Fourth Quarter and 2018 Investment Commentary

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1 Fourth Quarter and 2018 Investment Commentary Growls came from Wall Street as the Bear raised its UGLY head in the last quarter of 2018, and ugly it was. It sure doesn t feel good, and many of us had forgotten what being in these market conditions feels like. Our Bear market indicator was touched, but then moved back into more positive territory for now. As you know, our goal is to avoid the meat of a Bear Market, allowing our clients to sit on the sidelines until the worst is over, and then moving back into the markets to capture some of the upside in recovery. Our disciplines work in downward-trending markets. When a more upward-trending market is established, our disciplines can help us know when it may be an opportunity to venture back into the markets when it may feel tough. Please continue to read below for more details and insight into the 2018 markets and the disciplines we follow. The current market valuation is high, much like before the Financial Crisis of Therefore, we remain cautiously optimistic. In the "decades" timeframe, the current Secular Bull Market could turn out to be among the shorter Secular Bull markets on record. This is because of the long-term valuation of the market, which, after only nine years, has reached the upper end of its normal range. The long-term valuation of the market is commonly measured by the Cyclically Adjusted Price to Earnings ratio, or CAPE, which smooths out shorter-term earnings swings in order to get a longer-term assessment of market valuation. A CAPE level of 30 is considered to be the upper end of the normal range, and the level at which further PE-ratio expansion comes to a halt (meaning that increases in market prices only occur in a general response to earnings increases, instead of rising just because ). Of course, a mania could come along and drive prices higher much higher, even and for some years to come. Manias occur when valuation no longer seems to matter, and caution is thrown completely to the wind as buyers rush in to buy first and ask questions later. Two manias in the last century the 1920 s Roaring Twenties and the 1990 s Tech Bubble show that the sky is the limit when common sense is overcome by a blind desire to buy. But, of course, the piper must be paid and the following decade or two are spent in Secular Bear Markets, giving most or all of the mania gains back. The CAPE is now at and about at the level reached at the pre-crash high in October This value is in the lower end of the mania range. Since 1881, the average annual return for all ten year periods that began with a CAPE around this level have been in the 0% - 3%/yr. range. The big picture is the months-to-years timeframe the timeframe in which Cyclical Bulls and Bears operate. The U.S. is currently in Cyclical Bull territory. Timeframe summary: In the Secular (years to decades) timeframe (Figs. 1 & 2), the long-term valuation of the market is simply too high to sustain rip-roaring multi-year returns. The Bull-Bear Indicator (months to years) remains barely positive (Fig. 3), indicating a potential uptrend in the longer timeframe. In the intermediate timeframe, the Quarterly Trend Indicator (months to quarters) is negative for Q1, and the shorter (weeks to months)

2 timeframe (Fig. 4) is positive. Therefore, with two indicators positive and one negative, the U.S. equity markets are rated as Neutral. December, Q4 and 2018 Summary : US stock markets were a sea of red for all three timeframes that concluded in the week ending 12/28/18: the month of December, the 4 th Quarter, and the year On its face, an annual loss of 5% or 6% for the Dow and S&P doesn t seem so bad, until one remembers that the market was ahead by almost 10% for the year going into October, then gave all that up and then some in a very short time, concluding with the worst December since International markets were a sea of even redder red, as all major indices finished the month, quarter and year in negative territory, and all concluded the year in double negative digits for Due to our disciplines, we have not owned international stocks for the last two quarters avoiding losses in this asset class. Major commodities also fell for the year 2018, by as much as nearly -25% for wtic (West Texas Intermediate Crude). Unlike global stocks, the month of December and the 4 th Quarter were mixed, with both gains and losses among the major commodities; gold and silver finished in the positive. Finally : Back in 1965, Martha and the Vandellas sang Nowhere to run, baby, nowhere to hide. That was true as well in 2018, at least in the world of investing. The graphic below, from visualcapitalist.com, shows just how tough the investing environment of 2018 was. Bonds were flat, the US dollar was modestly higher and that was it. Non-US stocks fared much worse than US stocks, and the near-universal prediction that Emerging Markets would be the best bet for 2018 was a complete bust as Emerging Markets were the worst of worldwide equity indices.

3 Good risk managers are unapologetic about taking actions to avoid or mitigate risk - even if the actions don't always pay off - because they know that in the long run, their investors will survive the trip when other investors are left in smoking ruins at the side of the road to retirement. (sources: all index return data from Yahoo Finance; Reuters, Barron s, Wall St Journal, Bloomberg.com, ft.com, guggenheimpartners.com, zerohedge.com, ritholtz.com, markit.com, financialpost.com, Eurostat, Statistics Canada, Yahoo! Finance, stocksandnews.com, marketwatch.com, wantchinatimes.com, BBC, 361capital.com, pensionpartners.com, cnbc.com, FactSet; Figs 1 source W E Sherman & Co, LLC) Figure 1. Disciplines Bull-Bear Indicator The Bull-Bear Indicator is constructed from measurements of market internals and is intended to reveal the relationship of supply and demand at the longer-term timeframe of months to years. The measurements are ratios of supply and demand factors, normalized to a scale of 0 to 100. For example, the ratio of up-volume to (up volume + down volume) will always be in the range of 0 to 100, where the higher readings indicate a preponderance of demand (larger up volume) and lower readings indicate a preponderance of supply (larger down volume). Other examples of ratios of supply and demand are advancers to (advancers + decliners) and new 52-wk highs to (new 52-wk highs + new 52-wk lows). There are seven ratios in total. These ratios are then weighted, and combined into a single, statistically smoothed final Bull-Bear Indicator. When the Bull-Bear Indicator is in a Bull Market mode and then pierces the Bear Market Threshold, a new Bear Market is signaled. When the Bull-Bear Indicator is in a Bear Market mode and then pierces the Bull Market Threshold, a new Bull Market is signaled. Once a mode (Bull or Bear) is established, it is considered to remain in place until the Bull-Bear Indicator eventually pierces the opposite threshold.

4 Quarterly Trend Indicator Designed to act only at quarterly intervals, it is a quarter-by-quarter look at the probable risk environment of each quarter, using the trend status of US and International equities. The trend labeling is based on direction of the regression line through a smoothed price series, and the prices referred to are the Russell 3000 for the US, and the MSCI Ex-US for International. If either the US or International equities are in an uptrend, a lower-risk quarter is indicated; if neither the US nor International equities are in an uptrend, a higher-risk quarter is indicated. Intermediate-Term Indicator The Intermediate-term Indicator is constructed from measurements of market internals within 36 sectors of the US market, and is intended to reveal the relationship of supply and demand at the intermediate-term timeframe of weeks to months. Each sector is defined by a basket of stocks. Each stock within each basket is ranked as being in supply mode or demand mode, based on recent price and volume activity. If the majority of stocks within a basket are deemed to be in demand mode, the sector is deemed to be in demand mode; if the majority of stocks within a basket are deemed to be in supply mode, the sector is deemed to be in supply mode. Each sector in demand mode is assigned the value of 1; each sector in supply mode is assigned the value of 0. The Indicator value is then the statistically smoothed sum of these 36 assignments, which can therefore range from 0 to 36. A sum of 0 indicates all sectors are in supply mode and a sum of 36 indicates all sectors are in demand mode. Changes in the overall intermediate-term market outlook occur when the indicator changes direction after reaching at least the halfway point of 18 (one half of 36). After reaching at least the halfway point, a reversal by 20% causes a change in labeling and color. When the indicator is headed up, it is labeled as "Positive" and colored green; when the indicator is headed down, it is labeled as "Negative" and colored red. A change from green ("Positive") to red ("Negative") occurs upon a reversal downward of at least 20% of the highest value reached. For example, a reversal from green to red after a move up that peaks at 30, will occur at 24 (20% less than 30). Similarly, a change from red to green occurs upon a reversal upward of at least 20% of the lowest value reached. For example, a reversal from red to green after a move down that bottoms at 5, will occur at 6 (20% more than 5). The economic forecasts set forth in this material may not develop as predicted and there can be no guarantee that strategies promoted will be successful. The indices listed are unmanaged indices, which cannot be invested into directly. Unmanaged index returns do not reflect fees, expenses, or sales charges. Index performance is not indicative of the performance of any investment. Past performance is no guarantee of future results. The Standard & Poor s 500 Index is a capitalization weighted index of 500 stocks designed to measure performance of the broad domestic economy through changes in the aggregate market value of 500 stocks representing all major industries. The Russell 2000 Index is an unmanaged index generally representative of the 2,000 smallest companies in the Russell 3000 index, which represents approximately 10% of the total market capitalization of the Russell 3000 Index.

5 The Dow Jones Industrial Average is comprised of 30 stocks that are major factors in their industries and widely held by individuals and institutional investors. The NASDAQ Composite Index measures all NASDAQ domestic and non-u.s. based common stocks listed on The NASDAQ Stock Market. The market value, the last sale price multiplied by total shares outstanding, is calculated throughout the trading day, and is related to the total value of the Index. The TSX Composite Index is the benchmark Canadian index, representing roughly 70% of the total market capitalization on the Toronto Stock Exchange (TSX) with about 250 companies included in it. The Toronto Stock Exchange is made up of over 1,500 companies. The FTSE is a company, similar to Standard & Poor s, that specializes in index calculation. While the FTSE is not part of any stock exchange, one co-owner is the London Stock Exchange (LSE). The FTSE is comprised of blue-chip stocks that are listed on the LSE. The France CAC 40, the most widely used indicator of the Paris market, reflects the performance of the 40 largest equities listed in France, measured by free-float market-capitalization and liquidity. The DAX is a blue chip stock market index consisting of the 30 major German companies trading on the Frankfurt Stock Exchange. The FTSE MIB is the benchmark stock market index for the Borsa Italiana, the Italian national stock exchange. The index consists of the 40 most-traded stock classes on the exchange. The Shanghai Stock Exchange Composite Index is a capitalization-weighted index. The index tracks the daily price performance of all A-shares and B-shares listed on the Shanghai Stock Exchange. The Nikkei 225 more commonly called the Nikkei, the Nikkei index, or the Nikkei Stock Average is a stock market index for the Tokyo Stock Exchange (TSE). The Russell 3000 Growth Index is an unmanaged index comprised of those Russell 3000 companies with higher price-to-book ratios and higher forecasted growth values. The Russell 3000 Value Index measures the performance of those Russell 3000 companies with lower price-to-book ratios and lower forecasted growth values. The MSCI World ex USA Index captures large and mid cap representation across 22 of 23 Developed Markets (DM) countries*--excluding the United States. With 1,005 constituents, the index covers approximately 85% of the free float-adjusted market capitalization in each country. Alternative investments may not be suitable for all investors and should be considered as an investment for the risk capital portion of the investor s portfolio. The strategies employed in the management of alternative investments may accelerate the velocity of potential losses. Precious metal investing involves greater fluctuation and potential for losses. International investing involves special risks such as currency fluctuation and political instability and may not be suitable for all investors. These risks are often heightened for investments in emerging markets. The prices of small and mid-cap stocks are generally more volatile than large cap stocks. (Sources: all index return data from Yahoo Finance; Reuters, Barron s, Wall St Journal, Bloomberg.com, ft.com, guggenheimpartners.com, zerohedge.com, ritholtz.com, markit.com, financialpost.com, Eurostat, Statistics Canada, Yahoo! Finance, stocksandnews.com, marketwatch.com, wantchinatimes.com, BBC, 361capital.com, pensionpartners.com, cnbc.com, FactSet, Figs 1 source W E Sherman & Co, LLC)