Second Quarter 2018 Market Review

Q2 2018 – Tightening and Tariff Tantrums

The major indices performed much better in the second quarter than the first as very positive earnings reports produced gains of 3.44% for the S&P 500, 3.57% for the Russell 1000 and a whopping 7.75 % for the Small-cap Russell 2000. Bonds, as measured by the S&P US Aggregate Bond Index were down only 0.12% for the quarter and commodities as measured by the Dow Jones Commodity Index were up 1.06%. Finally, Bitcoin recovered a little bit in April and May before continuing its 2018 swoon (we haven’t gotten a call from anyone wanting to invest in Bitcoin or other Crypto currencies in several months).

While market volatility as measured by the VIX was nothing compared to the first quarter, the second quarter gains were not at all smooth and the number of one-day moves, up or down, of 1% or more was 26 out of 64 trading days in the quarter.

In our Q1 Letter we noted that, “There are four major factors driving the market. The factors are growth, trade wars, geopolitics and regulation of technology. “, and that opinion has not changed although trade wars and growth (and interest rates in particular), are having the greatest short-term impact on the markets.

In March, all eyes were on the Federal Reserve Bank and their monetary policy in the face of strengthening economic data. After a two-day meeting, the Federal Open Market Committee unanimously voted to increase its benchmark fed funds rate by 25 basis points, to a range of 1.50% to 1.75%. The Fed signaled two more rate hikes in 2018 amid speculation that it was considering adding a third increase. It did, however, raise its forecasts for hikes in 2019 and 2020, citing a stronger outlook on the economy. And then, in June, they voted to lift the target range for the federal funds rate by another 25 basis points to between 1.75% and 2% and signaled plans to do so two more times this year. That would be more than originally projected for this year, based on the risk of faster projected economic growth and low unemployment driving inflation beyond their 2% target.

We see these Fed moves as the #1 driver of the overall volatility in the market for several reasons:
The strategy of using interest rates to fight inflation is called “Contractionary Monetary Policy” and usually results in the Fed over-tightening by squeezing the buying power of households without a corresponding increase in wages. This, of course, can negatively impact revenue growth for businesses which can lead to negative earnings growth which, in turn, is a negative influence on stock prices.

As interest rates rise, savers have the opportunity to earn more interest on their debt instruments. Typically, higher rates draw money out of stocks and into interest bearing investments, adding another negative influence for stocks.

Higher rates also increase borrowing costs for businesses which may curtail business investment. Business investment is a driver of economic growth. Slowing economic growth would be, yet again, negative for stocks.
In their June statement, the Fed said that “In determining the timing and size of future adjustments to the target range for the federal funds rate, the Committee will assess realized and expected economic conditions relative to its maximum employment objective and its symmetric 2 percent inflation objective. This assessment will consider a wide range of information, including measures of labor market conditions, indicators of inflation pressures and inflation expectations, and readings on financial and international developments.”

We tend to live in the camp that economics is more art than science and believe we are all at risk when a governing body (Fed members are called “governors” after all) treats economics more like a science, believing that it can move levers and adjust the economy with scientific precision. Since the June 13 meeting, the S&P 500 has dropped approximately 2.5%. We don’t believe that this is coincidental and will continue to monitor Federal Reserve policies.

Regarding trade, the rhetoric is heating up as additional tariffs have been announced by the administration beyond those announced on Chinese imports. These new tariffs include a 25% tariff on imports of steel, and a 10% tariff on aluminum, from the European Union, Canada, and Mexico.

The tariffs angered U.S. allies, and have resulted in retaliatory measures taken by these countries as well as India. As these various measures and counter measures have been announced, we have seen brief market sell-offs in those sectors most likely to be affected. These sell-offs have been called “Tariff Tantrums” by some market pundits because of the panicked reactions to what could happen as opposed to reasoned action based on the fundamental data of what is actually happening. A recent article in USA Today went so far as to say that the tariffs in total will add over $5,000 to the price of every car sold in America! Interestingly, however, the article contained no analysis of actual cost data to support this claim.

We still do not think a full-scale trade war is in the cards as the risk of real economic slowdown is too high for all players involved. On July 2nd, Bloomberg ran an article showing how China is zooming to a record year of corporate-bond defaults in 2018. The article states, “Corporate profits have worsened this year and are unlikely to improve against the backdrop of an economic slowdown…” Therefore, it is not in China’s best interest to prolong any uncertainty regarding trade agreements with the US. Meanwhile the EU’s growth continues to disappoint. In 2017, the 19-country zone showed a decade-high rate of growth of 2.5%. By first quarter 2018, though, their growth had slowed to just 0.4 percent and Q2 results are not expected to pick up enough to sustain the 2017 performance.

We believe that the economic risks of a prolonged trade war are far too great for politicians to gamble with. How this gets resolved is still anybody’s guess. In June it was reported that President Trump proposed to the United States’ closest allies the idea of completely eliminating tariffs on goods and services. Apparently he did not get a very encouraging response. It may be that we start establishing separate trade deals with individual countries that contain better (but surely far from perfect) terms for the United States.

Concerning geopolitics in general and North Korea in particular, President Trump did meet with North Korean leader Kim Jong Un and the pair signed a document stating that Pyongyang would work toward (emphasis ours) “complete denuclearization of the Korean Peninsula.” While this is a far cry from final and ever-lasting peace, it is nonetheless a significant step forward. It must be noted that missile test launches and underground bomb tests in North Korea have ceased for the time being and there is certainly less concern around the possibility of an imminent nuclear world war than there was a year ago at this time.

Finally, we continue to watch the potential collision course between the FAANG companies (Facebook, Amazon, Apple, Netflix and Google, or it’s parent, Alphabet) and Washington D.C. While we are concerned that any legislation will create an increase in volatility of the major indices which are market cap weighted (the FAANG stocks make up 27% of the 2,595-security Nasdaq Composite), our bigger fear is the longer-term ramifications of legislation on growth and innovation.

For example, the Supreme Court’s decision on South Dakota versus Wayfair (now known as the “Wayfair Decision”) over South Dakota’s application of its sales tax to internet retailers who sell into South Dakota but have no property or employees in the state could have a chilling effect on the further development of e-commerce. Regardless of any opinion about whether this decision is right or wrong, we note that sales taxes, which exist in 41 states, apply to most purchases of retail goods within the state. The seller has the responsibility to collect the tax and forward the money to the state. E-commerce businesses will now have to collect the same sales tax collected by all other retailers. As e-commerce’s strengths over brick-and-mortar are more about convenience, wider selection, and lower costs, it’s unlikely this decision will hurt the larger e-commerce firms. As sales tax collection on e-commerce grew from almost zero to half of all sales, e-commerce has continued to grow sharply.

Our concern, however, is the ability of small e-commerce sellers to collect and pay sales taxes in a simple way. So, while the Amazons of the world will be able to absorb the costs of complying with sales tax initiatives, smaller retailers, as Amazon once was, may ultimately get squeezed out of the e-commerce channel. While this is just one example, one can see how government regulation can serve as a moat for the large, established tech companies to protect their market share from competition, whether it be in e-commerce, social networking, or healthcare.

During his March 2018 testimony before Congress, Facebook founder Mark Zuckerberg made clear that he was open to the government regulating Facebook in some way. “The question isn’t, ‘Should there be regulation, or shouldn’t there be?’ It’s ‘How do you do it?’” Zuckerberg told Zuckerberg knows that any legislation would not only impact Facebook but would also impact any small firm trying to compete with them and when it comes to business and regulation, the firms that can afford the best lawyers, accountants and technology will have a clear advantage over anyone else.

In conclusion, we continue to be cautiously optimistic, especially regarding US equities. A modestly bullish path forward is most likely. Net profit margins, fueled by the reduction in the corporate tax rate due to the recently passed tax reform, were at ten-year highs in 2017 according to FactSet. It is important to note, though, that net profit margins were improving on a sequential basis during all of 2017, prior to the tax bill becoming law. In any event, it appears the lower tax rate is more than offsetting any impact of higher wages and other cost increases, and many analysts expect even higher net profit margins for the S&P 500 for the remainder of 2018.

We believe that the best approach is to assess incoming data and update our opinions accordingly, stick with higher quality investments in correspondingly suitable allocations based on each investor’s financial and emotional tolerance for risk, and stay nimble.

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First Quarter 2018 Market Review

Q1 2018 – The Roller Coaster is on the Track

At the time of our last quarterly update, we had just finished a great year for the stock market.

Accordingly, we wrote “…we do not expect 2018 gains to match those of 2017.” So far, we have been more correct than we really wanted to be with the S&P 500 showing a modest decline year-to-date despite the exceptionally strong start in January.

The “modest decline” doesn’t adequately describe the very sharp moves, both up and down, by the S&P 500 and the Nasdaq Composite in the first three months of 2018.

Those sharp moves translate into an increase in market volatility starting in early February, as measured by the VIX, after spending a year below 12; a reading that is historically very low for the markets.

Some people who read stock market charts are describing the move in January as a classic “Blow-off Top” which, according to Investopedia is “A chart pattern that indicates a steep and rapid increase in a security’s price and trading volume followed by a steep and rapid drop in price and volume. While we see a steep and steady rise in price followed by a steep and rapid drop in price, when we add volume to the chart, we do not see the type of volume behavior that the definition is calling for.

According to wealth management company Gluskin Sheff’s Chief Economist, David Rosenberg, the S&P 500 Index is on pace for an incredible 100 sessions with a daily move of 1% or more. It’s still early, and there’s no guarantee this pace will continue. But it would place 2018 in rare company. In fact, this has only occurred in five previous years over the past 70.

Two of those years – 2001 and 2008 – occurred in the middle of a serious bear market decline. The other three – 1974, 2002, and 2009 – marked significant multiyear bottoms. But all five were incredibly volatile periods for investors.

What’s Going On?

There are four major factors driving the market. The factors are growth, trade wars, geopolitics and regulation of technology.

Each of the four factors has several potential outcomes, some being positive for the markets and others being negative. With each tweet, speech, data point and action that takes place, traders and investors recalibrate their outlook and adjust their positions accordingly only to have a contradictory tweet, speech, data point, etc., follow which forces them to recalibrate their viewpoint once again. No wonder the market seems confused.

US Economic Growth

With regard to growth, the bulls expect a boost from the Trump tax cuts. They are also anticipating inflation due to strong job creation, rising labor force participation and a low unemployment rate. They expect interest rates to rise but consider this more a sign of economic strength than a cause for concern. Strong growth is good for corporate earnings, and a little inflation is usually good for nominal stock prices, at least in the early stages.

Bears point to an economic slowdown in the first quarter (most projections are around 2% or less and by the time you read this the actual results should be known). This is consistent with the dismal average of 2.1% growth since the end of the last recession in June 2009. Stronger growth is impeded by demographic and debt head winds and the impact of Chinese labor and technology on global pricing power.

Tax cuts are not expected to help, because the drag on growth caused by increased debt will outweigh any stimulus from lower taxes.

The market is also concerned that the Fed is giving a weak economy a double dose of tightening in the form of rate hikes and the unwinding of several years of quantitative easing (loose monetary policy). We don’t think the Fed will push the economy to the brink of recession before they get the message and pause on rate hikes, probably after the November elections.

Trade Wars

To many, the possibility of trade wars are another conundrum. There is little doubt that a true trade war would reduce global growth. But many are wondering if we’re facing a trade war or just a series of head fakes by Donald Trump as he pursues the art of the deal?

For example, Trump imposed tariffs on steel and aluminum imports and then almost immediately carved out exemptions for Canada and Mexico pending progress on renegotiating NAFTA. Then the President trumpeted a trade deal with South Korea that imposed quotas on steel imports but almost immediately said that deal was conditional upon South Korean help in dealing with North Korea.

Trump has also threatened over $50 billion of penalties on China for theft of U.S. intellectual property, but within days China and the U.S. calmed market fears by announcing plans for bilateral trade negotiations.

So, is it really a trade war, or just a set of negotiating tactics?

We don’t believe a trade war is the real end game for the President. Trump is a New York businessman and he approaches the office of President like a New York businessman versus a politician. If his real goal is to create a more level playing field and address the burgeoning trade deficit we have with China, then a trade war would be a step backwards. We also question China’s strength in direct negotiation with the United States, While the news media would have us believe that China holds all the cards, the scenario changes when you actually look at the hand they have been dealt.

While it is true that China is the world’s fastest growing major economy, much of its growth has been from investment in an export-based model and now that strategy, wrought with examples of poor investment that we have mentioned before, may prove detrimental to their global ambitions.

China’s total debt has been building up in the economy during the last several years to support growth. China’s debt surpassed 300% of GDP in 2017. The People’s Bank of China has enabled the buildup of debt with “huge lending” to commercial banks. Debt-fueled consumer demand accounted for 71% of China’s economic growth in the first three quarters of 2016. China’s economic growth is being held up through extremely high credit generation. That is probably not sustainable for long without substantial damage to the economy and financial system.

Overcapacity in industrial enterprises is the biggest problem that China is facing today. China now has far more capacity than it – or for that matter, the world – needs. In some cases, overcapacity exists to the level of 30% of domestic need. The overcapacity problem has been exacerbated in recent times by the clear slowdown of China’s economy. Particularly, the slowdown in infrastructure projects and in the real estate sectors. Overcapacity in the manufacturing sector could take far longer to be sorted out, especially given the state of the global economy.

To tackle such conditions and avoid an impending crisis, China faces a very serious need to boost exports, as its domestic demand cannot absorb the goods that would be produced at the higher capacity utilization levels needed to sustain the economy. In such a scenario, any fall in Chinese exports due to a trade war has the potential to cause a huge setback to China’s plans and strategies.

Will the threat of a trade war work to level the playing field? Chinese President Xi Jinping has just promised foreign companies greater access to China’s financial and manufacturing sectors and pledged Beijing’s commitment to further economic liberalization despite (or because of) rising trade tensions with the U.S.

The news that China intends to try to do better is welcomed, but it’s nothing we haven’t heard before. There was no clear schedule for implementation of the proposals. Barring concrete progress on a trade deal, we suspect it’s simply a matter of time before tensions rise again.

Trump has left enough wiggle room to indicate he could back off the trade wars if he can attain enough concessions from China and the NAFTA countries. Our expectation is that trade talks and skirmishes are likely for some time to come. China will probably stall concrete action until the outcome of the November election to see if voter support for Trump increases or decreases. The advent of a Democrat majority in one or both Houses of Congress could change the political calculus.

Real Wars

Geopolitics is another on-again, off-again market driver particularly concerning war with North Korea.

If anyone had suggested, even three months ago, that North Korea would end up participating in the Winter Olympics and subsequently request a meeting with the U.S. to discuss nuclear disarmament, the suggestion would have been rejected outright as naïve. And yet, a rapid round of diplomacy involving summits including North and South Korea, China, and Japan, are all leading to a summit between Donald Trump and Kim Jong Un. Quite possibly these developments may point to a possible peaceful resolution of the impasse.

If you believe Kim Jong Un is dealing in good faith, you’ll be encouraged by these developments. If you believe Kim Jong Un is dealing in bad faith and just playing for time as he perfects his weapons technology, then you’ll expect that war is just a matter of time.

Take your pick.

Technology Wars

The final factor that is confounding markets is the potential for regulation of technology. Investors do not need to be reminded of the outsized impact of the FAANG stocks (Facebook, Apple, Amazon, Netflix and Google) on markets overall and the Nasdaq-100 in particular.

Suddenly, Facebook is facing scrutiny because of misuse of personal customer data and for acting as an accessory to alleged Russian meddling in U.S. elections. Amazon is under the gun on possible antitrust grounds, alleged government subsidies for shipping and Trump’s visceral dislike for the “fake news” Washington Post owned by Amazon founder Jeff Bezos.

There has already been a congressional hearing on one of these matters with a high likelihood of more to come. It’s possible that hearings could lead to legislation. Will Silicon Valley lobbyists dilute the legislation? Will antitrust allegations go up in smoke? Or will populist outrage with the tech giants lead to a sea change and aggressive enforcement as we saw with the Rockefeller trusts in the early 1990s?

The correct answer is that no one knows. This will be a battle between corporate lobbyists and populist outrage. Usually the lobbyists win, but this time may be different.

None of these four issues will be resolved quickly. It may take six months of data before the Fed realizes the economy is weak despite tax cuts or before growth bears throw in the towel.

Trade wars usually play out over years, not months. If Kim Jong Un wants peace, we should know fairly soon. If not, the countdown clock to war, currently on pause, will resume ticking.

The hearings and legislative process involving technology regulation could easily take a year or more to play out. Members of Congress like to milk these issues for campaign contributions from both sides before resolving them, so quick results here are unlikely.

Summing Up

The problem for investors is they have to wake up every day and commit capital whether they know the outcome of these issues or not.

If growth is strong, trade wars fizzle, North Korea wants peace and the tech lobbyists prevail, then Dow 30,000 is a possibility.

If growth is weak, trade wars escalate, North Korea is dealing in bad faith and popular outrage hamstrings the tech giants, then Dow 20,000 is the more likely market destination.

Of course, other combinations of these factors are more probable than a uniformly positive or negative scenario. Mixed results, though in unknown combination, are entirely possible.

Our estimate is that a slightly more optimistic, modestly bullish path is most likely. Money is still going to flow where it is best treated. We do not believe the economy is so strong that interest rates will rise enough to trigger an immediate mass inflow of investment into bonds. But it’s unwise to put a stake in the ground on any particular outcome. The best approach is to assess incoming data and update our opinions accordingly, stick with higher quality investments in correspondingly suitable allocations based on each investor’s financial and emotional tolerance for risk, and stay nimble.

It is highly unlikely that market volatility will go away any time soon because the issues now driving that volatility, if history is a guide, will not be resolved soon.

An update on Cryptocurrencies

For those who were worried last quarter that they were going to miss out on the next great wealth making investment, we have good news. Bitcoin, still the leader of the cryptocurrency revolution has dropped dramatically from its most recent run up.

This is not the first time this has happened, nor do we believe it will be the last. The cryptocurrency market is still in its infancy and has been compared to the Wild West. We do believe that in the long term, the promise of the underlying technology behind these currencies, Blockchain, could prove to be beneficial to a number of industries, but many of the companies involved in Blockchain are being valued on hopes and dreams instead of fundamentals.

In such an environment, picking winners from losers is still more closely related to picking numbers on a roulette wheel than it is to common sense investment principles.

We continue to monitor the markets for real opportunities based on the value-based approach that has served us well all these years and if the right company comes along, we will not hesitate to add it to our universe of stocks.

Until that time, we still regard investments in these currencies or blockchain start-ups as strictly speculative and not suitable for any core portfolio strategy.

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Fourth Quarter 2017 Market Review

Look Both Ways as You Cross the Street?

Stocks, as measured by the Russell 3000 Index, rose for a fourth straight quarter with a gain of 6.34%. Bonds, including treasuries, were up 0.39% even with the Federal Reserve hiking interest rates a quarter of a point in December. Commodities (as measured by the Bloomberg Commodity Index) again had a strong fourth quarter led by energy and metals. And Bitcoin…….well, despite its unprecedented increase in value, we still consider Bitcoin to be a medium of exchange and better suited as a store of wealth versus a growth or income-producing investment.

2018 Outlook:

As you recall, one of the key variables we identified as impacting the market was meaningful tax reform and, while far from perfect in our view, it is hard to argue that the reforms are not meaningful.

For those of us old enough to remember, the tax reforms of the 1980’s impacted the economy positively through deep cuts to personal tax rates. This bill delivers only modest personal relief for most of us who pay taxes, but it does create a much more favorable business climate than we’ve seen in many years through significant corporate tax reduction.

While we may see only modest gains in our personal tax bills, we will all certainly benefit from any gains in real economic growth that may be spurred on by these tax changes. If demand exceeds capacity, as it often does when economic growth is robust, that will fuel the need for capital investment in new and expanded factories and facilities across the nation. That expansion could push up the demand for labor and increase hiring and wages.

Economic growth should translate into increased revenue which, if companies hold their costs in line, would result in enhanced rates of earnings growth. Faster growth would have a positive impact on one of the fundamental components of stock pricing.

Interest rates will still be favorable for borrowers and near historic lows even if the Federal Reserve proceeds with its three projected interest rate hikes in 2018.

Couple all that with an already improved business regulatory climate and you have a constructive environment for continued market gains in 2018.

But while these catalysts typically signal that stocks have more room to run, there are still risks worth watching and we do not expect 2018 gains to match those of 2017.

The first question pertains to the effect of the tax cuts on the market from this point. We have heard opinions from “experts” that the reforms have been fully priced into the market or not priced in at all. We believe the truth is somewhere in between those two extremes, but there is a strong possibility that prices have gotten at least a little ahead of fundamentals. So, it would not be surprising if the market pauses until earnings announcements enable investors to better calibrate how “cheap” or “expensive” stocks really are.

Another common assumption is that major companies will repatriate the billions of dollars currently held overseas and use that capital for domestic investment, acquisitions, and share buy backs. While we do believe that this will occur to some degree, we also think that at least some of the repatriated cash will be applied to debt reduction.

Reducing debt would strengthen balance sheets which is good in the long run but it doesn’t necessarily drive increases in stock prices in the short run. Since these companies will determine what is in their own best interest, it is impossible to draw any macro conclusions about the impact of repatriation. We would prefer to err on the side of caution.

The risk of some sort of military conflict with North Korea still exists. The missile tests continue, bomb tests continue, military drills continue, and rhetorical spats continue. We do not see a peaceful path to eliminating the nuclear threat presented by this regime. Any resolution that results in a nuclear exchange occurring anywhere in the world will certainly rock the markets for some period; how significantly and for how long is open to debate.

International Economies – China

China’s growth rate has taken a hit this year which makes sense since you can only build so many empty cities. Unfortunately, GDP calculations in China have long been suspect making it difficult to determine the soundness of the Chinese economy. For instance, if the government spends money to have a hole dug, then spends more money to have that whole filled, economic measurements will show GDP growth even though there was no need to have the hole dug in the first place. Add to this slowing growth extreme debt levels, capital flight, corruption, and pollution, and you have a large economic house of cards that may become impossible to stabilize. The Chinese economy is now so large that even a moderate slowdown will negatively impact economic growth in much of the world with a likely knock-on effect for stock prices.

The Fed

With all major economies expanding, there is a possibility that central banks begin raising rates overly aggressively; particularly our own Fed as well as the European Central Bank.

We know that the Fed has already started to unwind their balance sheet and is now gradually ratcheting down the quantitative easing by $20 billion per month in January and further to $50 billion by October. As the Fed’s appetite wanes, the Treasury will need to issue more debt into the market, putting upward pressure on rates. We also know that the Fed wants to raise interest rates at the short end of the maturity spectrum sooner rather than later in preparation for the economic downturn that will inevitably occur at some unknown point in the future.

Meanwhile, the ECB announced in October that it would cut its quantitative easing to €30 billion a month in January 2018. That’s a 50% cut from the prior level of stimulus. At least some portion of that has found its way to the stock market over the last decade.

Couple these actions with the Fed’s projected interest rate hikes and it’s clear there is a risk that the Fed might “hit the brakes” too hard and too fast and adversely impact economic growth. If there’s anything that we have learned over the years, it’s that monetary policy is just as much art as it is science.

Yet another reason to believe that 2018 will not be like 2017 is that 2018 is an election year. As we have seen in the past, elections can bring market volatility. If the special elections last year are any kind of an indicator, we expect the 2018 political scene to be as contentious and over the top as anything we have seen in our lifetimes. The markets don’t like uncertainty, so we could very well see a bumpy ride starting sometime during the run-up to the elections.

When we look at all these factors we do not believe that we should be taking a defensive posture with our investments, but at the same time it would be a mistake to be complacent. Timing the markets is a dangerous game; in this environment, it makes more sense for investors to focus on making sure they are well-positioned to pursue personal goals. Our risk-based allocations are constructed using the historic performance of the component strategies in varying market conditions as a guide and, in our opinion, represent a rational approach to dealing with market uncertainty.

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Second Quarter 2017 Market Review

With the current stock market uptrend now the second longest bull market on record, and the economic expansion the third longest since the end of WWII, there’s been a lot of talk and, in some cases warnings, that both of these trends are in danger of coming to an end. Our short answers to these two questions are no and no.

First the economy. While we admit that very recent economic releases have come in somewhat below expectations, there are a number of solid reasons to believe that economic growth will continue to move forward. First and foremost, the Federal Reserve, while gradually bringing short term rates up to more normal levels, continues monetary policies that are far from being restrictive and has no desire to slow or stop economic growth since inflation is well below the target of 2%. The Fed, of course, also understands that the continuation of economic growth is important to lowering government deficits.

And because U.S. Corporations today derive about 50% of their profits from overseas, we are also benefiting from the recent upturn in Europe and Japan, as well as from the policies of their Central Banks which are on the same growth objective as our Federal Reserve. This synchronization of global markets presents a strong case that economic growth will continue to grow in the U.S. despite having already achieved one of the longest expansions over the past 70 years. In our opinion, there is a near zero percent chance a recession will present itself in the next 12 – 18 months.

That’s very good news for the stock market which tends to react to, with leads and lags, to the ups and downs of the economy. Other factors, such as a major geopolitical crisis or a financial crisis, can also cause a bear market. At the current time, however, we do not recognize there to be any critical financial issues or serious geopolitical risks.

While it’s unfortunate that North Korea apparently has nuclear weapon capability, they suffer from shortages of motor fuel, food, equipment and sanitation and health care for troops in the field. The Kim family regime recognizes they would lose control of the country should they start a war they have no chance of winning against the U.S. and its allies.

We have been positive on the outlook for U.S. stocks over most of the past eight years. One day we will turn bearish, but that won’t happen until we believe a recession is on the horizon. Right now we see more positive factors than negative ones. U.S. business and consumer confidence and corporate earnings are at record levels.

The number of available jobs is near record levels and more people are returning to the workforce. Consumer and business sentiment are near record highs while low inflation and interest rates justify (support) current stock prices, in our opinion.

Other issues that could temporarily derail the current uptrend of the market are unfortunate events like the recent Virginia disturbance and past Government shut-downs due to politicians bickering over the nation’s debt ceiling. These and similar issues tend to cause only short term disruptions for the market.

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First Quarter 2017 Market Review

Equity investors began their celebration immediately after the November elections. On the other hand, fixed income investors made an initial exit from the bond market only to cautiously creep back in after November’s shock. The markets were reacting to President Trump’s determination to “make America great again”, partly by reviving an economy that never was able to fully recover its momentum after the Great Recession of 2008-2009.

While a bit off of its closing high on March 1st of 2395.96, the S&P 500 has risen 13.3% from a closing low of 2085.18 on November 4th to end the first quarter at 2362.72. The Barclays Aggregate Bond Index dropped approximately 3.5% from its pre-election level to its bottom in mid-December. It has since recovered 2.2%.

Interestingly, the stock market has begun to falter ever so slightly as the Republicans’ failure to repeal and replace Obamacare has caused second thoughts about their ability to reshape the economy, especially through broad based changes in tax policy. The reasoning seems to be: “If they can’t agree on something that touches 14% of the US economy, how will they be successful on taxes which touch every aspect?” Only time will reveal their ultimate level of success.

As has been the case over the last months, the economic outlook is not without a mix of positive and negatives. Consumer confidence is at its highest level since 2000, and small business confidence remains high and at levels not seen since before the financial crisis.

The Federal Reserve is confident enough to have raised rates in March and is talking about ongoing rate hikes over the course of the year. Nonetheless, there are some signs of possible trouble ahead. Retail sales remain weak, with the latest report showing just a 0.1% rise. Prices of used cars are in steep decline and manufacturers are offering large incentives to move new cars off the lots.

Meanwhile, pending sales of existing homes reversed course to rise sharply (+5.5%) but were outdone by new home sales (+6.1%) and new home construction (+6.5%). Conversely, multifamily starts fell 3.7%. Demand for oil looks to be somewhat weak as evidenced by recent oil price drops. Ominously, we have also seen the biggest jump in unemployment claims in six months, yet today a very strong jobs report showed companies added 263,000 to their payrolls in March, far surpassing the 185,000 expected. Our conclusion is that while economic reports are a bit muddled, we don’t see much risk of an imminent recession.

Despite looming interest rate increases, long term bond prices rose in the first quarter and short term bonds fell. The fixed income holdings in your portfolio were up a respectable 0.41% with the government holdings detracting from a stronger showing by the portfolio’s corporate bonds.

The stock market did finish a consolidation phase in late January and continued its upward move to reach new highs. Valuations remain stretched, but the market has already had a minor correction in the wake of the healthcare reform debacle and that may be all we get for a while. In all likelihood, as long as a generally positive view on government reforms and modest rate hikes stays in place and corporate earnings don’t disappoint, we would expect the stock market trend to remain upward.

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Fourth Quarter 2016 Market Review

Investors spent much of the last few years concerned that the economy might slip back into a recession given the slow growth environment we were experiencing. This perception changed abruptly during the fourth quarter as indicated by the surveys for consumer confidence, investor confidence and small business expectations which all turned strongly positive. Since better economic growth usually results in higher inflation and interest rates, financial service stocks dominated with a 21.1% gain during the fourth quarter while the energy sector (inflation beneficiaries) was the second best with a 7.28% increase. Dividend stocks, on the other hand, were held back by an increase in inflation expectations and increased only 0.49% for the quarter.

Value stocks significantly outperformed growth stocks during both the fourth quarter and for the year, while small stocks also easily beat large cap stocks during both periods. Value stocks benefit the most from better economic conditions and the new administration’s plan to lower corporate tax rates would benefit small companies more as they tend to have higher effective tax rates. The S&P 500 increased 3.82% for the quarter and 11.96% for the year. And finally, with interest rates moving higher, 5-year municipal bonds declined 2.76%, while Intermediate Gov’t/Corporate bonds dropped 2.1% for the quarter.

We believe the sudden and sharp improvement in business and investor expectations has played an important role in the stock market’s success of late. As such, it may be that prices (stocks) have advanced too far ahead of the improvements investors are looking for. Under these circumstances, stock prices typically tend to consolidate or even correct lower as investors wait for the improved expectations to become a reality. This looks to be what has been happening during the month of January thus far. From our perspective, we see economic conditions and corporate profits already improving and this higher level of growth will continue throughout the coming year. As a result, it should be a favorable environment for the stock market.

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Third Quarter 2016 Market Review

The stock market shifted gears during the third quarter as investor concerns over the economy faded. As a result, growth oriented equities (like Technology stocks) moved from the worst performing (-2.84%) economic sector during the second quarter, to the best (+12.9%) during the third period. And because higher inflation and interest rates are highly correlated with faster economic growth, interest rate sensitive stocks such as utilities and telecom issues both declined almost 6% during the quarter. Third quarter corporate earnings came in above estimates and interest rates started an uptrend which accelerated over the next several weeks. The S&P 500 stock index increased 3.85% while the bond market, based on Barclays Intermediate Government Corporate Index, increased 1.21%.

Despite the near complete absence of fiscal stimulus, the economy showed good improvement during the third quarter and given the recent strength of the stock market, investors appear to be betting that the improved trend will continue. Corporate profit growth improved in the third quarter and forward earnings estimates rose to a record high during the first week in October. The CRB raw industrial spot price index has recovered smartly of late. That’s good news since there’s a very strong correlation between the level of inflation and earnings growth. Jobless claims are at their lowest readings since 1973 and wages are beginning to improve which should support higher levels of consumer spending going forward. Finally, history shows that the absence of political gridlock in America has been good for economic growth and stock prices no matter if it be Democrats or Republicans in control.

As always, we value your business and our relationship with you. Please don’t hesitate to call if you have any questions or comments, or if there’s any way in which we can be of service.

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Second Quarter 2016 Market Review

In all our years of working in and studying the stock market, we cannot recall when so many investors got it wrong. “Power to the People!” was a widely heard slogan in the U.S. during the 1960s. The U.K. citizens seemed to reflect that sentiment in late June when they voted to exit the European Union. Shortly after the vote it was found that many of the voters didn’t understand what they were voting for and that the advocates supporting the exit didn’t have even a rough outline of a plan as to how to accomplish an exit. Talk about creating a negative investment environment. The stock market, after moving in a modest uptrend for most of the second quarter, moved sharply lower in response to the results of the U.K. vote which was almost completely unexpected.

Fortunately, the U.K. accounts for only 3.9% of U.S. exports and the economic numbers for the U.S. were above expectations in the weeks following the market decline. In the end, the S&P 500 increased 2.46% for the second quarter and 3.84% during the first half of the year. For the second quarter, last year’s beaten down Energy sector posted the strongest gains at +11.62% while the Information Technology sector came in last place with a decline of 2.84% for the quarter and near the bottom with a decline of 0.32% for the first half. In the fixed income arena, interest rates in general declined to record or near record lows influenced by concerns over global economic conditions, especially in Japan, and in parts of Europe where a number of government rates are below zero. The U.S. 10-year Government Bond rate recently hit a record closing low of 1.395% while the Intermediate Government/Corporate Bond Index increased 1.59% for the quarter and 4.07% for the six months.
While the economies of most free world countries are not running on all eight cylinders, we are encouraged by the progress we see in the U.S. at the present time. Consumer spending has picked up, jobs are being created at a reasonable rate, wages appear to be firming, the Energy sector looks to be stabilizing, and monetary policy (i.e. low interest rates) continues to have a positive influence.

Importantly, all these factors are contributing to a better earnings picture. Compared to a somewhat dismal earnings trend of 12 months prior, analysts have been raising their earnings estimates for the
past 11 of 12 weeks. While valuations are not overly compelling, they are lower than they were at the beginning of the year, clearly lower than the peaks recorded in 2015 and they should be supported by the positive direction of the economic and corporate profit trends that we expect. Barring some obvious unforeseen political or terrorist event, the investment environment should be favorable for most of the time over the next 6 months.

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First Quarter 2016 Market Review

To say that the past three months have been a volatile period for the market is not an exaggeration. With terrorism in the background, oil prices plummeting, negative interest rates in Europe and Japan, and economic growth in question throughout most parts of the world, January got off on a terrible note, sending the Dow to its worst 10-day start to the year on record going back to 1897! Although the market began to turn back up during the latter part of January, it started to decline sharply again in early February, eventually bringing the market down to a year to date total return of -11.4% by mid-February. Fortunately, the fears of an economic meltdown gradually dissipated from that point on and the market actually ended the quarter up a modest 1.35%.

Nonetheless, the first quarter was one of those nervous market periods where so-called defensive stocks (as opposed to growth stocks) took their place on the leader board given the perceived stable nature of their operations. The Consumer Staples stock group (Proctor & Gamble, Coke, Clorox, etc.) is a perfect example of defensive type stocks. This sector accounted for 47% of the gains reported for the S&P. On the other end of the spectrum, Consumer Cyclical stocks ranked near the bottom during the period in terms of returns.

In the end, what matters most to investors is that economic growth remains healthy enough to increase consumer paychecks and grow corporate profits within a reasonable inflationary environment. The stock market began to move higher again in mid-February in response to what turned out to be an improvement in U.S. economic conditions. In addition, inflation is beginning to move higher and, excluding food and energy, is close to the Federal Reserve’s 2% objective for perhaps the first time since the stock market began to move higher in 2009. The velocity of money is also beginning to improve (+8%) which means the economy is finally making use of the extra money the Fed has been printing over the past several years. Barring a rash of terror attacks, talk of interest rate hikes, or another hit on oil prices, the investment environment should be OK for at least the short term.

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Fourth Quarter 2015 Market Review

Having finally taken the plunge to initiate a cycle of rising interest rates, the question uppermost on many investors’ minds is whether or not the Federal Reserve will follow through and continue to raise rates over the course of 2016. While the recent performance of the US economy is less than uniformly supportive, policy makers indicate that they believe it is strong enough to support increasing rates.

But there is more to consider than just the domestic economy. As you know, with the advent of the internet, instantaneous global communications, and increased cross border trade, no single country is immune to what is going on in the world around it. We have seen a significant slowdown in the growth of the Chinese economy, collapsing commodity prices (particularly oil), and a startling drop in international freight rates and traffic. On top of these fundamental issues, there are political issues including terrorism and huge immigration flows into Europe (and the US).

Interestingly, the Fed is caught in something of a lose – lose position from a market perspective. If it continues to raise rates, investors may view that as too much of a headwind for securities prices. On the other hand, should the Fed back down from rate increases, that climb down may well be interpreted as a lack of confidence in the economy, both at home and abroad. One thing that we can be reasonably sure of is that, should the Fed continue on its course toward normalization of interest rates, the necessary increases will be slow. Under either scenario, a low rate environment is expected to persist for some time.

The stock market repeated its August swan dive in December driven primarily by declining oil prices and China fears. This drop, unfortunately, was not enough to enable your Rydex fund holding to remain above its end of September value. For the quarter, it fell 7.34% and 4.39% for the full year. Fixed income holdings also show a negative yearly return of 0.66%. This reflects the effects of the rate increase as well as investor aversion to anything but the very highest quality issues.

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It’s Never too Early to Start Investing for Dividends

“The three worst things that ever happened to Investing are Ameritrade, E*Trade and Scottrade!”

Stock Market Data Showing Constant FluctuationsThat’s how I usually get started when I’m ready to climb on my soap box and discuss building wealth with anyone willing to listen. While I believe all of these institutions are reputable (in fact I have an account with Ameritrade), the “trade” in each of their names represents what I feel is a disturbing aspect of the investment industry; short-term thinking.

Instead of focusing on building a foundation for sustainable wealth, the focus tends to be one of beating the markets on a monthly, weekly, or even daily basis. Instead of finding well-run businesses that could eventually provide a predictable source of income, many investors are looking to derive income from trading, jumping in and out of the market; sometimes in minutes.

The Short Term Day-Trading Mindset Puts Long Term Financial Security at Risk

The day trading and active trading phenomenon has been a huge boon to the various discount brokers. Each transaction puts money in their pockets, regardless of whether it was profitable for the trader or not. There are a lot of disasters that result from the “trading your way to financial independence” mindset, but none are on the brokerage side of the business.

Even today, after two devastating stock market sell-offs in 2001 and again in 2008, individual investors are still looking to maximize their “total return” by whatever means is available to them. This is particularly true for pre-retirees who believe the best approach is to build up as much wealth as you can and then convert it over to “safer” investments after you retire.

Anyone following this approach saw their accounts drop considerably in value in 2001 and 2008 (and in the case of 2008, take nearly five years to recover if they stayed invested and performed like the broader market). But for those who manage their own accounts, there is a substantial risk of over-trading as market perceptions (read emotions) change. This often results in buying near market tops and selling near market bottoms: with the predictable result of wreaking havoc with your portfolio and your financial plans.

When you know you can sell something almost as soon as you buy it, it affects how you think about the purchase in the first place. You can be careless because you can get out quickly. With constant measurement of returns and the oppressive 24/7 media cycle, the pressure to act is immense.

You see a stock like Tesla (TSLA) start to run up and, remembering what happened in 2013 (the stock more than quadrupled), you buy in and try to ride the trend up just when it suddenly reverses (as it has three times since 2014) and hands you a short term trading loss.

Less Glamorous Dividend Investing Can Be a Great Long Term Investment

Check for Dividend Payment from Dividend Focused Investment PortfolioCompared to the excitement of finding the next moonshot stock, dividend investing is boring. In using dividends to secure financial independence, a portfolio of securities is run like a rental real estate portfolio. Each investment is made in anticipation of a future cash flow and judged versus the initial cost of that investment. The investor does not make any assumption of the future price of the stock as that price could be momentarily “unfairly” impacted by the market’s lack of enthusiasm for the business.

One of my favorite examples of this is Clorox (CLX). Clorox is almost never in the news; even during earnings season it hardly gets a passing mention. Yet Clorox has been paying a dividend since 1968 and has increased its dividend payment for 38 straight years.

In fact, based on numbers I took from Yahoo Finance, if you had started in 1990 with a $5,000 investment in Clorox and then made annual $5,000 investments plus the reinvestment of all dividends received, after nine more years you would have approximately $211,970 in your account. Your total investment would have been $53,614.33.

For the next 10 years from 2000 to 2009, if you only reinvested the dividends from your Clorox stock, the value of your shares would have grown to approximately $246,000. More importantly, the dividend income stream starting in 2010 would have grown from $9,574 per year to $12,572 in 2015. That’s a little over $1,000 per month that you would have received in 2015 by holding the stock. Let’s be clear: you would not have had to sell shares to have realized that monthly income.

For those of you keeping score, that’s an annual return of over 13% on your total investment of $92,743.72.*

Smaller Dividend ETF Investing Still Provides Strong Returns

Some would argue that this is a bad example since no one in their right mind would maintain such a large concentration in only one stock (assuming the $5000 invested is an IRA contribution). So let’s look at a more “realistic” example. Instead of investing in one stock, we will invest in an Exchange Traded Fund (ETF) called the SPDR S&P Dividend ETF (SDY).

This ETF “seeks to provide investment results that, before fees and expenses, correspond generally to the total return performance of the S&P High Yield Dividend Aristocrats™ Index. It has over 100 holdings comprised of companies from 10 different sectors that have a history of at least 20 consecutive years of dividend increases. It selects companies from the S&P 1500, which includes midsize and small-cap companies. That means the High Yield Dividend Aristocrats probably has some balance of both growth and income, as smaller companies are usually assumed to be faster growing than larger companies on average. With over 100 holdings, the risk of over-concentration in any one should be eliminated for all practical purposes.

Again using data from Yahoo Finance, I ran a ten-year study starting in 2006 using just $2,500 as the initial investment (assuming the other $2,500 would be invested in a non-correlated asset). Additional annual investments of $2,500 were made and all dividends were reinvested at the end of each year. By year-end 2015, the total annual contributions equaled $25,000 and reinvested dividends totaled $8,179 for a total investment of $33,179. The account balance at the end of 2015 was $42,099 and the total amount of dividends paid in 2015 was $2,436 (which is 7.3% of the $33,179 total investment).**

Again, we see that an investment plan focused on growing long term dividend income can be a very effective way to conservatively build a future income stream.

Try Summit’s Dividend Based Portfolio and Absolute Return Allocation

Can we do better than SDY? Sure! Summit has a dividend-focused portfolio consisting of 30 or so dividend paying stocks that are judged to be undervalued and therefore represent an opportunity for capital appreciation in addition to dividend income. We also combine this portfolio with a low correlation volatility-capture strategy in our Absolute Return Defensive allocation for those investors who are seeking dividend returns with less year-over-year volatility than equities alone.

In any case, the most important element of successful dividend investing is time. Time for accumulation and dividend compounding to start producing significant monthly payments that can supplement your other sources of retirement income. When it comes to dividend investing, time is the one thing that you can never get enough of.

So what are you waiting for?

Contact Summit for a free consultation on a long term dividend focused investment portfolio.
* In this study, for illustration purposes only, shares were purchased on the first trading day of each Calendar year. Your results may vary depending on the assumptions you make in trying to recreate this study. No assertion is made as to the accuracy of data provided by Yahoo Finance.
** In this study, for illustration purposes only, dividends were reinvested at the end of the week following the last dividend payment and additional shares were purchased on the last day of the Calendar year. Your results may vary depending on the assumptions you make in trying to recreate this study. No assertion is made as to the accuracy of data provided by Yahoo Finance.

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There is Still Time to Fund Your 2015 IRA

Many of us view April 15th*, the date by which we must file our tax returns for the preceding year, as an important deadline. However, for all of us, it actually represents a much more significant deadline:

Tax Day is the last day that we can make our 2015 contributions to our Individual Retirement Accounts.

Even if you have a 401(k), you can still have either a Traditional or Roth** IRA to make the most of your retirement savings. Your contributions may also be tax-deductable, which means they could reduce your taxable income and, therefore, the amount of tax you have to pay. If that’s the case, then each year you make a contribution, you could reduce your income tax and any gains in your account in your account will grow tax deferred.

The earlier you start saving with an IRA, the sooner you can start reaping the benefits of compounding and increasing your potential retirement income. Using the financial calculators at****, you can see the potential results.

Results Summary for 30 Year Old Investor Contributing $5,500/Year

Graph Showing Results of Max IRA Contributions for 30 Year Old by Age 65

An individual age 30 with an initial $5,500 contribution and a $5,500 contribution every year thereafter can potentially accumulate a significant amount of money for retirement by age 65.***

  • Starting balance: $0
  • Contribution for 2015: $5,500
  • Total contributions by age 65: $192,500
  • IRA total before taxes: $813,524
  • Total for an equivalent taxable account: $413,051


Results Summary for 30 Year Old Investor Contributing $300/Month

Graph Showing Results for 30 Year Old Investing in IRA

Even if you cannot contribute the maximum allowable to your IRA, you can still make substantial progress toward retirement with smaller amounts. For example, even with a contribution of $300 per month, the benefits of tax deferred compounding become readily apparent.***

  • Starting balance: $0
  • Contribution for 2015: $3,600
  • Total contributions by age 65: $126,000
  • IRA total before taxes: $532,488
  • Total for an equivalent taxable account: $270,361

Opening an account with Summit Investment Management is simple and easy.

You can either open an account online and access portfolios designed to align with your individual risk profile or you can contact us for a New Client Enrollment kit that gives you access to our advisors for a more personal experience.

Either way, you can benefit by investing your retirement savings with an experienced investment team that actively manages your portfolios making investment decisions that are based on our highly disciplined, rules-based selection process.

So what are you waiting for? April 15th is just a few weeks away, start investing in your future today!

*April 15th, 2016 is the District of Columbia Emancipation Day and is considered to be a legal holiday so the due date for the 2015 tax returns is the next business day April 18th.
**If your income exceeds $131,000, you cannot contribute to a Roth IRA.
***These examples are for illustrative purposes only and do not represent the performance of any specific product. They assume a hypothetical 7% annual rate of return in a tax-deferred account.
**** is an independent, advertising-supported publisher and comparison service. Bankrate may be compensated in exchange for featured placement of certain sponsored products and services, or your clicking on certain links posted on this website. Learn more by visiting their site.

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Third Quarter 2015 Market Review

History shows us that the greatest threats to a bull market are recessions. So when the market fell quickly (-11%) one week in August, investors and the financial press were quick to round up the usual suspects to blame for the recession that was likely to occur. Heading up the list was once again China which is struggling to keep its growth rate from declining too much due to the structural changes underway in that country.

Europe was also not progressing as well as hoped for despite the quantitative easing efforts their central bankers adopted a number of months ago.  And lastly, the talking heads on CNBC, etc. once again pointed to the perceived threat of Fed interest rate hikes that would “surely” pull the economy in the wrong direction.

The Dow Jones Industrial Average, S&P 500 and NASDAQ all declined in the 6%-7% range for the third quarter and brought the year-to-date results to minus 7-8%. Fortunately, the stock markets rebounded during October, which completely recouped these losses.  In addition, Intermediate Term bonds inched 0.95% higher during the quarter as the rates on 10 year U.S. Government Bonds declined from 2.33% to 2.06% for the period.

While we were surprised to see the market recover its losses so quickly, we did not believe a recession was imminent and, therefore, thought the August market decline was one of those “normal” corrections that most market gurus have been forecasting at one time or another over the past 2-3 years. In our opinion, China is doing an okay job of transitioning to a consumption based economy. Trends in Europe are still positive and their central banks are on alert to provide additional monetary stimulus if necessary.

And, finally, we very much doubt that a modest rise in interest rates will do noticeable harm to our economy. However, we rate the overall investment environment only good at the present time and we wouldn’t be surprised to see a bump in the road before global economic growth becomes more certain.

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Second Quarter 2015 Market Review

The U.S. Economy rebounded from its modest decline of the first quarter that suffered from inclement weather on the East Coast, a prolonged dock strike on the West Coast, an abrupt decline in oil prices and the negative impact on exports caused by a strong dollar. The rebound seemed to return economic growth to the 2% – 2.5% range, modest by historical standards, but at a level that could prove sustainable for the longer term.

Unfortunately, a number of additional negative factors external to the U.S. began to restrict economic growth again late in the second quarter. These included a replay of the Greece fiasco, an escalation of Mid East violence, Chinese economic and stock market problems, and the fears of pending Fed interest rate increases.  As a result, the S&P 500 stock index increased just 0.28% in the second quarter and only 1.23% for the first six months of the year.

Consumer Discretionary stocks increased the most (+4.78%) for the quarter and once again the Utility sector turned in the worst return at -5.78% following its first quarter decline of 5.17%.  In the bond market, interest rates turned back up during the second quarter, resulting in a modest 0.62% decline for Barclays U.S. Intermediate Government/ Credit Bond Index.

As we look into the prospects for the second half of the year, we are encouraged by the improved health of the labor market and consumer balance sheets, but at the same time, believe the economy may struggle a bit over the next few months resulting in a less than perfect investment environment.

The resurgent strength of the dollar (up 15% vs. last year) and weaker oil prices (-49%) are exerting a greater than expected negative impact on corporate sales and profits.  While these factors might keep the market from moving appreciably higher near term, we continue to maintain a positive outlook for both the economy and the stock market.

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First Quarter 2015 Market Review

The first quarter turned out to be one of the more volatile periods for the stock market we have seen since early 2012.  With the dollar strong and inclement weather a deterrent, investors first became concerned that economic growth was moving at a dangerously slow rate.  But then job growth picked up nicely, oil prices seemed to stabilize and investors began to regain confidence during February.  However, investors became concerned again, this time worried that the strong job gains would soon convince the Federal Reserve to raise interest rates.

The almost 0% short term interest rates that the Fed put into effect a few years ago have been the primary drivers of the economic recovery and especially important to the very good stock market we have experienced over the past 5 years.  As a result, investors have been highly sensitive to any potential upward adjustment in interest rates for quite some time now.

As a result of these on again, off again concerns, the S&P 500 stock market index rose just 0.95% during the first quarter despite no change in short term interest rates and good, albeit sub-par economic growth.  On the other hand, longer term rates did decline for the period as quantitative easing programs accelerated in Japan and began in Europe with some 10-year country government bond rates going to zero or less during the period.

This persuaded many global investors to convert their currencies into dollars and use these dollars to buy U.S. Government Bonds, thereby pushing prices higher and in turn, lowering interest rates.  As a result, the Barclays U.S. Intermediate Government Credit bond index increased 1.45% for the quarter.

Shifting gears back to the stock market, there was a relatively high degree of performance dispersion among the economic sectors during the period.  Benefitting from Government subsidies, Healthcare stocks performed the best (+6.5%) while the fear of rising interest rates hurt the Utility sector as stock prices in that category declined the most at -5.2%.

Finally, there was also a very clear performance distinction between growth and value stocks and between small, medium and large capitalization stocks.  Growth stocks outperformed in general and small capitalization stocks placed first overall.

The first quarter was a good period for active portfolio managers (i.e. stock pickers) given that the market was less correlated during the period than it has been in recent history.  According to a Barron’s article, “the 8,212 diversified equity funds tracked by Lipper…returned 2.48% for the January –March period, compared with just 0.8% for S&P 500 Index funds”. As noted earlier, the S&P 500 Index itself increased 0.95%.

The outlook for the stock market for the remainder of the year will continue to be importantly dependant on what happens to interest rates.  Overall, the global economy is still showing more signs of stagnation than not.  On the margin, the Eurozone’s economy appears to be improving, though barely.  U.S. economic growth has slowed this year and it’s not for certain that it was due primarily to bad weather.  The Japanese economy looks to be on its way to its third lost decade and China is slowing as are other major emerging markets.

This all suggests deflation is more likely the issue and raising rates would only slow business conditions further. We are also pleased to see that corporate earnings, excluding energy stocks, should increase about 8% this year, oil prices appear to be near a bottom, and the changing fundamentals of the Energy Industry promise to positively affect the economy and stock market long term.

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Fourth Quarter 2014 Market Review

Wall Street forecasters believe the U.S. economy started off 2015 with the strongest momentum in at least a decade and is in better shape today than any other developed country in the world.  Importantly due to the full scale resurgence of the U.S. Energy Industry, economic growth has averaged 4.8% over the past two quarters, the highest rate in over a decade

With this non-farm payrolls are increasing at the fastest rate since 1999.  As a result, most stock and bond prices rose last year with the S&P 500 up 13.7%, the Dow Industrial Average at +10.4%, the average domestic stock mutual fund up 7.5% and the Barclay’s Government/Corporate Intermediate Bond Index rising 4.9%.  Large and middle sized stocks performed much better than small cap stocks during the year, but in the foreign stock arena, emerging market stocks declined 2.06% while foreign markets with developed markets were off 6.43%.

The equity markets in the U.S. were unusually volatile last year as investors negatively reacted to a number of events including the abrupt slow down in the economy early in the year, followed by Russia’s takeover of Crimea (March) and then the Ebola (October) crisis.

While the market recovered from all of these events by the end of October, another blow to investor confidence surfaced in December as oil prices declined sharply prompting many to assume that the global economy was in trouble. The outlook for 2015 will have a lot to do with how well the European economy holds up next year and what happens to the price of oil.

European officials recently announced quantitative monetary easing program similar to what the U.S., U.K. and Japan have been using to stimulate economic activity.  At a minimum, their efforts should keep the Eurozone from slipping into a recession, ward off deflation, and perhaps help to modestly grow the economy.  This should be enough to remove the negative aura from the market.

We’ve several times in the past made mention of the very major and positive changes expected to incur in the energy industry, and these expectations are quickly becoming a reality.  The fact that the U.S. is near or at energy independence and prices have declined, has major positive long term benefits for the U.S. and many other parts of the world.  A near term perceived problem, however, is that the sharp drop in oil and other energy prices reflects a very weak global economy.

While we do not believe that to be the case, the stock market might prove volatile until it becomes clear that oil prices have at least stabilized. Longer term, the changing complexion of the Energy Industry promises to have fundamentally positive effects on the U.S. economy and its stock market

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Second Quarter 2014 Market Review

The stock market continued to move higher in the second quarter of 2014 despite the abrupt halt of Japan’s economic turnaround, the geopolitical issues in the Ukraine and the Middle East, and concerns that US economic growth was in jeopardy. But in the end, what matters most to the US Stock market is that our economy moves in a positive direction and that inflation does not get out of hand to the upside. Fortunately, government estimates of inflation indicate that it is well under control and the recent upturn in the economy is a clear signal that business conditions are moving in a positive direction.

As a result, the S&P 500 Composite Index of stocks increased 5.23% during the second quarter and 7.14% for the first half of 2014. Mid and Large Cap stocks easily outperformed small cap issues in both the growth and value categories for the second quarter. All ten economic sectors posted positive results for the quarter and the three biggest contributors to the first half were Technology (1), Health Care (2), and Energy (3).

Looking into the months ahead, it’s important to recognize that recessions are primarily caused by the Federal Reserve when it tightens credit conditions (raises interest rates) to slow economic growth that in turn helps to slow inflation rates. We do not believe a policy to tighten credit is imminent, especially given today’s circumstances. The obvious reason is that inflation trends have been modest in most cases and there also appears to be a good deal of excess productive capacity available in today’s global market place.

A second, and possibly more important reason, is that many major governments of the world need inflation (read higher taxes) to help service their debt obligations which have increased substantially over the past several years. On the other hand, should the Fed and/or other central bankers of the world tighten credit availability too soon, deflation and an extremely difficult financial environment would likely result. Fortunately, Central Bankers around the world are keenly aware of this scenario and, therefore, not likely to let the world fall into a deflationary mode.

As a consequence, it may be quite some time before interest rates are increased worldwide given the slower growth in China, the almost recessionary conditions in Japan and parts of Europe, and the relatively modest growth we are experiencing in the US. For the most part, the Federal Reserve has been on its own when it comes to reigniting growth in our economy and even though our economy is in better shape than others, it is evident that the Fed’s efforts have not led to an environment of self-sustaining growth.

And even if the Fed moves to increase rates sometime in the future, their influence on world markets is lessening given increased globalization. For instance, today’s U.S. 10-year Government Bond trades at an extremely low rate of 2.41%; heavily influenced by Spain’s 2.15% rate even though it is obviously a much riskier investment.

If world interest rates remain low and the investing public begins to believe they will stay low for more than just the short term, stock prices could move higher from current levels since history shows they are undervalued based on today’s interest rates. For example, a recent study by a well-respected financial firm indicated that based on current interest rates and consensus earnings estimates, the S&P 500 is currently about 7. 5% undervalued.

Please understand that there are a lot of “ifs” included in this scenario and that the implied revaluation is likely to unfold over the next year or so. In the meantime, our economy has improved, corporate earnings are improving, and the overall environment for stocks on balance appears positive.

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First Quarter 2014 Market Review

Volatility and a higher level of anxiety returned to the markets during the first quarter. The primary catalysts were the “evil empire’s” invasion of Crimea and a severe slowdown in the economy induced by colder than normal temperatures. The inclement weather kept consumers away from the shopping malls and Russia’s political aggressions clearly detracted from investor confidence. Fortunately, business conditions appear to be getting better with the cold weather behind us and the political issues could be dealt with by adopting some intelligent U.S. energy policies.

Value stocks clearly outperformed growth stocks during the period while midcap stocks outperformed both large and small stocks. Following several months of underperformance, utility stocks posted the best sector gains for the period and consumer discretionary stocks performed the worst, reflecting the sharp drop in economic growth.

Despite the economic slowdown, the majority of corporate earnings reported were above expectations and analysts have recently been raising their numbers for the second quarter. Overall, the market moved modestly higher during the quarter. The S&P 500 increased 1.8% and the Russell 1000 rose 2.05%. With business conditions sluggish, interest rates declined during the quarter and this provided a rebound in bond prices following last year’s 0.86% decline, the first fall-off that has occurred since the mid-1980s.

There seems to be a much higher than normal number of people calling for a severe market correction. One of the reasons often cited by naysayers is that the market is too expensive and therefore vulnerable to a bear market. The most recent earnings estimate published for the S&P 500 is $121.86 and at today’s stock prices, the market sells at a PE of 15.8x compared to 18.8x during the last market peak in 2007.

History shows that major downward moves are primarily influenced by economic recessions, not by valuation. The soft first quarter was a temporary weather-induced setback from the uptrend; recent activity has clearly improved; and with excess capacity available and no labor shortages, higher inflation is not a threat for the Federal Reserve to contend with. While this is not to say that we can’t have a meaningful correction, it’s difficult to see a full-fledged bear market on the immediate horizon.

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Fourth Quarter 2013 Market Review

A year ago today, investors were losing sleep over a number of issues that appeared to be legitimate concerns. Fortunately, almost none of these concerns materialized. There was no fiscal cliff, the U.S. did not default on its debt, Europe did not disintegrate, and while China’s growth slowed, there was clearly no hard landing.

The result was an outstanding year for the U.S. stock market. The S&P 500 posted its best gain (+32.39%) since 1997 and all ten economic sectors reported gains for the period. Growth stocks outperformed value stocks and that was especially evidenced by the modest returns earned by dividend yield stocks, many of which are found in the utility and telecommunication sectors.

Both of these sectors increased less than half as much as the S&P 500! The bond market struggled through most of the year as everything but savings rates and the lowest government rates moved higher. The Intermediate Government/Credit Bond Index declined 0.86% last year and the Aaa -A Rated Corporate Bond Index fell 1.94%. A legendary baseball coach once said “never make predictions, especially about the future.”

Having said this, we believe the economic outlook is good enough to support another positive year for stocks, despite the very strong gains the market has already achieved since 2009 and the current complacent mindset of investors. The latest survey shows that a 25 year low, 15% of market forecasters are bearish on the market. This is a contrary opinion indicator which currently suggests the market is due for a correction.

On the other hand, the economy should do better than 2013 as monetary stimulus continues and last year’s fiscal tightening from increased payroll taxes and the sequester lessens. Bottom line, any correction that might occur is not likely to reverse the market’s longer term uptrend.

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Third Quarter 2013 Market Review

After suffering through a plethora of negative events for more than three years, almost nothing appears to meaningfully raise the anxiety level of investors these days. We commented early in the year that a better housing market, permanent changes to our tax code, and fixes made to the European banking system should substantially lessen the market’s volatility and risk exposure.

The virtually crisis-free environment over much of the past twelve months has resulted in good stocks going up and problem stocks going down. This more normal investment environment is expected to continue the majority of time over the next several years. The good news is that our company-specific, fundamental type selection process tends to perform well during periods like these.

Growth stocks significantly outperformed at all market capitalization levels and for the second quarter in a row, while the higher dividend paying utility, telecommunication and consumer staples stocks collectively lost money. Small Capitalization stocks outperformed both mid-cap and large-cap stocks. The small company Russell 2000 Index was up 10.2%, the Russell Midcap gained +7.7%, and the large cap Russell 1000 and the S&P 500 Indexes rose 6.02% and 5.24%, respectively.

Interest rates rose slightly during the period, resulting in a modest 0.62% gain for Barclay’s Intermediate Government/Credit Index and a 0.72% gain for the S&P 2018 Municipal Bond Index. Looking into the fourth quarter; U.S. economic growth is slower but not negative; Europe seems to be gaining some traction for the first time since 2007; the political wrangling has been put on hold for 90 days; the sequester is reducing Government debt; and the appointment of Janet Yellon to head up the Fed may provide even more stimulus to the economy and markets than “helicopter Ben” bestowed upon us.

Short term, the market is overbought and investor sentiment is a bit complacent. While these last two factors have typically resulted in a temporary market consolidation, we haven’t had a meaningful correction since the market began its turnaround in 2009, and this pattern might just remain the same this time around.

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Second Quarter 2013 Market Review

Events like the IRS scandal, Egyptian political problems, Obamacare missteps, NSA phone taps, China’s credit crunch, the Benghazi disaster, and Japan’s economic instability were not significant enough to disrupt the stability of the U.S. stock market in the quarter just ended.

On the other hand, most foreign stock markets were noticeably weak during the period, and the abrupt increase in interest rates caused a temporary 6% correction of stock prices and an even greater correction for stocks that pay above average dividends. This hurt prices for stocks like utilities, which declined 2.73% for the quarter. On the other end of the spectrum, financial stocks led the way with a 7.25% gain followed by consumer discretionary stocks at +6.81%.

Overall, the S&P 500 increased 2.91% for the quarter. Growth stocks outperformed in the small and mid-cap space, but it was value stocks that took first place in the Large Cap arena. The average U.S. domestic mutual fund increased 2.29%, the average Foreign Stock fund was off 2.2% and taxable bond funds declined 2.43%.

Our experience in the most recent quarter continues to bolster the opinion held by many fund managers that the market continues to be decoupled from the overall economy as a result of unprecedented intervention by Central Banks worldwide. This is evidenced by the spike in volatility we observed at the mere hint that the US Federal Reserve may begin tapering its current stimulus effort known as QE3. Moving forward, we expect Federal Reserve policy to remain accommodating as the fundamentals of the economy have leveled off and in some areas have even begun to deteriorate.

While these policies have been bullish for stocks to this point, the longer they continue without substantial improvement in the economy, the greater the risk of periods of higher volatility for which our newly revised hedge is well suited. Add to this the uncertainty over the continued implementation of Obamacare, the first major city bankruptcy in Detroit, the ongoing tax and budget battles in Washington DC, and you have an environment where unhedged portfolios could experience uncomfortable P/L swings.

Still, over the near term, we do not believe we are on the verge of a new recession and that equities, with proper protections in place will continue to be the place to be invested.

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First Quarter 2013 Market Review

The investment climate was remarkably good during the first quarter.

With the exception of the financial melt-down of the tiny island, Cyprus, and some late in the period saber rattling by the North Koreans, investors benefited from a virtually crisis free environment. The housing industry continued to improve. Corporate profits were modestly higher and above expectations. Economic growth was mostly steady and only softened with the uncertainties created by the sequester. And finally, stock market volatility dropped sharply and more than half of the ten economic sector stock price indexes posted double digit gains for the quarter.

The Health Care sector led the way with a 15.22% gain while both Technology and Basic Materials came in below 5% for the period. The S&P 500 reported a total return of 10.61% for the period, the Russell 1000 increased 10.96% and the average diversified domestic stock mutual fund was up 10.2%. Small Cap stocks outperformed large company stocks and value (defensive) stocks outperformed growth issues in most areas. In the fixed income area, the Intermediate Government/Credit Bond Index increased just 0.26%.

Given the above average strength of the stock market over the past six months, it is not unusual for the market to pause or pull back for a period of time.

In addition, the April to May period is a typical seasonal period during which such corrections have occurred in the past. It is not necessarily usual, however, for the markets to undergo a major decline unless stocks are extremely overvalued, economic conditions deteriorate substantially or something catastrophic like another financial meltdown occurs. Stocks are not excessively expensive based on historical standards, and in our opinion, economic conditions are holding and another financial meltdown is not in the cards.

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The Stock Market’s Pre-Halloween Horror Show

A Five Part Chill Ride

From an attitude of complete complacency throughout 2013 and through the summer of this year, investors are suddenly beginning to take fright. But, what, exactly, are they afraid of? Here’s a short list of things that seem to be going bump in the night.

  1. October

    This is probably the least frightening thing, but it is true that historically, October is the most volatile month of the year. Whether this has to do with mutual fund jockeying before the end of the fiscal year or pre-holiday jitters, no one knows for sure. What the market has shown so far this month is not out of the norm.

  2. Fed tightening

    The Federal Reserve continues to rumble about eventual tightening. At the same time, it repeatedly assures that any interest rate increases will be slow and measured to make sure the economy doesn’t crumble in response. Can we trust them? Do they know how to deliver what they promise? If the past is any guide, rate increases will probably provide something of a bumpy ride for the market.

  3. Geopolitical problems

    From ISIS, to Russia, to China, to our own southern border,there seems no end to geopolitical worries now that our government has stepped back from its traditional center stage role in international affairs.

    • ISIS has taken large chunks of territory in both Iraq and Syria. It sits on the border of Turkey, a member of NATO and is threatening Jordan and Lebanon. ISIS has announced their intention to bring down the government of Iran and to hijack that country’s own contentious nuclear program. Furthermore, they have ambitions to infiltrate terrorists into the US through our virtually unguarded border with Mexico. Certainly, if they can destabilize Turkey, take down Iran, or manage a large scale terrorist attack within the US, the fallout could be damaging to the market. Russia and China have both taken much more aggressive military postures of late.
    • Russia, of course, has annexed Crimea and is making at least a small scale war in eastern Ukraine. Obviously, part of the motivation is pure opportunism, but at what point will the West call Putin’s bluff. If it is a bluff. Russia’s economy runs on oil and with the oil price having come off signifcantly of late, it will be intereting to see if that take the wind out of Putin’s sails, or, on the other hand, further motivate him to be adventurous abroad to divert his public’s focus from a stalling economy.
    • China, too, is flexing its military muscles. With tens of millions of young men with no chance of finding a bride, thanks to its misguided “one child policy”, the testosterone levels in China’s armed forces must be unbelievable. So far, China has been limited to bullying Japan and trying to push the US Navy around a bit in the waters off the Chinese coast. Nonetheless, China’s tone and actions have been worrying enough to push Japan to the point where that country is rethinking its commitment to post WWII pacifism.
    • So much has been written about our southern border problems that it’s hard to add anything new. Nonetheless, it should be repeated that a lack of control of who enters the US could lead to severe internal security problems in a worst case scenario.


  4. Ebola

    With the first reported US fatality, a fatality and confirmed case in Spain, and worries about suspected cases in the UK and Australia, the fear of Ebola and its possible consequences is certainly onthe rise. Beyond the health fears, though, lies a fear that points a potential dagger at the heart of the market. The economies of the countries hardest hit by the plague, Liberia and Sierra Leone, have virtually collapsed. Could a similar chain of events bring the US economy, or the world economy, to a standstill?

    Western medicine is certainly light years ahead of the healing arts in west Africa. The medical authorities in developed countries claim that they are prepared and that there will be no pandemic in Western nations. But the apparent bungling of cases in Spain and here in Dallas leave the public, and the market, skeptical.

  5. Global economics

    While the US seems to be making slow but fairly steady progress, things are not so good in other corners of the globe. The European economy is definitely slowing, as are Japan and China. Can a weak, but recovering, US economy withstand the headwinds from the rest of the world? At 10/9/14’s close of 1928.21, the S&P 500 is only 4.5% off its most recent intra-day high of 2018.66, set back on September 19th.

The market was certainly ripe for a correction, at least, and whether this dip turns into more than that may well be known by the time Halloween arrives.

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Kendra L. DeBaets

Portfolio Manager Kendra DeBaets

Kendra has been employed by Summit Investment Management, Ltd since May 2001, and has many years experience working in the Investment management business.

She handles all of the daily operations and administrative needs of the office.

She also works with our clients on a variety of issues from account set up to funds distributions and beyond.

Prior to joining Summit, Kendra gained her initial experience in the investment industry while working at Ellenbecker Investment Group as an Administrative Assistant.

Summit Investment Management, Ltd. (2001 – Present)

  • Operations and Client Service Manager

Ellenbecker Investment Group (1999 – 2000)

  • Administrative Assistant


  • B.S. (Early Childhood Education) – University of Wisconsin – Milwaukee





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Thomas J. Czech, CFA

Financial Advisor Tom Czech

Tom serves as Chairman of Summit.  He came to Summit from Blunt, Ellis and Loewi/Kemper Securities in 1991, where he was employed as the regional brokerage firm’s First Vice President and Investment Strategist.

Tom brought Summit his concept of disciplined fundamental investing that forms the basis for many of the company’s equity strategies. Under Tom’s direction, these strategies were first offered to clients in late 2002. Tom was named Chairman of the Board in 2008.

After earning his MBA at Northern Illinois University, Tom was hired by Blunt Ellis & Loewi as an equity analyst in 1972. He was tasked as a generalist to discover attractive small growth companies across all industries. His success as an analyst brought him to the attention of upper management, and in 1984 he was made the company’s Director of Research. In that position, Tom oversaw the work of a dozen analysts that included pioneer work in the water industry for which the firm became nationally recognized.

He also served as the Chairman of the Stock Selection Committee which decided the designation of the rating that Blunt Ellis & Loewi gave to companies – buy, hold, or sell. Additionally, Tom was a member of the Due Diligence Committee which reviewed companies prior to their Initial Public Offering (IPO) to make sure that they met the brokerage firm’s standards.

Summit Investment Management, Ltd. (1991 – Present)

  • Chairman (2008)

Blunt Ellis and Loewi (1972 – 1991)

  • First V.P. and Director of Research


  • MBA – Northern Illinois University
  • B.S. Finance – Northern Illinois University

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Ronald E. Chandler

Portfolio Manager Ron Chandler

Ron has many years of option trading and strategy development experience. Before joining Summit in 2012, Ron had worked as an option instructor for Optionetics Inc., as well as Managing Partner for Chandler-Wiles Group, LLC, a management consulting firm and Big Dog, LLC. a  private investment firm. Ron is Summit’s President.

Ron has executive experience across a wide variety of industries (automotive, pharmaceutical, petrochemical, service, food retail and financial) and disciplines (sales, engineering, program management, product development, and operations).
After selling his manufacturing business in 1994, Ron established himself as a turnaround consultant working with troubled companies.

Ron holds a Series 65 Securities Licenses as well as State insurance licenses in Life and Health in the state of Wisconsin. He is also certified as a Lean Manufacturing Expert and a Six Sigma Black Belt by the University of Michigan-College of Engineering and has co-authored a book on those subjects.

He has been a featured speaker at investment conferences across the country and volunteers his time teaching financial literacy to school age children and young adults.

Summit Investment Management, Ltd. (2012 – Present)

  • President

Chandler-Wiles Group, LLC (2002 – 2012)

  • Managing Partner

Bankruptcy Turnaround Management (1996 – 2001)

  • Consultant


  • M.B.A. (Marketing, Finance) – University of Detroit
  • B.S. (Chemical Engineering, Bio-Chemical Engineering) – University of Michigan

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