Quarterly Update

Tom Galvin, Chief Investment Officer | April 2022

Market Update: Risks Rising to Virtuous Cycle between Corporations and Consumers

Risks Rise from Tightening Fed, Slowing Global Growth

Advantages of US Economy Drive Asset Allocation

Uncertain Times Require Vigilance, Adaptability

For some time we have felt that the secular strength in the US economy would offset high levels of inflation during the first half of the year and drive growth into 2023. Rising corporate profits have led businesses to increase investment and hiring, which is supporting spending by consumers and, in turn, further profit growth. While this remains our base case, we now see risks rising to a continuation of the virtuous cycle between corporations and consumers, especially from a more hawkish Fed and slowing economic growth on a global basis.

So what are the primary areas we are keeping our eyes on that could cause us to shift our economic outlook and portfolio positioning?

High on our list are further disruptions to global commodity supplies from the Russian-Ukraine conflict that could exacerbate already high inflation here at home (see CRB Commodities Index chart). In addition to uncertainty on oil prices, upward pressure on food prices is increasing in probability as a result of likely interruptions to the spring planting season in Ukraine and rising prices of fertilizer due to the high price of oil. Unlike oil, agricultural products do not have a high level of potential extra reserves to fall back on. While Europe has significantly more commodity exposure to the Ukraine crisis, the US is not completely immune given the global nature of the commodities market and that spending on food in the US is a higher percentage of GDP than energy.

Another risk to our inflation forecast comes from China’s latest bout with COVID-19, which is not only hurting domestic economic activity in that country, but will negatively impact the global supply chain at a time when things were just starting to improve. Should these risks materialize and inflation not trend lower, it would increase the challenge for Fed officials trying to get inflation under control. Relatedly, we are watching closely to see whether cyclical pressure from Ukraine and China become secular trends. Will national security responses to both the Ukraine crisis and China’s COVID-19 outbreak lead to more de-globalization, with investment in domestic markets further increasing demand for labor?

The relative advantages the US economy enjoys versus other regions of the world remain foundational to our asset allocation. In equities, this view supports our emphasis on US high-quality companies selling at reasonable prices that can both continue to grow earnings and dividends at an above average pace, and that also have durable franchises and strong management teams to weather a recession should one occur. The strength in the US economy should also minimize credit risks in both the corporate and municipal fixed income markets across the yield spectrum. However, because the outlook beyond the first half of 2023 is increasingly clouded, we have broadened our range of potential outcomes from normal growth, to slower and a milder recession. As stewards of capital we remain vigilant during these uncertain times and are prepared to adjust course should the risks to the outlook described above materialize, or should another exogenous shock occur that would negatively impact the virtuous cycle that exists with corporations and consumers.

Key Points

Risks Rise from Tightening Fed, Slowing Global Growth

Advantages of US Economy Drive Asset Allocation

Uncertain Times Require Vigilance, Adaptability

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Important Information

Any opinions, projections, forecasts and forward-looking statements presented herein are valid as of the date of this document and are subject to change.

The information presented does not involve the rendering of personalized investment, financial, legal or tax advice. This presentation is not an offer to buy or sell, or a solicitation of any offer to buy or sell any of the securities mentioned herein.

Certain statements contained herein may constitute projections, forecasts and other forward-looking statements, which do not reflect actual results and are based primarily upon a hypothetical set of assumptions applied to certain historical financial information. Certain information has been provided by third-party sources and, although believed to be reliable, it has not been independently verified and its accuracy or completeness cannot be guaranteed.

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Private investments often engage in leveraging and other speculative investment practices that may increase the risk of investment loss, can be highly illiquid, are not required to provide periodic pricing or valuation information to investors, and may involve complex tax structures and delays in distributing important tax information.

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Investments in below-investment-grade debt securities, which are usually called “high-yield” or “junk bonds,” are typically in weaker financial health and such securities can be harder to value and sell, and their prices can be more volatile than more highly rated securities. While these securities generally have higher rates of interest, they also involve greater risk of default than do securities of a higher-quality rating.

There are inherent risks with equity investing. These risks include, but are not limited to, stock market, manager or investment style. Stock markets tend to move in cycles, with periods of rising prices and periods of falling prices. Investing in international markets carries risks such as currency fluctuation, regulatory risks, and economic and political instability. Emerging markets involve heightened risks related to the same factors, as well as increased volatility, lower trading volume and less liquidity. Emerging markets can have greater custodial and operational risks and less developed legal and accounting systems than developed markets.

There are inherent risks with fixed-income investing. These risks may include interest rate, call, credit, market, inflation, government policy, liquidity or junk bond. When interest rates rise, bond prices fall. This risk is heightened with investments in longer-duration fixed-income securities and during periods when prevailing interest rates are low or negative. The yields and market values of municipal securities may be more affected by changes in tax rates and policies than similar income-bearing taxable securities. Certain investors’ incomes may be subject to the Federal Alternative Minimum Tax (AMT), and taxable gains are also possible. Investments in below-investment-grade debt securities, which are usually called “high yield” or “junk bonds,” are typically in weaker financial health and such securities can be harder to value and sell, and their prices can be more volatile than more highly rated securities. While these securities generally have higher rates of interest, they also involve greater risk of default than do securities of a higher-quality rating.

All investing is subject to risk, including the possible loss of the money you invest. As with any investment strategy, there is no guarantee that investment objectives will be met, and investors may lose money. Diversification does not ensure a profit or protect against a loss in a declining market. Past performance is no guarantee of future performance.

Indices are unmanaged, and one cannot invest directly in an index. Index returns do not reflect a deduction for fees or expenses.

Alternative investments are speculative, entail substantial risks, offer limited or no liquidity and are not suitable for all investors. These investments have limited transparency to the funds’ investments and may involve leverage which magnifies both losses and gains, including the risk of loss of the entire investment. Alternative investments have varying and lengthy lockup provisions.

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Index Definitions

S&P 500 Index: The S&P 500 Index, or Standard & Poor’s 500 Index, is a market-capitalization-weighted index of 500 leading publicly traded companies in the U.S. It is not an exact list of the top 500 U.S. companies by market cap because there are other criteria that the index includes.

Bloomberg Barclays US Aggregate Bond Index (LBUSTRUU): The Bloomberg Aggregate Bond Index or “the Agg” is a broad-based fixed-income index used by bond traders and the managers of mutual funds and exchange-traded funds (ETFs) as a benchmark to measure their relative performance.

GT2 Govt, GT3 Govt, GT5 Govt, GT10 Govt, GT30 Govt: US Government Treasury Yields

DXY Index: The U.S. dollar index (USDX) is a measure of the value of the U.S. dollar relative to the value of a basket of curren-cies of the majority of the U.S.’s most significant trading partners.

Dow Jones U.S. Select Dividend Index (DJDVP): The Dow Jones U.S. Select Dividend Index looks to target 100 dividend-paying stocks screened for factors that include the dividend growth rate, the dividend payout ratio and the trading volume. The components are then weighted by the dividend yield.

P/E Ratio: The price-to-earnings ratio (P/E ratio) is the ratio for valuing a company that measures its current share price relative to its earnings per share (EPS).

The Commodity Research Bureau (CRB) Index acts as a representative indicator of today’s global commodity markets. It measures the aggregated price direction of various commodity sectors.

The MSCI indexes are market cap-weighted indexes, which means stocks are weighted according to their market capitalization — calculated as stock price multiplied by the total number of shares outstanding.

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