investors for some time now. Those who have ridden the wave since the ugly market bottom of March 2009 can afford to be worried as they weathered an uncertain recovery in the market and have generally seen their assets grow quite well. Unfortunately the fires of gloom were hot after the financial crisis with the media fanning the flames of pessimism. Therefore many late arrivers to the market may still be struggling to reestablish their previous portfolio values.

Is it time for a correction? That is the question that has been on the mind of many investors for some time now. Those who have ridden the wave since the ugly market bottom of March 2009 can afford to be worried as they weathered an uncertain recovery in the market and have generally seen their assets grow quite well. Unfortunately the fires of gloom were hot after the financial crisis with the media fanning the flames of pessimism. Therefore many late arrivers to the market may still be struggling to reestablish their previous portfolio values.

In spite of an increase in daily volatility the stock market has been stuck in a tight trading range this year. There has been a lot of huffing and puffing with markets going nowhere until very recently. Many stock indices were down for the quarter, some only positive due to their dividends and have returned less than 2% in 2015. The biggest action was a reversal in interest rates as investors anticipated the Fed raising interest rates later this year.

Markets have been churning but not really going anywhere for a while. Convincing arguments can be made that both stocks and bonds are pricey. While this doesn't mean prices will go down in the near term it does mean returns in some future periods may be more modest. It's a frustrating environment that makes investors impatient and a great time to discuss a key characteristic needed to be successful at investing.

Volatility continues to be the theme for stocks. The S&P 500 was down big in January, rallied even bigger in February and went down again in March ending the quarter up 0.95%. The real action was in Europe where stocks clocked double-digit returns.

Investing is a funny business. It is usually wise to invest the opposite of how the market feels to you. Six years ago stocks had fallen by 50%, the financial institutions that underlie our global economy were buckling, and the economy was in shambles. Investors were running from the stock market in droves. But because prices and expectations were low and because all the major central banks flooded the world with liquidity it was actually a great time to invest.

We expressed some concern about financial markets in last quarter's client letter and stated the theme of the letter was volatility. That characteristic carried over into the fourth quarter and caused our concern to heighten considerably.

Late in the summer we sold several fully valued stock positions and kept the proceeds in cash. We had trouble finding attractively valued alternatives, were alarmed about the falling prices in everything except large capitalization US stocks, and worried about the high degree of optimism in the stock market.

The theme for this newsletter is volatility. Not only are we seeing volatility in financial prices, but also in economic data and in some indicators we use to gauge the market's risk level.

We wrote after the strong first quarter to expect volatility to increase with stocks remaining the preferred asset class and that is largely what happened in the second quarter. Almost all risk assets wobbled after the Federal Reserve (Fed) hinted at a possible tapering of quantitative easing later this year. Regardless, most domestic stocks did well in the quarter.

While some investors have begun to return to US Equity (funds) there is still a large amount of money on the sidelines. End of year 2012 data shows investors have trillions in money markets and savings accounts. While there is no guarantee all that money will make its way back into the market the matriculation has begun.

Momentum from 2012s surprisingly strong performance continued into the first quarter of 2013 with stocks rising sharply. Our portfolios did well but lagged behind our benchmarks in the quarter. Taking a little longer view, over the trailing 12 and 36 months we mostly matched the double-digit gains of our benchmarks, which we are very pleased with since we usually underperform during strong market advances. So far this year small- & mid-capitalization, value, and domestic stocks were the market leaders, while international, growth, commodity stocks and Apple were laggards.

Since the turn of the century (2000) investors have not had to think much about tax-friendly investment strategies due to two major bear markets. But times have changed. The stock market is near all-time highs and many, if not all, of investors' loss carry forwards have been used up. More importantly, the Obama administration has already raised tax rates on the wealthy and the outlook is for tax increases to broaden as part of the solution to taming our debt and deficit problems. The bottom line is that investors need a new strategy for this environment.

When it was all said and done not much happened in the final quarter of 2012. Anxiety picked up immediately after the election as the bickering over the fiscal cliff escalated. In the end, the worst-case scenario was avoided at least for a couple of months and stocks ended about where they began the quarter.

To summarize our current position, while we acknowledge there are many risks we feel those are already reflected in the market and stock prices will drift higher as investors begin to recognize the positive developments outlined above. Analysts remain very bearish and continue to recommend a below-average weighting to stocks. Moreover, despite strong returns from equities investors have pulled money from U.S. stock funds for 18 straight months and are largely under-allocated when compared to history.

The stock market has surprised most everyone by rallying of over 11% since bottoming in early June. At that time the market had given up most of its double-digit gain for the year and seemed destined to continue to fall given the poor macro-economic environment . A heavy dose of uncertainty in Europe caused a further exit from investors. Fortunately going into that decline we had accumulated a healthy cash position. After the decline into early June we decided to increase our equity exposure despite the uncertainty for several reasons.

Stock markets retreated in the second quarter of 2012 but the damaged was minor due to a rally in June. After falling almost -9% by June 4th the S&P 500 ended the quarter off by only -2.75%. Our emphasis of Blue Chip stocks helped our performance during the quarter. Small and mid-cap stocks did a little worse, down around -4%, but the real damage continued to be European and emerging market stocks, falling by about -8% and -10%, respectively. The All World Index (ex US) fell over 16%.

There is a very important debate taking place on the best way to fix our economy between those who favor more spending versus those who favor austerity. Recently the spending camp has been very vocal in promoting their theory, including recent papers by Larry Summers, Brad DeLong and Paul McCulley, Zoltan Pozsar and a new book by Paul Krugman. What is not in dispute in the debate is that the private sector is deleveraging as an aftermath of the financial crisis, negatively impacting growth. What is in dispute is the appropriate response.

Overall both risk and return seem muted until something in the current environment changes. As long as yields on assets like bonds and cash remain low, it is hard for stock markets to collapse. But those yields are so low because central banks are frightened about the economic outlook which makes it very hard for a bull run to be sustained. While there has been improvement is some areas of the economy some are struggling to grow beyond previous levels.

So far in 2012 the stock market rally that began in the gloom last October continues to power ahead producing one of the best starts to a year in over a decade. The primary reason for the rekindling of animal spirits is the efforts of the ECB and our Fed. While we applaud these move that reduced the chance of another financial crisis in the short term, we question the speculative response by the stock market because long-term solvency issues still need to be addressed.

Most recent economic news has surprised on the upside, including improvement on the jobs front. We are not willing to argue yet that this is the start of a long-term trend, but it is nonetheless encouraging. We see no compelling reason to make significant changes to our strategy. Well maintain a cash cushion to protect from any downside volatility and continue to emphasize traditional blue chip, high-quality, and deep value stocks. At some point it will be advisable to broaden our portfolio but the time has not yet come.

Despite our macro concerns there are opportunities in the stock market, especially in the mega-cap arena where valuations are attractive and yields are high. Investors are in a unique period of time where they can own very high-quality stocks and generate a sustainable and growing income stream well above money markets and medium term U.S. Treasury securities. High-quality stocks have started to outperform after being ignored over the past decade. We believe this asset class is underrepresented in institutional portfolios and will benefit as this group rediscovers the value in this area.

The quarter was weak. If this is due to factors like the earthquake and high energy prices, the soft patch should end in the second half of 2011. However, even if this plays out, longer term headwinds remain. What has become clear is that we are in a period of suboptimal economic activity, despite aggressive fiscal and monetary policy. Almost all rich countries are still stuck with a toxic mix of modest growth, depressed housing markets, negative real interest rates, even more asset concentration at our financial institutions, and uncomfortably high unemployment and government deficits.

Currently the stock market is rightly focused on the many risks emanating from the macro environment. The European debt crisis, inflation and social unrest in emerging markets, especially China, and our economy has slowed while unemployment remains elevated.Most of these conditions were peculating well before the stock market started its decline in early May. We took advantage of that period to reduce risk in our portfolios by selling some stocks, especially the more cyclically oriented companies. As aresult our portfolios are holding up better than their benchmarks in the current correction.

Recently the financial media has been focused on the end of QE2, the process by which the Fed has been minting new funds to buy back U.S. Treasuries to pressure interest rates down. While they have been successful in driving rates down, the additional borrowing has put additional strains on the rising debt limits the legislature must continually approve. Regardless of whether the Fed officially ends QE2, as of June 30th it will not end the Fed?s Treasury buying spree as they will continue to repurchase Treasuries using the proceeds of maturing mortgages they took over in the financial crises.

The range of possible outcomes for the economy and market is still wide. We believe QE2 is simply a continuation of a boom-and-bust regime. Fundamentals are good now but are unlikely to be sustainable. Printing money to support asset prices cannot go on forever and usually ends in disaster like it did after both the technology and housing busts. Therefore, we dont believe this is a time to be aggressive. We are maintaining our strategy of emphasizing steady-growth businesses, with strong balance sheets, healthy dividends, attractive valuations and exposure to emerging economies.