Quarterly Update

Jan. 2019

, | Jan. 2019

U.S. Equity Outlook: The Battle Royale Continues

This earnings season may be the most important one in years

We are listening for any evidence of fundamental deterioration

Our focus on high-quality companies should serve us well

After undergoing a “healthy correction” in December, we believe U.S. equity markets are undergoing a multi-month corrective process driven by trade tensions, the path of Fed hikes, and the outlook for earnings. We have taken a conservative stance toward earnings growth in 2019 and have held a below consensus, base case forecast of 5%. This earnings season is perhaps the most important one in years.

Key things we are listening for to see if there is risk to our expectations include:

Any evidence of fundamental deterioration. While economic activity is slowing both domestically and internationally, it is still growing. Revenue growth generally produces positive operating leverage, which should also be helped by lower input prices as many commodity prices have declined. Rising interest rates are also a modest positive as the balance sheet of the S&P 500 has more cash than debt. Increased labor costs are a potential headwind to margins. Corporation cash flows should remain solid. Net, we believe reported results will be choppy, but overall fine.

The tone and specifics of forward guidance from companies. Results of the positive stimulus of tax cuts are beginning to fade, and concerns over the implications of trade tensions, Brexit, and Fed policy are impacting business decisions as evident by declining PMIs and declining global trade. Given this backdrop managements are likely to be cautiously optimistic and conservative in their commentary about the future. As a result the bottom-up earnings forecasts for many companies, which have been declining rapidly, could be reduced further, and our current base case assumption may have to be trimmed.

We have specific expectations for each of our holdings as it relates to revenues, earnings, and guidance. Should there be meaningful changes to our assumptions or our investment thesis, we will take appropriate action and maintain a solid pipeline of investment ideas. We believe our focus on high-quality companies with solid earnings visibility will serve us well as the Battle Royale continues.


Key Points

This earnings season may be the most important one in years

We are listening for any evidence of fundamental deterioration

Our focus on high-quality companies should serve us well

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Important Disclosures

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.

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

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.

Concentrating assets in the real estate sector or REITs may disproportionately subject a portfolio to the risks of that industry, including the loss of value because of adverse developments affecting the real estate industry and real property values. Investments in REITs may be subject to increased price volatility and liquidity risk; concentration risk is high.

Investments in Master Limited Partnerships (MLP) are susceptible to concentration risk, illiquidity, exposure to potential volatility, tax reporting complexity, fiscal policy, and market risk. Investors in MLPs are subject to increased tax reporting requirements. MLP investors typically receive a complicated schedule K-1 form rather than Form 1099. MLPs may not be appropriate investments for tax-advantaged accounts because of potential negative tax consequences (Unrelated Business Income Tax).

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.

Investments in emerging market bonds may be substantially more volatile, and substantially less liquid, than the bonds of governments, government agencies, and government-owned corporations located in more developed foreign markets. Emerging market bonds can have greater custodial and operational risks and less developed legal and accounting systems than developed markets.

As with any investment strategy, there is no guarantee that investment objectives will be met, and investors may lose money. Returns include the reinvestment of interest and dividends. Investing involves risk, including the loss of principal. Diversification may not protect against market loss or risk. Past performance is no guarantee of future performance.

Index Definitions

The Standard & Poor’s 500 Index (S&P 500) is a market capitalization-weighted index of 500 common stocks chosen for market size, liquidity, and industry group representation to represent U.S. equity performance.

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

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