3rd Quarter 2017 Market Commentary

Look Before you Leap – “Don’t be the last bear or the last bull standing, let history guide you,
be contrary to the crowd, and let the tape tell you when to act.” Jeffrey A. Hirsch, Editor, Stock
Trader’s Almanac.

On Cruise Control – Investors have reason to be pleased with this year’s market
performance, however there is a sense of unease in the air. Why? The economy continues to hum
along with the last two quarters achieving three percent growth for the first time in ten years.
Interest rates remain near historic lows. Corporate profitability has exhibited steady
growth. Overseas economies have rebounded as have many foreign stock markets. Perhaps the
most obvious negative is the contentious political atmosphere and the number one antagonist is our
President. That is why individuals gathered in cities across the country last week on the
anniversary of his election to SCREAM!? There is also the dysfunctional Congress to be
considered. Finally, and most importantly, valuations are stretched. Price/earnings ratios
are well above historic norms and the average dividend yield for the Standard & Poor’s 500 is now
below two percent. Unless corporate earnings accelerate from current levels, it will be difficult
to justify a meaningful advance from current levels. Another looming concern is interest rates.
It has been well telegraphed that the Federal Reserve (i.e., the FED) is likely to increase the
federal funds rate by 25 basis points (or ¼ of one percent) next month. In
addition, the FED is rumored to be considering three more quarter point increases during 2018
before the President decided to replace Janet Yellen as Chair. There is a legitimate
concern that higher interest rates will erode support for stocks and set the stage for
the inevitable market correction. As a consequence, liquid investments will once again
provide at least a modest return for those who shun risk.

Finding Cover– When things have been going well for an extended period of time, it is easy to be
lulled into a false sense of security. Investors expect continued gains in market
prices until the correction begins. Before they can decide on which way to turn, the losses are
piling up. Therefore, the time to begin thinking defensively is when there are no clouds on the
horizon. Squirrels do not start gathering their acorns when they are covered with snow,
and investors shouldn’t wait to reap some gains until the correction is underway. One tactic
used to maintain reasonable portfolio balance and reduce stock exposure before a serious correction
is to rebalance a portfolio on a regular basis. For example, if the stock allocation is 50 percent
and a rising market increases it to 60 percent or more, the indicated action is to reduce stocks
back to the 50 percent level. Such an approach applied in both rising and falling markets
helps to reduce volatility and vulnerability to any sudden decline. Sales made as a result
of this strategy should be carefully chosen so as not to generate a large capital gain liability.
In summary, given the significant gain in stock prices since last fall’s election, now is an
excellent time to examine a portfolio’s current allocation to determine whether or not rebalancing
is appropriate.

Tax Cut or Tax Reform? – Before answering that question, our President and the Congress should
first be prepared to answer another question, “What are you trying to accomplish?” The Republican
mantra of “Tax cut! Tax cut!” is ill-timed. Fiscal stimulus at this point in the economic cycle is
likely to prove counterproductive over the near term. With unemployment approximating four
percent, there is little slack in the economy. Moreover, with the economy accelerating as
witnessed by growth of

three percent in the last two quarters, stimulus of this magnitude is likely to result in an
overheated economy and a possible resurgence of inflation. Interest rates have begun to move
higher, so a more robust economy would only serve to exacerbate these undesirable trends. The
Republicans are always quick to label the Democrats as tax-and-spend liberals, while they are now
proving to be tax cut- and- spend conservatives. What do they have in common? Easy, an unbridled
willingness to spend. Even the supposed conservative budget hawks in Congress, who owed their
success to the Tea Party voters a few election cycles ago, have been neutered by either the
establishment Republicans or the dreaded tweeting of the President. The end result is the swamp
creatures in Washington have prevailed and the annual deficits and the $20,000,000,000,000
(yes, trillion) national debt are no longer a serious concern. The sad truth is we are
sowing the seeds of our own destruction by continuously demanding the government provide us more
goodies, yet always expecting someone else to pay for it – you know, the top 10% are paying
70% of the bill. Tax reform and regulatory relief are changes capable of providing
the maximum long-term benefit with little added cost and the potential for some additional revenue.

No Diamonds; Only Rough – Pick your market and the answer is the same. There are no compelling
ideas. Stocks are, generally speaking, too rich (i.e., pricey). Bonds and other
fixed income investments do not yield enough, although there are finally some signs that
is beginning to change. For several years, money market funds yielded zero (0!), now they are
around 0.50% and climbing. Even better, six month U.S. Treasury bills yield 1.3% and moving higher
as well. Unfortunately rates for longer maturities remain disappointingly low. Spreads over
Treasuries are minimal. Investors are not being adequately compensated for the added risk. Thus
far this year, equities have provided above average total returns, but little of the credit goes to
the dividend contribution, which has shrunk to less than two percent. What this likely means is
more investors will be taking more risk than they should to capture returns that may never
materialize. Unless some miraculous pro-growth legislation is generated in Washington soon,
investors should plan for mid-single digit returns at best in 2018.

Wrapping Up the Year with a Bow – With Thanksgiving coming next week (Yikes!), it is time to
provide a few financial housekeeping tips to address before the end of the year. Any investor over
70 and ½ who owns an IRA is required to take a required minimum distribution every year. Failure to
take your withdrawal leaves you vulnerable to a severe penalty. Now is a good time
to reexamine the holdings in your investment portfolio. Many stocks have achieved healthy gains
this year, so if you wish to realize some profits or if you decide it would be wise to
employ the re-balancing strategy mentioned earlier, it provides an opportunity to
eliminate any underperforming investments. Your losses can be used to offset your
gains, and therefore reduce your capital gain liability. Any extra losses can be used to
reduce your taxable income (up to $3000 per year for a joint return). Two other important
reminders at the end of a good year are to review the list of charitable organizations you
chose to support and perhaps consider an increase in some cases. Keep in mind you
can gift appreciated securities, avoiding the capital gain tax, yet still write off the full
market value. It is worth noting you can use this approach in making gifts to family members as
well, especially if they are in a low tax bracket, of course you cannot write off gifts
to family. With any of the recommendations above you should speak with your tax preparer to
insure you take the right steps in a timely manner.

Finally, with winter on our doorstep we have to consider there may be extended electrical outages.
If so and you’re unable to reach us at our office you can accomplish any task we
ordinarily provide (except for advice) by contacting Schwab directly through their Schwab Alliance
service at 800-515- 2157 or www.schwaballiance.com.
Have a Happy Holiday Season!! –JML