Update – Summer 2018

Wobbly Markets, Strong Economic Fundamentals

Highlights
 The back-and-forth movements in stock prices are likely to continue for some
time.
 Escalating trade tensions appear to be the main risk to the global economy and
financial markets, but perceived fears are worse than reality.
 The current bull market should continue, but caution about the longer-term
prospects for equities may be prudent.

Global equity markets have swung wildly so far this year. The S&P 500 Index peaked at
2,875 in late January before quickly plummeting to 2,532 at the bottom of the February
correction. Markets outside of the United States have also been volatile and global
equity markets are in negative territory so far this year, although U.S. stocks have made
small gains. What should investors expect for the rest of the year? Stock prices are
likely to continue churning in the near term, especially given the uncertain trade
backdrop, but, over the long-term, fundamentals suggest this equity bull market will
continue for a bit longer.

Trade protectionism may be the biggest risk to the economy and equity markets
The threat of protectionism has increased notably in recent weeks. Markets have held
up reasonably well in the face of a potential escalating trade war, and investors seem to
be betting a worsening back-and-forth in tariffs and rising tensions won’t translate into a
wholesale slowdown in global growth.

Trade-related protectionism probably represents the most significant threat to the global
economy. Trade barriers effectively act as a tax that separates producers of goods from
consumers and interrupts economic growth. At this point, it is still uncertain whether
rising rhetoric between the U.S. and China will turn into an all-out trade war, although
the likely outcome is that it will not; no one actually wins in a trade war, but President
Trump is looking for a victory going into the 2018 midterms. Given all the uncertainty,
risks are high, but it is likely the parties will come to an agreement which will avoid
major damage to the world economy.

From an investment perspective, investors should be careful not to overreact to the

heated rhetoric. We’ve seen only limited evidence that trade issues are causing
businesses to change their plans or scale back investments. Given the risks, however,
U.S. companies with higher levels of exposure to domestic rather than international
sources of revenues look more attractive and are more insulated from trade issues.
The bull market is likely to continue
Given these views, along with accelerating U.S. economic growth and strong corporate
earnings, current market headwinds are unlikely to morph into a bear market. At the
same time, we are probably in the closing innings of the bull market, even if stocks can
make new highs in the coming 6 to 12 months. Two key points should be noted about
the current bull market:

1) Equity bull markets rarely end until the economy is heading for recession. Some
areas of the world economy appear to be slowing. While the Index of Leading Economic
Indicators is gaining strength in the U.S., it appears to be slowing in most of the rest of
the developed world. There are few signs of a recession occurring in the next year, and
global and U.S. economies remain in expansion mode.

2) Age doesn’t determine the end of market cycles or bull markets. The current
expansion and equity bull market have been going on for a long time. That fact by itself
tells us nothing about when the economic expansion will end. Recessions and bear
markets require some sort of catalyst. Investors should keep a close eye on trends such
as a possible trade war, geopolitical shock, rising inflation, a spike in bond yields or a
monetary or fiscal policy mistake. All of these conditions have appeared this year to
some extent, but none have reached a disruptive point.

Remain positive toward stocks—at least for now

Over the near term, equity markets will likely remain choppy until trade tensions ease
and until global economic growth gains momentum. Until that happens, strong
corporate earnings should remain a tailwind, meaning equities are likely to remain
range-bound.

As such, it makes sense for investors to maintain a pro-growth investment stance. From
a valuation perspective, equities look more attractive now than they did at the beginning
of the year since corporate earnings growth has been outpacing stock price
appreciation. At some point in the coming months, it is likely equities will break out of
their trading range to the upside and post new highs.

At the same time, however, longer-term equity risks are rising. Even if trade issues calm
down, inflation is moving higher, the Fed (and other central banks) are growing less
accommodative and bond yields are likely to rise. Investing has become more difficult in
2018 than it was in 2017, and that trend doesn’t look likely to end. But the good news is
equity prices haven’t run out of runway yet.

Transformative Growth Leaders Strategy Update

This new strategy was implemented during the second quarter of 2016 and involves a
focused basket of roughly 15 stocks with the expectation these companies’ underlying
growth will be faster and superior to that of the overall economy and the specific
markets they operate in. These companies in some way have fashioned new products
and innovative offerings, spawned new industries and sparked change in consumer and
business habits and practices. Most of these companies are household names, have
dominant brands, are leaders in their respective markets and industries, and in many
ways are part of, and indeed have changed, our daily lives. To manage risk, the
“Transformative Growth Leaders” segment of the portfolio has no more than a 10%
overall allocation.

Since implementation of this stock portfolio, this basket of stocks has gained 62% in
value, nicely ahead of the broader market, as evidenced by the S&P 500, which has
generated a 29% return over the same time period. A performance table is listed below:

6/29/2018
Purchase Close Return%
Alibaba $170.94 $185.53 8.5%
Amazon $716.46 $1,699.80 137.2%
Apple $93.08 $185.11 98.9%
Costco Wholesale $139.71 $208.98 49.6%
Disney $97.80 $104.81 7.2%
Facebook $158.99 $194.32 22.2%
Google (“Alphabet”) $704.98 $1,129.19 60.2%
Mastercard $89.25 $196.52 120.2%
Netflix $90.84 $391.43 330.9%
Nike $57.44 $79.68 38.7%
Starbucks $52.43 $48.85 -6.8%
Tesla Motors $210.20 $342.95 63.2%
Under Armour $26.40 $22.48 -14.8%
Ulta Beauty $199.81 $233.46 16.8%
Visa $74.25 $132.45 78.4%

The quarter saw some notable developments within the portfolio – Mastercard and
Apple holdings gained over 100% appreciation from their initial investment, and half of
the position in each holding was sold as these gains occurred within a relatively short
period of time (both had been held for roughly 18 months). This enabled us to cash out
our initial investment in each company, and let our winnings ride (“playing with the
house’s money”, as the old saying goes). These 2 stocks join Netflix and Amazon as
stocks that have more than doubled since we made initial investments in them.

Looking forward, the economic and earnings environment should support a continuation
of the bull market, albeit with more volatility and some heightened risks in the near
term. Even in this challenged environment, really strong market leaders continue to
grow and increase earnings.

Amin Khakiani
July 18, 2018