A more selective market

Following a very strong 2013, the first quarter of 2014 has seen much more subdued equity market returns. Where 2013 had several major U.S. stock market indexes generate total returns in excess of 30% with low levels of volatility, 2014 has produced negligible changes for many of those indices.

Given that we have recently celebrated the fifth anniversary of the bull market for stocks that began on March 6, 2009, we are not surprised to see the market become more challenging. There are very few bull markets that endure for five years and fewer still that have lasted for six years.

Following a strong year, itis not surprising to see the stock market go through a period of digestion.

Richie Freeman, Managing Director, Portfolio Manager, Legg Mason

The trend towards a more selective market has continued to play out in 2014 as the importance of stock picking in generating competitive returns has made itself increasingly evident. Following a strong year, it is not surprising to see the stock market go through a period of digestion.

It is hard to gauge the strength of the broad U.S. economy during the quarter because the unusually cold weather had an atypical impact on so much of the country. We believe that the economy remains in a slow growth mode, domestically as well as overseas.

We saw several large merger and acquisition (M&A) [1]

transactions last year, and the trend has continued in the first quarter. Looking ahead, we continue to expect the M&A environment to be robust as companies starved for growth seek to find it through accretive acquisitions. Although interest rates remain at historically low levels, cues from the Federal Reserve (Fed) [2] about a rising rate environment may be helping to pull forward deals.

As we noted at the end of last year, we remain very high active share [3] managers. Because of our bottom-up, fundamental-driven stock selection process, our portfolios tend to look very different than the benchmark index. Our goal is, as it always has been, to invest where we find earnings and cash flow growth, good management teams and solid balance sheets.

Looking ahead, we continue to expect the M&A environmentto be robust.

Evan Bauman, Managing Director, Portfolio Manager, Legg Mason