2017 Prestwick Commentary

2016 The Year in Review & 2017 The Year Ahead

Prestwick Capital Advisors 1

Prestwick Capital Advisors

Table of Contents

A Letter to the Readers – Pg. 3

2017 Themes – Pg. 4

Presidential Regime Change– Pg. 6

Central Bank Policy – Pg. 10

Slowing of the Fixed Income Bull

Market – Pg. 15

Global Equity Markets – Pg. 18

Looking Ahead – Pg. 22

Additional Links – Pg. 23

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A Letter to the Readers

The past year has certainly been one to test investor’s patience as it began with a precipitous drop in the equity markets during the first quarter and rebounded through the rest of the year. There was the Brexit vote in which the general consensus was the United Kingdom was going to vote to stay in the EU, but to everyone’s surprise they voted to leave. The markets initially dropped on the news , but quickly recovered, and the long term implications are unknown. It also proved to be quite interesting with an election that will certainly go down in the history books as Donald Trump was elected to be the next Commander in Chief after a highly polarizing campaign that drew both criticism and welcome from around the globe. Since the election the S&P 500 has gained ~6.3% and the Dow Jones has rallied ~8.6% to the near record of 20,000. Much of the gains can be attributed to the expectations for fiscal stimulus thorough increased infrastructure spending, a decreased business regulatory environment, and sector repositioning for the new political landscape. The economic conditions have continued to improve on the back of the “Trump rally” and the FOMC finally raised short term interest rates by 25 basis points with the insinuation that they would do so three additional times in 2017. As we look ahead to 2017 there are a number of potential influencing factors that can either help the economy and markets continue ahead, or potentially derail the bull market that has been in place now for close to 8 years. The earnings recession ended in the 3Q and with the resumption in earnings growth expected to carry into 2017, the equity markets should continue higher. The administration change brings anticipated fiscal measures that should spur the growth of the economy which is already strong with job growth, non-manufacturing strength, and a recovery in manufacturing. There are potential negative forces, however, that could derail the current bull market. Donald Trump has made many policy proposals that could help to spur economic growth, however that political process could prove to be more challenging than everyone expects. The current valuation of the market (~18.9x for the S&P 500) is a bit expensive relative to the 1, 3, 5, 10 & 15 year averages. Much of those price increases in the S&P 500 have come from both earnings growth and valuation expansion. However, with stocks at elevated valuations already, earnings growth is going to have to continue in order for the equity markets to continue their climb. There is also the possibility that if the Fed tightens too rapidly or too slowly, inflation can pick up and cause increased volatility in the markets. Over the next several pages we will discuss some of the themes for 2017 and how they effect the economy and markets. Some of the themes are familiar as our themes for 2016 are continuing to play out into the new year, such as the Central Banks continuing their path to policy normalization and the slowing of the bull market in fixed income. I do expect that returns of balanced portfolios will continue to face headwinds as interest rates continue to rise and the likelihood of pullbacks continue to increase. However, those pullbacks will most likely be limited in number and degree. If you would like the abbreviated version, I suggest reading pages 3 - 5, 22 – 24.

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Themes for 2017 Themes for 2017 Donald Trump’s Election Ushers in a Sense of

Encouragement by Expectations of Rollback in Regulations and a Major Fiscal Stimulus Package The details of many of the policies being

discussed are not yet known, but they are favorable for the economy.

Among those being discussed include the repeal of the ACA, personal income tax cut, corporate tax cut, infrastructure spending and reduced regulation.

Timing is going to play a major role. Central Bank on Track to Policy Normalization

Economic data have been consistent with moderate growth in 2016, but with mixed strength across sectors.

The labor market has continued to strengthen with the unemployment rate now at 4.7%1

The Fed raised interest rates only one time in December of 2017 and insinuated they would do so an additional 3 times in 2017.

The 35 year Bull Market for Fixed Income appears to be concluding Interest Rates have been on a downward trend

since their peak in 1982. The 10 year treasury climbed more than 100

basis points since its low on July 8th. How should portfolios be positioned given the

potential for a rising interest rate environment?

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Themes for 2017 Continued Themes for 2017 Global Equity Markets Cautious Amid the Future

Cohesion of Europe after the Brexit Vote, and a Slowing Chinese Economy

European markets experienced a volatile year after the surprise decision of the U.K. electing to leave the European Union.

The European region continues to struggle with little economic growth, fragile banks, and a number of important elections.

Economic growth in China, while still attractive, has raised concerns over the sustainability.

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Presidential Regime Change

Themes for 2017 Donald Trump’s Election Ushers in a Sense of

Encouragement by Expectations of Rollback in Regulations and a Major Fiscal Stimulus Package The details of many of the policies being

discussed are not yet known, but they are favorable for the economy.

Among those being discussed include the repeal of the ACA, personal income tax cut, corporate tax cut, infrastructure spending and reduced regulation.

Domestic equity markets have responded positively to the election results.

Timing is going to play a major role.

Donald Trump’s surprise election has changed the outlook in Washington which also now has a Republican controlled House and Senate.

Repeal Affordable Care Act (ACA) – This is a top priority not only for Trump, but also many of the Republican members of Congress. This is will most likely be addressed within the first 100 days in office.

Personal Income Tax Cut – Trump has proposed simplifying the tax code system to 3 brackets and providing savings, especially to those in the middle and lower income levels.

Corporate Tax Cut – While corporate taxes don’t make up a significant amount of government revenue, it could have a significant impact on the economy. Also to consider is the repatriation of the estimated $2.4T that corporations are currently holding overseas.

Infrastructure Spending and Reduced Regulation – Trump called for infrastructure spending throughout his campaign, but additional federal spending will most likely prove difficult to pass through the House.

Trump has stated that he will eliminate regulations that have been impediments to small and medium sized business owners.

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Seen below are the potential impacts of the various policy proposals of President Donald Trump.



President Trump has proposed simplifying the tax code into 3 brackets, repealing the 3.8% tax, and a change to other areas of the current tax code. The biggest beneficiaries are going to be those in the top income tax bracket in which their tax rates will be decreased from nearly 40% to 33%


Source: Russell Investments


Since the election of Donald Trump the domestic equity markets have rallied, and there has been much more dispersion in asset class returns, with financials leading the way. The environment has become much more of a “stock pickers” market with active managers able to generate more attractive returns.

Asset class returns were very compact until the election of Donald Trump.



Central Bank Policy

Themes for 2017 Central Bank on Track to Policy Normalization

Economic data have been consistent with moderate growth in 2016, but with mixed strength across sectors.

The labor market has continued to strengthen with the unemployment rate now at 4.7%1

The Fed raised interest rates only one time in December of 2017 in her speech on January 18th, Chairwoman Yellen said she expects to raise interest rates a “few times” this year.

The Fed continues with its dual mandate of maintaining a reasonable inflation and unemployment rate, although the targets continue to fluctuate.

Inflation currently stands well below the 2% target at 1.5%, and unemployment currently stands below the 5% target at 4.7%

In December, the Fed finally raised the fed funds rate for the first time in 2016 by .25% to a target rate of .50-.75%

The historically low interest rate environment that has

persisted for years is beginning to be more harmful than helpful.

The Fed does not have many tools left to leverage if the domestic economy slips into a recession.

Pension funds, insurance companies, and conservative fixed income investors continue to be negatively affected by the low interest rate environment. They are not able to meet their income needs without taking on undue risk.

The Presidency of Donald Trump presents an opportunity to change the makeup of the Federal Reserve.

There are currently two vacant positions on the Federal Reserve Board of Governors. Chairwoman Janet Yellen and Vice Chair Stanley Fisher could also concede their board seats, thereby giving Trump the opportunity to replace four of the Fed’s seven leading officials.

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There are diverging expectations as to the path of future rates, however they have narrowed over the past year.

After the recent decisions to raise in December of 2016, the Fed insinuated they would raise an additional 3 times.

The market is pricing in additional rate hikes, but not to the extent that the FOMC has estimated.

FOMC estimates of 2.88% by year-end versus market expectations of 2.09%

Central Bank Policy


The prolonged low interest rate environment has put fixed income investors in a situation were they have consistently been unable to keep up with inflation. Investors either have to take more risk to meet their income needs, or adjust their standard of living due to the decreased income streams.

Central Bank Policy


Like fixed income investors, defined benefit pension plans and insurance companies have been plagued with low rates and now face significant underfunding as a result. The return assumptions on which pension funds and insurance companies base their actuarial assumptions far exceed the actual returns they have been receiving over the past decade, thereby creating a compounding deficit.

Central Bank Policy


Central Bank Policy The equity markets did not react negatively after the most recent rate increase, as they have in the past during periods in which the Fed slowed its balance sheet expansion. After years of monetary policy influencing the market, expectations of fiscal stimulus have been moving the market higher.


Slowing of The Fixed Income Bull Market

Themes for 2017

The 30 year Bull Market for Fixed Income appears to be concluding Interest Rates have been on a downward trend

since their peak in 1982. The 10 year treasury climbed more than 100

basis points since its low on July 8th. How should portfolios be positioned given the

potential for a rising interest rate environment?

The current bull market for fixed income began in 1982 when interest rates began their downward trend from a Fed funds rate target of 20% to it’s current target of .50% -.75%

Due to the inverse relationships that interest rates have with fixed income, bond holders have been the beneficiaries of rising prices as well as very attractive coupons.

The current environment is favorable for borrowers but not investors.

Borrowers are able to access credit at historically low rates, thus encouraging spending. Investors, on the other hand, have historically low yields with a looming environment of interest rate increases.

The Fed raised the fed funds rate in December by .25% and

Yellen insinuated they would hike “a few “additional times in 2017.

A rising interest rate environment can be both a positive and a negative or the capital markets and economy.

As discussed in the previous slides, higher rates will benefit pension funds, insurance companies, savers, and financial institutions.

However, a rising rate environment can be a detractor to investment portfolios if not positioned correctly.

The Fed must be cautious as they continue towards a historically normalized rate environment.

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Slowing of The Fixed Income Bull Market The yield on the 10-Year Treasury has climbed more than 100 basis points since the low on July 8th, however since Fed raised rates December, they have been range bound. There is a chance that the Federal Reserve can continue to a normalized rate environment without a shock to the fixed income, but it is going to take precision moves and timing on their part.


As the bull market in fixed income slows and potentially concludes, and investors now face a rising interest rate environment, the effects to asset classes vary. As illustrated below, the length and magnitude to a normal interest rate environment can have very different outcomes.

Slowing of The Fixed Income Bull Market


Global Equity Markets

Themes for 2017

Global Equity Markets Cautious Amid the Future Cohesion of Europe after the Brexit Vote, and a Slowing Chinese Economy

European markets experienced a volatile year after the surprise decision of the U.K. electing to leave the European Union.

The European region continues to struggle with little economic growth, fragile banks, and a number of important elections.

Economic growth in China, while still attractive, has raised concerns over the sustainability.

The beginning of 2016 started with a precipitous drop to

the equity markets, both domestic and international, but were able to rally back during the duration of the year.

Slow growth continues to plague the European region as they continue with monetary stimulus and deal with a fragile banking system. The Brexit vote and it’s long term implications are

still unknown. There are a number of important elections with the

two most notable being in France & Germany.

China has continued to deliver attractive growth rates, however there is increasing worry as to the sustainability. China continues to face rising debt levels as well as

a rapid increase in the property market values.

International Markets present attractive investment opportunities based on valuations and expected GDP growth.

S&P 500 valuation with a P/E ratio of 18.9x seems a bit

full with the likelihood of further valuation expansion not very good. Earnings growth is going to have to continue in

order for the domestic equity market to continue higher.

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Eurozone

The Eurozone continues to strengthen as growth has resumed, unemployment continues to decrease and credit demand increase. Many of their central banks continue with easy monetary policy and there are expectations of 5-10% corporate earnings growth.



China

China’s home prices continue to skyrocket with a nearly 19% price increase in the past year. The country’s debt has quadrupled since 2007 and is now over 250% of GDP as cheap credit has been used to stimulate the slowing economy. The stimulus has helped the country in the short term, but if problems arise China’s financial system will have problems immediately.



Though there are some risks associated with the international markets, such as political events, GDP and earnings growth continue. International markets, both developed and emerging markets, are less expensive from a valuation standpoint and offer attractive investment opportunities.


Looking Ahead

As I look ahead to 2017 ,I believe there are a few different scenarios that could play out. Donald Trump was sworn in as the 45th President of the United States on January 20th and he has already been hard at work. He continues to fill his Cabinet with pro business people and the administration continues to reveal their plans for the Country. President Trump is taking a much different approach than the previous administration by actively engaging with Congress as well as leaders of major corporations. There are significant infrastructure spending proposals along with significant budget cuts amounting to approximately $10.5 trillion over the next 10 years. The economy has been fueled by years of easy monetary policy and is now shifting to fiscal policy with the main objective of growth. There is no arguing that the current bull market is lengthy (approximately 90 months) from a historical perspective, but there has been a renewed sense of optimism since the election about faster economic earnings growth from lower taxes and less regulation. The base case is that in the near term equity markets will likely grind higher on the renewed optimism and potential for increased fiscal stimulus and the likelihood of continued corporate earnings growth. Structural and fiscal stimuli will most likely boost growth, and I expect to see higher inflation and a continuation of interest rates increasing. The market could slow during the second part of the year if the proposed Trump reform is met with difficulty implementing and there are any issues with the uncertainty around NAFTA. Assuming the elections in Europe don’t derail the economic recovery, the Eurozone will continue to have meaningful earnings growth and their markets will continue to rise. Japan and China also play into the baseline as we anticipate the Bank of Japan to continue with fundamental reform and fiscal stimulus. China certainly has issues to work through with their debt, but historically they have restructured their debt and Chinese lenders tend to be more lenient when it comes to debt restructuring. As is common during the later years of an equity bull market, pullbacks can develop. However, with a resumption in growth, proposed fiscal stimulus and the growth expectations in the global economies, pullbacks are not likely to be significant. I do acknowledge that while there has been a sense of renewed enthusiasm since the elections, President Trump has to be cautious as to his aggressiveness and rhetoric towards the global community, as it could derail the global economic recovery. Most of us are long term investors, and we must keep in mind that both the economy and markets are cyclical in nature and recessions are a natural part of these economic cycles. It is easy to become short term oriented with the tremendous amount of news and data that is fed to us, most of which is preferential negative, because that is what our minds pay attention to and that is what sells. The reality is the global economy has made tremendous progress, despite the booms and busts, the recessions and expansions. To help put things into perspective consider the following: over the last century the average human life span has more than doubled, average per capita income around the world has tripled, childhood mortality has decreased tenfold. In addition cost of food has decreased 10x, cost of electricity decreased 20x, cost of transportation decreased 100x, and cost of communications decreased over 1000x. The point is that we are in the midst of one of the most technologically disruptive periods in human history.


Looking Ahead Continued

All that being said, our world as we know it is continuing to become increasingly globalized and is constantly becoming a better place to live due to the technological advances and innovations in water, food, healthcare, education and freedom. Our passion is helping people cut through all of the noise and help them to achieve whatever it is they may be passionate about; whether it is philanthropic, providing their loved ones with a comfortable lifestyle, or making a lasting impact on the lives of many. The only constant is change, and anticipation of these changes, whether in the markets or economy, is why we try to constantly evolve as investors and advisors. As Warren Buffet said, “I have no idea what the stock market is going to do in the next year. I do know it’s going to be a lot higher 10 years from now and 20 years from now. There will be hiccups in the economy from time to time, but go back to 1776 and we have come a long way.” I wish everyone a prosperous 2017 and thank you for your continued trust, and know that we are here for you and your families. ~L. Grier Williford


Additional Links

“Happiness is not in the mere possession of money; it lies in the joy of achievement, in the thrill of creative effort.”

~ Franklin D. Roosevelt

We manage capital with the mindset of managing the risks that we see in the capital markets, which are constantly changing, but doing so with a long term mentality. We think about the implications of every decision in terms of years and decades.

~ Prestwick Capital Advisors

Byron Wien (Blackstone)

“Ten Surprises for 2017” https://www.blackstone.com/media/press-releases/article/byron-wien-announces-ten-surprises-for-2017

Peter Diamandis

“Exponential Growth Will Transform Humanity in the Next 30 Years”

https://singularityhub.com/2016/12/21/exponential-growth-will-transform-humanity-in-the-next-30-years/

Alliance Bernstein

“More Turbulence on Tap, but Global Economy Getting Stronger”

https://blog.abglobal.com/en/2017/01/more-turbulence-on-tap-but-global-economy-getting-stronger.htm

Raymond James Point of View “How to Build a Winning Financial Team”

https://www.raymondjames.com/pointofview/how-to-build-a-winning-financial-team

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Contact Information

L. Grier Williford, CFP® Financial Advisor O: 843.720.3507

C: 478.714.5358

[email protected]

Cowles Whitley, Registered Sales Associate II O: 843.720.3509

[email protected]

360 Concord Street, Suite 210

Charleston, SC 29401

www.prestwickcapitaladvisors.com

Raymond James & Associates, Inc., Member New York Stock Exchange/SIPC

“An objective and pragmatic approach

to comprehensive wealth management.”


Footnotes 1) Data according to the Bureau of Labor Statistics

Disclaimers The views in this commentary do not take into account the particular investment objectives, financial situations, or needs of every individual client. Investments are subject to market risk, including possible loss of principal. International investing involves additional risks such as currency fluctuations, differing financial accounting standards, and possible political and economic instability. These risk are greater in emerging markets. Links are being provided for information purposes only. Raymond James is not affiliated with and does not endorse, authorize or sponsor any of the listed websites or their respective sponsors. Raymond James is not responsible for the content of any website or the collection or use of the information regarding any web site’s users and/or members. Views expressed in this newsletter are the current opinion of the author and are subject to change without notice, and not necessarily those of Raymond James Past performance does not guarantee future results. There is no assurance that these trends will continue. Raymond James & Associates, Inc. Member New York Stock Exchange/SIPC 360 Concord St., Ste. 210 Charleston, SC 29401 843-720-3527 Raymond James & Associates, Inc. member New York Stock Exchange/SIPC

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Definitions

P/E is the price of the stock divided by its earnings per share. Gross Domestic Product (GDP) is the annual market value of all goods and services produced domestically by the U.S. REITs are financial vehicles that pool investor’s capital to purchase or finance real estate. REITs involve risks such as refinancing, economic conditions in the real estate industry, changes in property values and dependency on real estate management. Treasury Inflation-Protected Securities (TIPS) provide protection against inflation. The principal increases with inflation and decreases with deflation, as measured by the Consumer Price Index. At maturity you are paid the adjusted principal original principal, whichever is greater. Increases in TIPS principal value as a result of inflation adjustments are taxed as capital gains in the year they occur, even though these increases are not realized until the TIPS are sold or mature. Conversely, decreases in the principal amount due to inflation can be used to offset taxable interest income. Material is provided for informational purposes only and does not constitute a recommendation. It has been obtained from sources believed to be reliable, but accuracy is not guaranteed. There is an inverse relationship between interest rate movements and bond prices. Generally, when interest rates rise, bond prices fall and when interest rates fall, bond prices rise. Asset allocation and diversification do not ensure a profit or protect against a loss. Investments are subject to market risk, including possible loss of principal. Commodities are volatile investments and should only form a small part of a diversified portfolio. There may be sharp fluctuations even during periods when prices are rising overall. The price of gold has been subject to dramatic price movements over short periods of time and may be affected by elements such as currency devaluations or revaluations, economic conditions within an individual country, trade imbalances, or trade or currency restrictions between countries. As a result, the market prices of securities of companies mining or processing gold may also be affected.


Index Definitions The S&P 500 is an unmanaged index of 500 widely held stocks. It is not possible to invest directly in an index. The Dow Jones Industrial Average is an unmanaged index of 30 widely held securities. The NASDAQ Composite Index is an unmanaged index of all stocks traded on the NASDAQ over-the-counter market. U.S. Treasury securities are guaranteed by the U.S. government and, if held to maturity, offer a fixed rate of return and guaranteed principal value. Barclays Capital U.S. Aggregate Bond Index is made up of the Barclays Capital U.S> Government/Corporate Bond Index, Mortgage-Backed Securities Index, and Asset-Based Securities Index including securities that are of investment grade quality or better, have at least one year to maturity, and have an outstanding par value of at least $100 million. The Russell 3000 index is an unmanaged index that measures the performance of the 3000 largest US Companies based on total market capitalization Keep in mind that indexes are unmanaged and individuals cannot invest directly in any index.

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Documents

2017 Prestwick Commentary