2018Q1 Quarterly Client Newsletter

Dear Clients,

The big news during the start of the year is the return of volatility to the stock market. In the 16 months following Trump’s election, we have had one of the smoothest, least exciting periods in stock market history. This February, that all changed. Now, it isn’t uncommon for the market to rise or fall 2% in one day. I have always told clients that as investors in the stock market, they should get used to stock market rises or falls of 2%+ or more in a single day. The proliferation of index funds, ETFs, and computerized trading has made the market more volatile. This doesn’t mean volatility is something to be worried about. We just aren’t used to it. Now, a 2% drop is more like the old 1% drops. Neither is something to be shocked or surprised about. I’ll talk more about the recent volatility later in this newsletter.

Change When Change is Needed

First, I want to talk about some interesting changes I’m seeing in the business world.

Over the years, I’ve listened to many company investor conference calls, read numerous industry reports and consulting studies, and read many financial statements. I am puzzled by the number of companies that do not listen to the changing needs of their customers and do not make serious attempts to improve their products or services.

Take the traditional media companies, for example. Netflix’s streaming service debuted in 2007. It’s 2018, and the traditional media companies still do not have an alternative product that is on the same level as Netflix. Time Warner’s HBO comes close. Hulu is half way there. One important draw of Netflix is that it allows viewers to binge watch a complete season(s). Hulu’s paid subscription product generally makes only the latest five episodes of most shows available.

Another example is the major advertising agencies. The big five advertising agencies, WPP Group, Omnicom, Interpublic Group, Publicis Groupe, and Dentsu, haven’t really changed their business model since the 1970s or so. They operate as a collection of smaller independent agencies under the same corporate owner. Lately, global consultancies like Accenture and Deloitte have been taking market share by offering companies a “one stop shop” for their advertising needs. These competitors act as one company and they assemble a team of industry and country experts to meet a client’s unique needs. These consulting firms have also been quicker to embrace new digital marketing tools, such as Adobe’s cloud software.

I’ve watched as companies staunchly defend their traditional business model even as the world changes around them. We all know that more and more retail sales are moving online, and jewelry sales are not immune to that trend. Tiffany’s former CEO never made any effort to enhance the company’s online sales channel, claiming that high-end jewelry shoppers will still prefer shopping in person. This is despite the fact that the fastest growing category of jewelry sales online was… you guessed it, high-end jewelry!

As things change in various industries, our investment holdings change as well.

Investment Updates

We have had a lot of activity in the portfolio this quarter and the past few quarters as well. We have made efforts to further diversify our clients’ portfolios in light of increasing uncertainty in many business sectors. I’m a big believer in the Japanese business philosophy of “kaizen” or constant improvement. I’m always searching for ways I can help improve my clients’ investment performance and keep your hard earned money safe and growing.

We sold two of our long-time advertising agency holdings – Omnicom (OMC) and Interpublic Group (IPG). We originally invested in Omnicom back in 2009, but, as we stated above, neither company has thoroughly embraced the new advertising model many customers want. In addition, the rise in digital media advertising spending has been concentrated among a few large firms, such as Google (which also owns YouTube) and Facebook, rather than spread out over many traditional media outlets. This has allowed large companies to do more of their marketing and advertising in-house using tools like Adobe’s Marketing Cloud software suite. (We added a small position in Adobe in part because of this new trend.) Big consumer goods companies are relying less on outside ad agencies, such as Omnicom.

We also sold our holding in Qualcomm (QCOM). Fellow chipmaker Broadcom offered to buy the company for $82 per share. While the deal may not have had a chance of being approved without serious divestures, the fact is Qualcomm has been mismanaged and is in desperate need of new leadership and a new strategy. The stock price jumped up to  $70 per share, although Qualcomm management signaled it wasn’t willing to accept a deal. We decided that $70 per share was good enough and sold. Qualcomm ultimately rejected Broadcom’s offer and the stock now trades around $50 to $55. It looks like our decision to sell paid off!

We added two small positions in Autodesk (ADSK) and Adobe Systems (ADBE). Autodesk is a CAD software company that has undergone a successful transition to the Cloud and should be more profitable with steady revenue growth going forward. As we previously mentioned, Adobe is benefiting from a change in advertising and marketing spending patterns, but we believe the core business of imaging and media software is also attractive. Today, many new companies are entering the media creation market. Tech companies like Amazon, Google, Apple, Facebook, and Netflix are all experimenting with creating or licensing their own media content. Additionally, there has been an explosion of smaller digital media companies. All of this means a growing market for Adobe’s image and video editing and creation software.

In the world of telecommunications, we added Comcast (CMCSA), Charter (CHTR), American Tower Corp (AMT), and SBA Communications (SBAC) to the portfolio. Comcast and Charter are virtual monopolies. While you may think cord cutting (getting rid of cable TV) would be a threat to both companies, the truth is that the net profit margin for video cable subscribers is around zero dollars. Providing high speed data service is where the real money is. As more consumers switch to streaming services, the demand for more data should grow. The lack of serious competition for either company also means profits should stay high. You’ve used American Tower’s and SBA’s products all the time without realizing. These companies own or lease the sites and/or towers used for wireless cell service (and other wireless services). The continued growth in demand for ever faster wireless data service makes these businesses attractive.

In the world of health care, we made in investments in Walgreens Boots Alliance (WBA) and CVS Health (CVS). While both companies have seen some challenges in their front-of-store-merchandise sales, the majority of their profits come from pharmacy sales, which are growing quite nicely. We made investments in both companies because we are unsure which company’s business model will ultimately turn out to be best. CVS is pursuing a vertically integrated business model where it owns a retail pharmacy, a pharmacy benefits manager, and has a bid in to add Aetna health insurance company as well. Walgreen’s is sticking with the traditional retail pharmacy model for now.

More on the Market Volatility

The biggest reason for increased market volatility seems to be fear of a trade war. I’ve written two previous e-mail newsletters on the subject, but I’ll restate some of my thoughts here for clients that don’t get or didn’t read them. At the end of the day, I don’t believe we have any real reason to fear that a full blown trade war will develop and severely impact the economy or the stock market. It’s important to keep several things in mind.

So far, the actual tariffs enacted against China have been 25% on $3B worth of goods. There has been a proposal for an additional 25% tariff on another $50B worth of goods subject to a negotiation period in May of this year. Trump has also reportedly requested the US trade office look into another set of tariffs on another $100B worth of goods. There is a big difference between an actual trade war and the President haphazardly throwing around potential new policies.

It’s also worth remembering what happened with the steel and aluminum tariffs. The tariffs were announced with big fanfare and came as a shock. Soon afterwards, however, most were walked back. Only a few countries that make a small portion of US steel and aluminum imports ended up subject to the tariffs. It’s likely the current situation with China will follow a similar pattern with surprising and broad announcements that are changed and adapted later.

The current and recently proposed tariffs also add to up to only .07% of our GDP or Gross Domestic Product. In other words, the 25% tariffs amount to only .07% or seven hundredths of one percent of the size of our economy. This is not big enough to make a huge impact.

The market and the media prefer sensational headlines. It’s why you see the term “trade war” being thrown around. A better term would be “trade skirmish” or “trade spat.” It’s something to keep an eye on, but right now, it is nothing to get alarmed about.

Investment Performance

Global stocks returned -1.56% and the S&P 500 returned -.76% so far.

Here’s how the rest of the portfolio performed in 2018:

Domestic Investment Grade Bonds: -1.57%
International Government Bonds: .89%
Investment Grade Corporate Bonds: -2.41%
Inflation Protected Bonds: .70%
Real Estate: -8.12%
Emerging Market Stocks: 2.54%

(All the returns listed are those of the ETFs we use.)

Again, as a reminder, your portfolio will contain a combination of most or all the investments listed, so its performance will be a blend of all the returns.

Reminder

Although you are all familiar with my investment management and retirement planning services, I want to take time in this newsletter to remind you of the other financial services I offer.

These services are available to clients as part of their comprehensive fee. I work with clients to build monthly budgets, help pick the best credit card offer, and give advice on their existing company retirement plans. Almost anything related to finance or money is something I’m available to help you with. I’ve even helped clients with non-financial things, such as picking out a new car. I enjoy helping clients, so please do not hesitate to give me a call. Shoot me an email or text if there is any way I can be of assistance.

How is Ben Invested?

Here is how my personal portfolio (my SEP IRA at FOLIO Institutional) is positioned for 2018.

My investment breakdown is as follows:

• 16% in our Dividend Folio
• 26% in our Capital Appreciation Folio
• 26% in our Concentrated Stock Folio
• 26% in our Aggressive Growth ETF Portfolio
• 1% in Real Estate (Vanguard Real Estate Index, VNQ)
• 1% in Emerging Market Stocks (Vanguard Emerging Market Index, VWO)
• 1% in Investment Grade Bonds (Vanguard Total Bond Market Index, BND)
• 1% in Inflation Protected Bonds (Barclays iShares TIPS Index, TIP)
• 1% in Municipal Bonds (iShares S&P National AMT-Free Municipal Bond Index, MUB)
• 1% in International Investment Grade Bonds (Vanguard Intermediate Term International Bond Index, BNDX)

As you can see, I have a stock-heavy portfolio. I believe our strategies for investing offer the best opportunity for long-term wealth creation.

Note: I also have an older IRA account at Scottrade opened during grad school. That account is invested solely in one stock, Philip Morris International (PM), which is a stock we hold in both of our stock portfolios.

Sincerely,

Performance Disclosure:

The performance data presented prior to 2011 represents a composite of all discretionary equity investments in accounts that have been open for at least one year. Any accounts open for less than one year are excluded from the composite performance shown. From time to time clients have made special requests that SIM hold securities in their account that are not included in SIMs recommended equity portfolio, so those investments are excluded from the composite results shown. Performance is calculated using a holding period return formula, reflects the deduction of a management fee of 1% of assets per year, and reflects the reinvestment of capital gains and dividends.

Performance data presented for 2011 and after represents the performance of the model portfolio that client accounts are linked too, reflects the deduction of management fees of 1% of assets per year, and reflects the reinvestment of capital gains and dividends.

The S&P 500 and Dow Jones Developed Market Index are used for comparison purposes and may have a significantly different volatility than the portfolios used for the presentation of SIM’s returns.

A copy of our most recent Form ADV Part 2A and Part 2B is available upon request.