First Quarter 2018 Investment Commentary

First Quarter 2018 Investment Commentary
What a ride the first quarter of 2018 has been!? Please see our latest market comments below.
As you will remember from past emails, the current market valuation is high, much like before
the financial crisis of 2008. 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
eight 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”). It is now at 31.79 and possibly could go higher.
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. Aren’t you glad you have an investment
manager who applies disciplines to possibly miss the “meat” of another major Bear market?
The CAPE still exceeds the level reached at the pre-crash high in October 2007. 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.
Timeframe summary:
In the Secular (years to decades) timeframe, the long-term valuation of the market is simply too
high to sustain rip-roaring multi-year returns – but the market has entered the low end of the
“mania” range, and all bets are off in a mania. The only thing certain in a mania is that it will
end badly…someday. The Bull-Bear Indicator (months to years) is positive), indicating a
potential uptrend in the longer timeframe. In the intermediate timeframe, the Quarterly Trend
Indicator (months to quarters) is negative for Q2 2018, and the shorter (weeks to months)
timeframe is positive. Therefore, with two indicators positive and one negative, the U.S. equity
markets are rated as Neutral.
(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)

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General Market Comments
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March Summary: The Dow Jones Industrial Average lost 926 points, or -3.7%, while the NASDAQ
Composite gave up 209 points, a -2.9% decline.
By market cap, the S&P 500 retreated -2.7%, the mid cap S&P 400 gained 0.8%, and the small cap Russell
2000 rose 1.1%. Major international markets were down across the board in March. Canada's TSX fell
half a percent, the UK's FTSE fell -2.4% and France's CAC 40 declined -2.9%. Germany's DAX fell 2.7%
and Italy's Milan FTSE dropped -0.9%. In Asia, the Shanghai Composite fell -3.0% while Japan's Nikkei
lost -4.0%. As grouped by Morgan Stanley Capital International, emerging markets rose 0.5% in March,
while developed markets fell -0.8%. Precious metals were mixed in March. Gold rose
0.7%, while Silver fell -0.9%. Oil added 5.4% and copper ended the month down -3.4%.

Q1 of 2018 Summary: For the first quarter, the Dow Jones Industrial Average fell 616 points or -2.5%,
while the NASDAQ Composite gained 2.3%. The S&P 500 and S&P 400 each declined -1.2%, while the
small cap Russell 2000 fell just 0.4%. World markets were mixed for the quarter, but the bigger markets
were all down. The Canada's TSX fell -5.2%, the UK's FTSE 100 lost -8%, while France and Germany lost -
2.7% and -6.4%, respectively. The Shanghai Composite ended the quarter down -4.4%, while Japan's
Nikkei lost -7.1%. As grouped by Morgan Stanley Capital International, emerging markets added 1.2% in
the first quarter, while developed markets retreated -0.6%. Gold gained 1.1%, Silver added 9.8%, and
Oil rallied 7.7%.

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Observations
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The volatility that was notable by its absence in 2017 came back with a vengeance in Q1 of 2018. After a
straight-up rocket-ride in January, all hell broke loose in February and March with daily triple-digit Dow
gyrations being the rule rather than the exception. All (and more) of January's gains were given up in
February and March in all major indices except for the NASDAQ Composite, which managed to hang
onto a portion of its January gains.

Our shorter-term indicator changed twice during the quarter in the midst of all the volatility. Two
changes in one quarter is very unusual, and a testament to the high volatility experienced in the quarter.
The intermediate-term indicator (the Quarterly-Trend Indicator) changed to negative as Q1 ended and
Q2 started, signaling a heightened potential of a rough time for equities in Q2, while the longer-term
indicator (the Bull/Bear indicator) remained in positive territory throughout the quarter.

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 behind 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)

Figure 1. Disciplines
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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.

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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.

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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).

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(Figs 1 source W E Sherman & Co, LLC)

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 indexes listed are unmanaged indexes, 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.

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