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Third Quarter 2016


The markets have been surprisingly resilient through the end of the third quarter. As we have mentioned in earlier letters, it isn’t unusual to have positive markets in an election year, but may be surprising to many since this year has been particularly negative in terms of the campaign. U.S. markets have done well overall, but when you look closer, concerns of potentially higher interest rates may be the reason some rotation has happened away from higher yielding stocks, which did very well earlier in the year. The Federal Reserve did not raise rates earlier, but signaled that they might before the end of the year. Oil prices have started to rise and that also might be influenced by the outcome of the election. With interest rates very low and U.S. stocks on the rich side, it is important to be balanced in areas that are not as expensive and more opportunistic such as developed, international and emerging markets (Europe, Asia). We also consider investments on both the stock and bond side that use less traditional strategies to achieve additional diversification and potential return. Those can include managed futures and long/short strategies. These tend to be more tactical and have more flexibility to change direction. We cannot predict or control what the markets will do, but we can influence other factors that have a big effect on the overall growth of your portfolio and sustainability. These factors include rebalancing, taxes, managing risk and spending policy, as well as which account to draw from - tax deferred or after tax. Studies have shown that these are critical components of a successful long-term strategy. The 40 years of experience we have through multiple economic environments should serve us well.

To illustrate one point, consider the following:

"An individual with $1 million invested 100% in the S&P 500® as of 1/01/73 withdrawing an inflation-adjusted $100,000 per year would be out of money in 9 years. A second individual with $1 million invested in the S&P 500® as of 1/01/82 withdrawing an inflation-adjusted $100,000 per year would have an accumulation of $4.26 million remaining after 34 years, i.e., as of 12/31/15. This calculation ignores the ultimate impact of taxes on the account which are due upon withdrawal, is for illustrative purposes only and is not intended to reflect any specific investment or performance. Actual results will fluctuate with market conditions and will vary." (Source: By the Numbers Research)

This is because of what we call "sequencing of returns." For the 1973 retiree, early stock market returns were poor and we experienced high inflation. The 1982 retiree had spectacular markets for the next 15+ years and lower inflation. This is why it is important to stress test a spending plan to help pad for unexpected, future events.

Also, stock leadership is unpredictable. "An equal investment taken at the end of the trading day on 12/31/15 in the 10 worst performing individual stocks within the S&P 500® from calendar year 2015 is up +40.2% YTD through 8/31/16." (Source: By the Numbers Research)

New Legislation

Earlier this year, the Department of Labor (DOL) passed a law that requires our industry to act in the clients’ best interest (a fiduciary) for all IRA and retirement plan accounts. This is a good thing and we believe it should go beyond just IRA and 401(k) accounts. As the industry begins the process of understanding the provisions and how to comply with new requirements, (which will include many more disclosures) you will likely be receiving mailings from all your banks and financial services companies, including us, to update you. This is somewhat similar to legislation passed a few years ago in regards to 401(k) and other retirement plans, which was followed by significant, additional disclosure documents and forms. I do not expect it to be much different this time. We will be sure that whatever is needed to update your accounts will be handled accordingly. We are pleased that our philosophy of putting our clients first will now become an industry norm. While we agree conceptually, we hope the unintended consequences will be minimal. A recent example is Obamacare - the Affordable Care Act. ACA had good intentions, but has experienced challenges and high costs.

On a final note, while the election has been unusually contentious, there are some positives we can focus on. Banks in the U.S. are strong and meet capital requirements. The FDIC insurance fund balance is higher than it was before the financial crisis. We are becoming energy independent. Manufacturing output is at an all-time high. Unemployment is down. Technology is driving costs lower in critical areas like health care. Advances in cancer treatments are on the rise and the world’s population of those living in extreme poverty has dropped dramatically!

We have significant risks that cannot be discounted. However, the 24-hour news cycle almost never focuses on anything else. Once we know who we elect as a president, we can begin to turn our focus on 2017 and what ways we can benefit from changes that may evolve.

Have a wonderful fall.


Financial Market Update* Year-to-date change as of September 30, 2016
S&P 500 Index 7.84%
Morningstar Commodities
Broad Basket Category 9.48%
MSCI EAFE US$ (International) 1.73%
Barclay US Aggregate Bond 5.80%
*Indexes are for illustrative purposes only. One cannot invest directly in any index. Assumes dividends are reinvested.
Source: Morningstar

The S&P 500 is an unmanaged index of 500 widely held stocks that is generally considered representative of the U.S. stock market. The Morningstar Commodities Broad Basket Category is a composite of returns of all funds in this category. The MSCI EAFE is a free float-adjusted market capitalization index that is designed to measure developed market equity performance, excluding the United States & Canada. The EAFE consists of the country indices of 21 developed nations. The Barclays US Aggregate Index is an unmanaged market value weighted performance benchmark for investment-grade fixed rate debt issues, including government, corporate, asset backed, mortgage backed securities with a maturity of at least 1 year.

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