A Turning Point

Dear Clients and Friends,

At midnight on December 31, many of us cheered the turning of the calendar as a year of challenges took its place in the history books. We hope the new year will be a year of recovery—a turning point in public health, the economy, and the markets. We are expecting a year of contrasts, where vaccines crush a lethal virus, the economy heals, and market performance slows.

Markets anticipated a vaccine-led recovery in 2021, which led the S&P 500 18% higher in 2020 (and a blistering 12% in the fourth quarter). With so much excitement already built into the market, we might see more muted equity returns this year. Nonetheless, we recommend staying fully invested with an allocation appropriately aligned with your long-term objectives in order to generate at least modest returns on capital that exceed inflation.

Economy turns to growth

Healthcare workers and at-risk Americans began taking two Covid vaccines last month. We could see as many as five vaccines reach the U.S. by spring, boosting personal protection against the virus, improving consumer confidence, and leading to further and lasting reopening of the economy. As vaccinated consumers rediscover airlines, hotels, and restaurants, we expect the decimated travel and leisure industries to come roaring back . Massive hiring in these rebounding industries would put cash in the pockets of millions of unemployed people struggling to make ends meet.

We expect these trends to drive the unemployment rate down below 6% later this year, from a peak of roughly 15% in spring 2020. With more workers and companies back in business, we anticipate that the economy will grow more than four percent in 2021—quite an improvement from last year’s 3.5% contraction.

While jobs and growth are at a turning point, we see less dramatic movement for inflation and interest rates. Downward wage pressures may keep inflation under two percent this year (up from one percent last year). Additionally, as monetary stimulus from the Federal Reserve continues to drive bond buying, we expect sustained upward pressure on bond prices, keeping yields in a tight range. We expect the 10-year Treasury yield to remain around one percent this year.

Markets keeping a close eye on changes in PPE

During our Quarterly Market Outlook webcast last month, we focused on PPE—Politics, Policy, and Earnings –as important drivers for investor sentiment. One month later, this is where we stand with regard to Politics and Policy: With Democratic control of Congress on the line, the Georgia Senate runoff takes place January 5, though final results may trickle out if we get a close election. If Democrats win both Senate seats in Georgia, we could see a more activist agenda for President-elect Biden such as large-scale stimulus proposals, tax hikes, and green energy infrastructure spending. Alternatively, if the GOP retains Senate control, tax and spending plans may moderate.

As for earnings, we anticipate a recovery in hard-hit industries such as consumer discretionary and energy that could lead to 23% profit growth for corporate America (compared to a 17% decline in 2020). Investors may get an early taste of the profit outlook when companies start to report quarterly results in mid-January.

We generally agree with the mantra that stocks chase earnings, and with profits flipping to growth this year, does that mean markets could also power ahead? Unfortunately stocks generally chase future earnings, and in 2020 stocks surged in anticipation of the 2021 earnings recovery. With that in mind, we expect stock performance to be below trend this year, perhaps generating low to mid-single digit returns.

How are we positioning?

With low interest rates and modest stock returns in view, investors may feel a temptation to sit this one out and wait for better days ahead. However, we prefer time in the market, rather than timing the market—especially after what global investors experienced in 2020. Investors who became risk averse in spring 2020 likely missed out on a surprise bull market as the S&P500 rose 70% from late March to year end. Even if equity markets struggle to generate returns this year, we favor full investment allocations as dividends and bond coupons can help offset inflation.

As we look at equity exposures, we continue to review diversification. Large cap U.S. stocks are up more than five-fold since the depths of the 2008-09 recession. By comparison, other developed and emerging markets have only doubled in the same period. If the next ten years see a moderation in U.S. versus international performance, investors would likely benefit from non-U.S. exposure. Our preferred method for geographic diversification is owning multinational companies in targeted sectors such as technology and utilities, where we have begun to add positions and where we expect to broaden our horizons over time.

Markets have wrapped up another year, and we sit at what we believe is a global turning point—not only for PPE, but for the markets and the world in which we live. While we continue to face the daily challenges of Covid in the near term, we expect many favorable changes this year. These fundamental improvements may have a modest impact on markets in 2021, but our sense is a full economic recovery will set up companies for durable earnings growth post-Covid. With this in mind, we continue to evaluate opportunities for total returns that track improving corporate fundamentals. While these opportunities may present themselves in surprising ways (as they did last year), we remain committed to our core investment principles and ever mindful of your goals and objectives.

Wishing you and yours a healthy and prosperous New Year,

Michael Bailey, CFA
Director of Research

Michael Mussio, CFA, CFP®
President

All opinions expressed in this newsletter are not intended to be a guarantee or forecast of future events, do not constitute a solicitation to buy or sell securities nor are they a complete description of our investment policy, the markets, an investing strategy or any securities referred to in the newsletter.  Opinions expressed herein are not intended to be used as investment advice and are subject to change without notice based on market and other conditions. Different types of investments involve varying degrees of risk, and there is no assurance that any specific investment will either be suitable or profitable for a client’s or prospective client’s investment portfolio, and no one should assume that any information presented here serves as the receipt of, or a substitute for, personalized individual advice from FBB Capital Partners, its research team or its portfolio managers. The value of investments and the income from them may fluctuate and can fall as well as rise.

Retirement Planning Considerations Surrounding the Election

In November 2016, I remember carrying my three-month-old daughter late into the evening of election night. I told my wife not to worry and that I would be on duty that night. The markets had been caught off guard and equity futures were plummeting. Futures triggered built-in market circuit breakers and trading was halted. Even as an experienced professional, this can be quite stressful. While I had no idea what to expect going into the office that next day, our process of constantly reviewing our clients’ portfolio allocations, equity positions, and long-term planning provided an investing discipline that put me at ease. Although anxiety was at its highest in the morning, something unexpected happened. The market took a turn, and the Dow index closed on a high.

That experience only confirmed what I knew but sometimes need a reminder of: Markets are unpredictable. However, having the right plan, strategy, and team can make all the difference. If you are thinking about retiring, then it could be the difference between retiring confidently or retiring with worry.

With this in mind, as we continue forward from election day, here are three action items that you should do to mitigate sequence risk — the danger of retiring in a down market, where the early withdrawals affect the longevity prospects of the portfolio.

Plan Your Budget

As a conservative measure, plan on having the same budget at retirement as you had while you were working pre-COVID-19. Your budget will vary depending on whether you will take it easy in retirement or start travelling more. Consider, what are your plans at retirement? The answer to this is a lot different now than it would have been nine months ago. I realize that while we are amid a pandemic, it is going to be tough to travel, but eventually, travelling will get easier. There will also be more activities, events, and hobbies that will cost money. So while we are in the pandemic, sure your needs may be lower, but it is better to have that cushion between your budget at retirement and your actual expenses pre-retirement.

In addition, make sure you still have your emergency fund, which is anywhere between six to nine months of monthly expenses. This will help you to plan for the unexpected. If the heater goes, the roof needs fixing or your pet needs a visit to the vet, you will have the budget to do so. The truth is that your spending is going to fluctuate the first couple of years of retirement as you settle in. Right now, the pandemic will dictate some of the fluctuation. However, this too will pass. Once it does, plan to closely monitor your spending.

Plan Your Income

Once you have your budget, look at your income and where it is going to come from. Do you have a pension? Are you planning to leverage Social Security? Is all your income going to come from your 401k, or do you have after-tax dollars too? What does your income look like before you start your required minimum distributions? Should you consider some ROTH conversions?

While you sum up all your income streams make sure you take taxes into consideration. For planning purposes, it is better to be safe here as well, as $1 million in a tax-deferred account is much different than $1 million on an after-tax basis.

When planning your income, there are many different variances, which will depend on your situation. If all your income will come from savings, what percentage of your portfolio is that? How much equity exposure are you taking? It’s very important to check your allocation – equity vs. fixed income, types of holdings, target equity exposure, etc. As long as you know what your exposure is and it fits your risk preference, market volatility will be palatable. And the good news for any election period is that the markets are not affiliated with a political party.

There are a few additional things to keep in mind while you review your holdings: Do you have a lot of appreciated stock that you plan to donate? What types of companies are you invested in? What sectors are you favoring? The answers to these questions will help provide further guidance as you plan your income.

Compare Your Budget and Income

Now that you have planned both your budget and income, model the scenario to make sure your expected budget is sustainable by your portfolio. In other words, can your portfolio handle the level of withdrawals for the long haul? Ideally, your income will cover your expenses. If this is not the case, you need to figure out next steps. Do you need to take more equity risk? Do you need to postpone retirement?

If your income covers your expenses, your job then becomes monitoring your expenses and portfolio to make sure you are still following your plan. Early on, you may find that you need to revisit your plan quarterly, but once you are in the groove of retirement and your expenses have settled, you may find that revisiting the plan annually is plenty.

Doing this exercise will give you a good idea of what retirement looks like for you regardless of who is in office. Remember, once you have a plan, you just need to stick to the plan. Here are some final tips: Do not over-rely on static calculators; be conservative with assumptions, especially the impact that inflation can have (a stamp or gallon of milk will most likely be more expensive tomorrow than it is today); and I can’t say it enough, make sure you are taking taxes into consideration. If you are having trouble or if this seems overwhelming, then it is a good time to reach out to a financial advisor and start the discussion. What is great is that the initial consultation is often complimentary.

Knowing what I know from the 2016 election and given that my youngest is now two years old, I was able to go to bed early on November 3.

About the author: Jaime Quiros, CFP®, is a portfolio manager at FBB Capital Partners in Bethesda, Maryland. He is also registered with the National Association of Personal Financial Advisors, and he serves as a board member of Life Asset and the Washington Health Initiative. His experience in financial services spans equity trading, market making, portfolio management and private client lending.

Embarking on Retirement in a Time of Low-Interest Rates

Retirement planning can be fear evoking — the fear of not having enough resources, the fear of how you will fill your days, and the fear in your significant other’s eyes as they realize you will be together 24/7! Yet a new worry has emerged on the horizon, and that is historically low-interest rates. In early September, Federal Reserve Chairman Jerome Powell stated that interest rates would likely stay low for years as the economy fights its way back from the pandemic.

So what does this mean for both those in retirement and those on the cusp of retirement?

The traditional school of thought has been to adjust your portfolio allocation as you approach retirement by lowering your equity exposure to lessen volatility and adding bonds to provide a stream of income. That was a sound way of thinking fifteen years ago when investors could yield an estimated 5% on the 10-year Treasury note, providing a consistent method to garner income to supplement Social Security benefits. But now that the 10-year Treasury note is paying below 1%, retirees may want to take alternate steps to meet their income needs.

Consider Increasing Your Risk Appetite

Most people will spend at least twenty years in retirement. Currently, retirees need to balance their portfolios for the growth required to keep up with inflation and income for safety and volatility mitigation. When interest rates fail to provide for income purposes, you may want to think about increasing your equity exposure marginally.

We are not talking about backing up the truck and loading up on risky stocks. Instead, evaluate your risk-reward parameters and add high-quality dividend-paying stocks. Another option is to add preferred shares, which are a class of stocks that have a higher claim to assets in the event of a liquidation. When thinking about retirement planning strategies, we recommend keeping preferred exposure to no more than 10% of your portfolio allocation to fixed income.

If you are not comfortable increasing your equity exposure, your best option may be to remain on the sidelines. You will not want to invest in any vehicle that is highly sensitive to interest rates or too long in duration due to the inverse relationship of the price of these instruments and the interest rates themselves.

That may mean purchasing short-term Treasuries that pay minimal yield but provide safety and liquidity. You will then be able to take advantage of the higher-yielding opportunities when the market does move to more attractive rates. This option may come with the task of reviewing your expenses and keeping them as low as possible to keep your principal intact.

Delay Taking Your Social Security Benefits

In this low-rate environment, it may make sense for retirees meeting full retirement age to delay taking their Social Security benefits. When you review the assets you have saved for retirement, it is essential to remember that your Social Security benefits are also an asset.

Each year you delay taking your benefits, they increase by 8%. It makes sense to hold out and collect an extra 8% while you spend down other savings that are not earning close to that level of yield. Each year, you can reevaluate and decide if it makes sense to claim your Social Security benefits or delay another year.  Currently, you can defer receiving your benefit up to the age of 70.

Review All of Your Options, Including Working Longer

I know this is not the option you wanted to hear, but working longer and essentially waiting out a low-interest-rate environment may make sense. This is especially true if you can work a reduced schedule. You can take advantage of some of the free time retirement offers while still earning income.

The bottom line is that retirees have options even in this low-interest-rate environment. Retirement planning may take some creativity and research; however, it is empowering to know you have choices. Carefully assess your risk tolerance, review your budget, and discuss the next steps with your financial advisor. You may discover you are closer to financial independence than you thought!

Maggi Keating, CFP®, is a senior portfolio manager and shareholder at FBB Capital Partners in Bethesda, Maryland. She has over 20 years of experience in the financial industry. Maggi takes pride in educating her clients as she works with them toward their financial goals.

Charitable Giving During a Pandemic – Part 2

In this series, we continue to explore recent changes to the giving environment since the Tax Cut and Jobs Act of 2017 (TCJA) and now in the context of COVID and the related Coronavirus Aid, Relief, Economic Security Act (CARES).

In the last post, we reviewed recent updates to the tax code that have changed the landscape of how Americans view charitable planning. Here, we will explore new opportunities and strategies for giving within this context and during a time of great need. Take a few minutes to review these strategies and speak with a Certified Financial Planner professional and your tax advisor about how they might apply to your individual planned giving strategy.

What tax benefits are available for charitable donations?
In some ways, you can have your cake and eat it too.  The new tax legislation has separated the charitably inclined donors from those motivated to give primarily due to tax incentives (that no longer exist). Still, there are several strategies that will help those charitably inclined to reap some tax benefit, while also supporting their favorite charitable causes.

In these strangest of times, if you are among the fortunate who still have disposable income available for donations, the following are a few simple giving strategies that should be accessible to many. These strategies will benefit those who have a charitable intent but may not qualify for tax deductions using the same old tricks.

Deduction Lumping
Tax filers with deductions that approximate the standard deduction—whether just below, above, or at the deduction amount—might consider “deduction lumping” across tax years. In other words, give a lump sum of several years’ donations in a single year.

Lumping multiple years of charitable deductions in the same calendar year may help some filers reduce their taxable income in a given year. In the example above, the couple might consider lumping at least three years of charitable deductions in a single year.

You might also consider pairing this charitable planning strategy with donations to a donor-advised fund or a qualified charitable remainder trust.

Donor-Advised Fund
Donor-advised funds have become increasingly popular vehicles to facilitate “deduction lumping.” If you have an annual gifting budget of around $5,000 per year, and you contribute 10 years of contributions to a donor-advised fund, you could theoretically deduct the entire $50,000 gift in a single tax year (assuming you report sufficient income to do so). However, you could make several “grants” from your donor-advised fund to several different organizations over a number of years.

Gifting of Appreciated Stock
Gifts of appreciated stock are still eligible to be deducted post-TCJA. These gifts typically allow a donor to give even more to a charity due to the elimination of the capital gains tax.

Additionally, you might consider giving appreciated stock to a donor-advised fund for even more effect (limited to 30% of AGI).

Qualified Charitable Distributions
Those with Required Minimum Distributions may make “Qualified Charitable Distributions” from their IRAs, eliminating the need to tally your itemized deductions. This strategy is quite appealing for those above age 72 years (70.5 for anyone already taking RMDs) since it allows those who file using the standard deduction to satisfy requirements for annual distributions while also excluding the distribution from income.

Note that qualified charitable distributions may not be made into a donor-advised fund.

The Coronavirus Aid, Relief, and Economic Security (CARES) Act
There are several provisions of the CARES Act that also impact the charitable giving landscape. Following is a summary of relevant items that may help you support your most cherished organizations and causes this year.

Special Deduction for Tax Filers who take Standard Deduction
For those who are philanthropically minded, the CARES Act makes it easier to make charitable contributions. Even if a taxpayer does not itemize deductions, the CARES Act allows for a special above-the-line deduction of up to $300 for cash contributions made to nonprofits in 2020.

In other words, you may lower your AGI by up to $300 by making donations this year, perhaps making it an opportune time to help others who may be in a more tenuous financial position because of the pandemic.

Higher Limits for Cash Contributions
For those itemizing their deductions, the CARES Act allows donors to deduct up to 100% of their AGI for cash contributions made directly to nonprofit organizations. Typically, these contributions are limited to 60 percent of a taxpayer’s AGI. Additionally, taxpayers may carry forward qualified donations above their AGI for up to five years. (Note that this additional permission may not be used for contributions to donor advised funds or private foundations.)

Corporate Giving Incentive
The AGI limit for cash contributions was also increased for corporate donors. Corporations may deduct up to 25 percent of taxable income (increased from 10 percent).

Minimum Distributions Waived, but QCDs still Permitted
Even though RMDs are waived in 2020, you are still permitted to make a Qualified Charitable Distribution (QCDs) from your retirement account.

Final Thoughts
As with any tax planning strategy, we encourage you to speak with a Certified Financial Planner professional and your tax advisor about your individual tax filing situation and gifting objectives prior to initiating any of the strategies mentioned in this article. Many organizations and the individuals and families they serve will benefit from your generosity in this most uncertain time.

About the Author
Jane DeLashmutt O’Mara, CFP® brings more than a decade of experience working in financial services to her practice. Jane believes that client education and compassion are vital to the financial planning process. Whether she’s working with a client to plan for retirement or navigate a major milestone such as marriage, divorce, or loss of a loved one, she enjoys educating and empowering her clients. Jane also enjoys working with families with unique or complex estate planning needs. Contact her by calling 410-822-0813 or email jane@fbbcap.com.

FBB Capital Partners is excited to announce it recently hired Jackie Fontana, CFP®, as an Associate Portfolio Manager.

Fontana brings 15 years of experience in financial services and business development.  Having held several roles overseas, she brings a global perspective to her role.  Her primary focus at FBB Capital Partners is to help her clients grow their assets to achieve their long-term financial goals.

Jackie began her private wealth management career, serving with Sanford Bernstein and Deutsche Bank in the Los Angeles area. She then made a significant move to Melbourne, Australia, working in executive recruitment for Robert Half International.  Before joining FBB Capital Partners, Fontana served with the Institute of International Finance, managing key relationships with prominent senior banking executives across Europe and Asia.

“We are confident that Jackie will be an excellent match for this position and a strong asset to the FBB Capital Partners team,” says Michael J. Mussio, President of FBB Capital Partners.

Fontana holds a Bachelor of Arts Degree from the University of California Davis and a Master’s of Arts in International Affairs from American University.

Jackie and her husband Eric, have three boys and reside in Silver Spring, Maryland. Outside of work, Jackie is an outdoor enthusiast passionate about travel and cheering for her boys at swim meets.

Rising to the Challenge

Dear Clients and Friends,

Americans are encountering a series of challenges this year, as COVID-19 continues to disrupt work and school routines. Meanwhile, social distancing guidelines weigh heavily on travel and leisure industries, while job losses and an economic slowdown fuel emotional and financial havoc. Nonetheless, recent trends suggest that parts of the economy are starting to improve, and markets are taking notice. Manufacturing, services, and technology earnings are recovering, and the Federal Reserve stands ready to support the next leg of economic growth.

Within this context of a gradual recovery, broader stock markets rose 9% in the third quarter as investors pounced on technology solutions that are helping the globe navigate social distancing requirements. With many workers and families spending more time at home, buyers and sellers are doing more business online, driving demand for online ads, ecommerce, smart phones, and cloud computing. In some ways, the tech sector, which makes up nearly a third of the S&P500, is rising to the challenge. As technology companies provide a bridge to a COVID vaccine, stock prices are chasing the upward move in tech earnings.

During the quarter, we found opportunities to take profits in some of our surging tech stocks as we gradually shifted into more defensive sectors such as healthcare. We are comfortable with a meaningful exposure to software, IT services, and tech hardware. However, we also like the durable growth and reasonable valuations we see in drug, device, and health service companies.

COVID and the Three Es

We expect market volatility to increase heading into year-end as new information emerges on the path of the virus and the speed of a vaccine rollout. Additionally, investors will be closely watching the three Es: the economy, the election, and earnings.

So far, we have seen two COVID waves and a third could stem from increased personal activity or hospital bottlenecks as doctors treat flu and COVID cases simultaneously. A third COVID wave could lead to more quarantines and slower economic activity. Still, a growing body of scientific data suggests that new COVID vaccines and treatments may start to reach the broader population in 2021. The timing and execution of a vaccine rollout will likely impact consumer confidence and the broader economy.

In addition to the COVID dynamics, we are also watching other factors that could drive the economy in the fourth quarter. Surveys suggest that manufacturing and services may continue to expand, although unemployment may remain stuck at elevated levels. The Federal Reserve seems willing to let inflation run up a bit, which could help the job market if steady monetary stimulus continues to support the economy. Another shot in the arm for jobs and the economy could come from an additional round of fiscal stimulus, although negotiations are currently tied up in political knots.

Speaking of politics, investors are also focusing on the upcoming Presidential election for clues on potential tax and regulatory changes that may impact markets. During our recent call with political strategist Greg Valliere, we came away with a sense that Democratic control of the White House and Congress could lead to higher corporate tax rates over time. We could see some short-term volatility coming out of the election, but we expect markets to gradually refocus, as they tend to do, on the economy and earnings.

The corporate earnings picture will become clearer beginning mid-October as firms report quarterly results giving investors a chance to see how companies are recovering. We expect year-to-date trends to persist as technology companies exceed investor expectations, while more cyclical industries such as energy, banks, retail, travel, and leisure continue to struggle. If overall corporate profits exceed Wall Street estimates again, our sense is stocks could see a modest leg up.

How are we positioning?

Our analysis of COVID trends and the three Es suggests maintaining a defensive posture. We currently favor a modest cash position to take advantage of any market volatility stemming from unexpected events heading into the New Year. We also prefer more stable sectors such as healthcare, consumer staples, and utilities compared to industries struggling under the weight of the recession (commodities and financials). For technology stocks, we favor a selective approach to owning long-term market share gainers with reasonable valuations.

Turning to bonds, low levels of growth, inflation, and Federal Funds rates are keeping interest rates low for high quality, income-generating bonds. Within these constraints, we continue to own short-term Treasuries as a safe way to partially offset inflation. If we get a modest uptick in either inflation or growth, we may swap into longer-term Treasuries to lock in more attractive yields. At the same time, we are extending corporate bond ladders by purchasing some longer-term high-quality bonds as older bonds mature.

As we approach year-end, we will be watching fiscal and monetary policy makers as well as tech companies as they continue to rise to the challenges of a global pandemic. COVID trends and treatments along with the economy, election, and earnings may fuel some volatility for markets. However, our broader view of an economic recovery suggests cautious long-term optimism as we see opportunities to own attractive stocks, bonds, and other securities. As we enter the final stretch of the year, we remain committed to our core investment principles and ever mindful of your goals and objectives.

With Warm Wishes for Fall,

Michael Bailey, CFA
Director of Research

Michael Mussio, CFA, CFP®
President

All opinions expressed in this newsletter are not intended to be a guarantee or forecast of future events, do not constitute a solicitation to buy or sell securities nor are they a
complete description of our investment policy, the markets, an investing strategy or any securities referred to in the newsletter. Opinions expressed herein are not intended to
be used as investment advice and are subject to change without notice based on market and other conditions. Different types of investments involve varying degrees of risk,
and there is no assurance that any specific investment will either be suitable or profitable for a client’s or prospective client’s investment portfolio, and no one should assume
that any information presented here serves as the receipt of, or a substitute for, personalized individual advice from FBB Capital Partners, its research team or its portfolio
managers. The value of investments and the income from them may fluctuate and can fall as well as rise.

National list recognizes FBB Capital Partners as a client-focused advisory firm.

FBB Capital Partners is pleased to announce it has been named in the 2020 edition of the CNBC FA 100, which ranks the top financial advisory firms in the country.   The CNBC FA 100 celebrates the advisory firms that top the list when offering a comprehensive service that helps clients navigate through their financial life.

This is the first time the Bethesda, MD based firm has been named to the list, ranking at #63.

“We are honored to be included in this list of forward-thinking advisory firms,” says Michael Mussio, President of FBB Capital Partners. “The FBB team takes a holistic financial planning approach and is committed to offering our clients an exceptional experience.  As a fiduciary, we are diligent in gaining a strong understanding of our clients’ needs and take pride in delivering customized solutions to meet those needs.”

The CNBC rankings are based on data culled from thousands of advisory firms and provided by AccuPoint Solutions.  Evaluation criteria include disclosures, years in business, the ratio of Investment Advisors to the total number of employees, total assets under management, and total accounts under management, among others.

About FBB Capital Partners 

FBB Capital Partners (www.fbbcapitalpartners.com) is a Bethesda-based, fee-only wealth management firm that has been in operation for 30 years. FBB Capital Partners specializes in providing tailored, independent investment management and wealth advisory services to affluent families and individuals, business owners, foundations, and endowments.

For the past six of seven years, the firm has been named to the Financial Times 300, which has listed FBB Capital Partners among its Top 300 Registered Investment Advisers (RIAs) in the country. Today, FBB Capital services clients in the greater D.C. region and 27 states across the country.

Charitable Giving During a Pandemic – Part 1

Amid the chaos, a beautiful thing happened this year.

Amid the haze and hardship that COVID has wreaked around the globe, compassion, community, and humanity continue to shine. In April, while more than 23 million workers were out of work in the United States and unemployment peaked at an all-time high of nearly 15%, Americans were giving.

As you might imagine, a large portion of donations went to food banks, social services, and COVID- focused organizations.  In the past decade, the percentage of Americans who give has declined. However, recent surveys by Gallup and Campbell Rinker have reported that most plan to retain and even increase their donations to nonprofits in 2020, while only a small number intend to reduce donations.

That is a huge relief to the nonprofit community on the heels of the Tax Cut and Jobs Act of 2017 (TCJA), which many feared would disincentivize taxpayers from focusing on charitable planning. With only two tax filing years behind us post-TCJA, it is hard to know what the long-term effects of the legislation will be. However, fears of smaller donor bases and fewer donations has once again accelerated amid the backdrop of a global pandemic and related economic woes.

In this series, we will explore some of the recent changes to the giving environment since the TCJA of 2017—and now in the context of COVID and the related Coronavirus Aid, Relief, Economic Security Act (CARES). In a later post, we will describe new and emerging planned giving strategies that allow individuals opportunities to be generous while also taking advantage of tax incentives.

What are the recent changes to tax legislation?  How do these changes affect charitable contributions?

The Tax Policy Center estimates that the TCJA may affect as many as 21 million taxpayers who previously donated to qualifying charitable organizations. The legislation, which became effective in 2018, limits the ability for many tax filers to claim tax benefits for their charitable endeavors.

You may recall that TCJA limited a taxpayer’s ability to itemize his or her deductions by effectively doubling the amount of the “standard deduction” for a single filer in 2018 from what would have been $6,500 to $12,000 (the standard deduction for tax filing year 2020 is now $12,400).

The standard deduction is a deduction from a filer’s taxable income. Taxpayers may choose to deduct the higher of either the standard deduction or the total of his or her itemized deductions, which include a number of eligible expenses related to medical expenses, mortgage interest, state and local income taxes, and, notably, charitable deductions.

The significance of this change is that taxpayers with itemized deductions totaling less than $12,400 will claim the standard deduction rather than itemize deductions. Previously, those same filers may have benefited from itemizing deductible expenses such as charitable planning contributions. In short, taxpayers had great financial incentive to make charitable contributions previously, and many of the incentives no longer exist.

As you might imagine, this has caused great concern in the nonprofit arena.

Simultaneously, the TCJA eliminated the “personal exemption” and placed limitations on the amount that could be deducted for various expenses, including:

• Mortgage Interest Deduction—Mortgage interest deductions are now limited to the first $750,000 of acquisition indebtedness, and interest paid on home equity lines is no longer deductible. Previously, deductions were permitted up to $1 million of debt principal (prior purchases are grandfathered in under the new legislation).
• State and Local Taxes (also known as the “SALT” deduction)—The maximum deduction for state and local income taxes and property taxes paid is $10,000. Previously, there was not a maximum level for state and local taxes, which benefited tax filers living in high-tax areas.
• Miscellaneous Itemized Deductions—Deductions that fell into this category have been eliminated entirely. However, many filers were unable to claim deductions in this category previously, as the deductions had to exceed a certain percentage of a filer’s Adjusted Gross Income.

(Interestingly, the limitations on the above deductions are the same for taxpayers filing Single or Married Filing Jointly.)

Suffice it to say, the TCJA made it significantly harder to file a tax return with itemized deductions, which has the potential to negatively impact contributions to nonprofits.

To illustrate the point – Imagine a couple (both spouses retired), who claimed the following deductions totaling $37,000 in 2017:

• Zero mortgage Interest (their mortgage was paid off in full)
• SALT deductions of $25,000
• Miscellaneous itemized deductions of $5,000
• Charitable deductions of $7,000
• Total deductions: $37,000

In 2017 the imaginary couple would have itemized their expenses rather than take the standard deduction—then $12,700 for a married couple filing jointly—since their itemized deductions were greater than the standard deduction.

Assuming all variables remain the same, under the TCJA that same couple would be eligible for the following deductions totaling just $17,000, as compared to $37,000 in the prior year:

• Zero mortgage Interest (their mortgage was paid off in full)
• SALT deductions of $10,000 (even though they paid $25,000 in state and local taxes)
• Zero miscellaneous itemized deductions (Even though they had expenses totaling 5,000)
• Charitable deductions of $7,000
• Total deductions: $17,000

As a result, the sample couple would claim the standard deduction of $24,800 in 2020 since the standard deduction exceeds their total itemized deductions ($17,000).

In fact, our sample client would not be eligible to claim any itemized deductions until they had incurred an additional $7,400 in itemized deductions—and only at that point would itemizing their deductions break even with the amount of the standard deduction anyway.

Some might argue this client no longer has a financial incentive to make charitable donations. However, we have culled through the details to identify nuggets of opportunity that we hope will continue to incent you to give while also reaping a tax benefit during a time of much need. Stay tuned to learn more about some of these strategies in our next blog post.

Of course, understanding the timing and application of which strategies will maximize your own particular tax filing situation is important. We highly recommend speaking with a Certified Financial Planner professional and your tax advisor about how these strategies might apply to your individual planned giving strategy.

About the Author:

Jane Delashmutt O’Mara, CFP® brings more than a decade of experience working in financial services to her practice. Jane believes that client education and compassion are vital to the financial planning process. Whether she’s working with a client to plan for retirement or navigate a major milestone such as marriage, divorce, or loss of a loved one, she enjoys educating and empowering her clients. Jane also enjoys working with families with unique or complex estate planning needs. Contact her by calling 410-822-0813 or email jane@fbbcap.com.

2nd Quarter Earnings Season

2020 has been a year of surprises and dramatic swings in health concerns, economic trends, and stock prices. We continue to expect the unexpected, especially as Covid cases remain elevated, heavy job losses continue, and as we approach the Presidential election. With all these uncertainties surrounding investors, many are struggling to figure out what is next for markets.

As fundamental investors, we try to boil down all the medical, economic, and political themes into a bottom-line estimate of how companies will perform amid all the uncertainty, and for us the bottom line is corporate earnings. Historically, stocks tend to chase earnings.  With that in mind, we are taking another look at what recent profit trends can tell us about the next moves for equity markets.

This Spring, governments, businesses, and individuals voluntarily reduced economic activity for a chance of improving health security as lockdowns started in March, peaked in April, and started to unwind in May and June. For companies, the second quarter, which includes April, May, and June, started off terribly as economic activity slowed to a crawl in April. However, corporate profits started to recover by the end of the quarter as the economic freeze began to thaw out.

So, what happened with overall profits during this period of economic turbulence? Many companies shelved their profit forecasts as the Covid lockdowns began, leaving Wall Street to make an educated guess as to how fast profits would evaporate in the second quarter. Leading into the second quarter reporting season, many investors expected profits to plunge as much as 45% from the year-ago period, amid the cratering economy. However, as companies unveiled their results, the overall pain was a bit less than the consensus expectation as profits only fell about a third, year over year.

Winners and losers

The one-third drop in corporate profits last quarter is like saying your team had a losing season with some terrible losses and a few wins. Covid hit hard in parts of the economy where social distancing was impossible or where lower economic activity created a vicious cycle, while a few industries emerged with steady or improving growth.

A near-total wipeout for travel and leisure demand drove major declines in consumer discretionary profits in the quarter as hotels, airlines, and sit-down restaurants became ghost towns. The overall economic slowdown lead to lower industrial production for heavy equipment, rising bad debts for banks, and lower oil prices, which hit energy companies.

Amid all the gloom and doom, a few bright spots emerged as consumers stayed home, took care of their health, and shopped online as they worked from home. Steady electric power demand boosted utility

profits in the quarter, while mail-order prescription drugs and Covid testing drove growth for healthcare companies.

Consumers also shifted browsing and buying habits quickly as online ads and ecommerce spiked in the second quarter. Remote working and rising data usage boosted demand for cloud computing as well. Perhaps the most dramatic example of the haves and have nots in the quarter fell within the consumer discretionary sector, which includes ecommerce as well as traditional retailers. Amazon’s second quarter earnings doubled over the prior year, while profits outside of ecommerce fell 90%.

What next for earnings and stocks?

As companies lick their wounds coming out of the second quarter, we look ahead to economic trends that may drive corporate earnings in the back half of the year. Our sense is the wide gulf between winners and losers in the second quarter will start to close as time marches on. In particular, a reopening economy will likely increase demand for industrial production, oil, and even travel and leisure pursuits. Still, the black cloud of Covid will likely extend a corporate profits recession through year end as the hurricane that hit profits in the second quarter weakens into a nasty storm as we approach 2021.

Since stocks have recovered much faster than earnings, many investors are struggling with how to position their portfolios. Stock prices are likely banking on glide path toward a vaccine and an economic recovery, while in the short-term, corporate profits may struggle as the economy navigates through some turbulent air. Over the next few months, companies will be fighting to escape the bad old days of declining earnings as they do the blocking and tackling involved in growing sales and profits.

We find ourselves in a tricky situation where stocks are up, but earnings are down, prompting us to take a defensive posture for client portfolios in case Covid trends worsen, or the economic recession lingers. We generally favor defensive sectors plus technology as these parts of the economy may perform well in a recovery or another downturn. Additionally, we prefer a bit more cash to allow opportunistic purchases in case markets take another dip.

Second quarter earnings likely marked the bottom of the Covid cycle for the economy and future periods will probably start to claw back some of the losses related to the pandemic. With this in mind, we will continue to monitor earnings trends as a barometer of the next move for markets. While markets may continue to surprise investors in the coming months, a grounded focus on bottom line results should help provide a guide toward future growth.

Michael D. Bailey, CFA
Director of Research

All opinions expressed in this newsletter are not intended to be a guarantee or forecast of future events, do not constitute a solicitation to buy or sell securities nor are they a complete description of our investment policy, the markets, an investing strategy or any securities referred to in the newsletter. Opinions expressed herein are not intended to be used as investment advice and are subject to change without notice based on market and other conditions. Different types of investments involve varying degrees of risk, and there is no assurance that any specific investment will either be suitable or profitable for a client’s or prospective client’s investment portfolio, and no one should assume that any information presented here serves as the receipt of, or a substitute for, personalized individual advice from FBB Capital Partners, its research team or its portfolio managers. The value of investments and the income from them may fluctuate and can fall as well as rise.

The Wager: Active vs. Passive

In order to prove investors were better off investing in index funds rather than pay for stock pickers, Warren Buffett famously made a wager in 2008 that the Standard and Poor’s 500 index fund would outperform five funds of hedge funds over the ensuing ten-year period. The Oracle of Omaha won this bet fair and square.

Active managers charge fees to compensate for stock picking efforts, which begs the question: Are investors better off sitting back and investing in a low-cost passive strategy such as exchanged-traded index funds (ETFs)? Or should they consider hiring experienced portfolio managers and stock pickers that are more proactive selecting investments?

So what is a passive investment strategy? It is one that removes human interaction from the process. The most popular form of passive investments are ETFs, which are securities that comprise of an underlying basket of stocks or bonds that often track an underlying index, such as the Standard and Poor’s 500.

Supporters of passive management and index funds can be traced back to the efficient market hypothesis, which has been widely popularized throughout financial academia since Eugene Fama publicized his theories in the 1960s.[1] The efficient market hypothesis asserts the market is efficient, and therefore prices fully reflect all public and private information that could be available to investors, which is another way of saying stock pickers might as well pack up their bags and find a new career. We believe such assertions may prove unfounded, as we discuss further below.

Are ETFs Making Markets Less Efficient? An Opportunity for Stock Pickers

The critical assumption made by the efficient market hypothesis is that all market participants are proactively trying to determine the accurate price of securities given available information. However, these days, over half of the total value of all U.S. equities is passively managed,[2] due to the advent of ETFs, and coincided with the longest bull market in stock market history. We would argue the key assumption to support the efficient market hypothesis has not held up as fewer market participants actively involved in stock selection could in turn make markets less efficient.

According to research firm Coalition Development, there was a 20% decline in equity research analysts at 12 major Wall Street banks from 2012 to 2019.[3] Given the critical assumption to support the efficient market hypothesis above, the continued flight of human touch from the stock selection process could

make the stock market more volatile, and less efficient. This could lead to further opportunities for traditional stock picking.

Active Managers can Mitigate Downside and Capitalize on Market Dislocations to Outperform

Index funds are indifferent to bubbles. The Standard and Poor’s 500 index fund is weighted by market value, so even when valuations reach staggering levels, the index will overweight these stocks. As of the time of this writing, the top 5 stocks in this index – Apple, Microsoft, Amazon, Facebook, and Google – accounted for approximately 23% of the entire index. The Standard and Poor’s 500 index is currently at concentration levels observed in the dot com bubble.[4]

One of the best ways for stock pickers to outperform indices over a long period of time is by being down less in down markets, a metric sometimes referred to as “downside capture.” Active managers can outperform in down markets by avoiding the “losers” that may be indiscriminately held in passive funds, or by holding more cash if stocks seem expensive. To put this in perspective, index funds returned an annualized 7.13% for the 20-years ended November 30, 2017. If the 25 worst performing stocks were excluded from the index, annual returns would have improved to 17.9% over the same period[5].

Here at FBB Capital Partners, a $1B+ RIA based out of Bethesda, Maryland, we have a team of CFA, CPA, and CFP credentialed personnel that actively seek out investment opportunities for our clients. A large part of the research team’s time is spent speaking with company executives, competitors, suppliers, and other industry specialists to ensure we are focused on the best investment opportunities while minimizing risk. We also put together detailed earnings and valuation models to ensure we buy low and sell high. The deep understanding and high conviction of the stocks we manage on behalf of our clients, as well as the ability to be proactive and deploy cash during the market’s dislocation allowed us to outperform the benchmark during and through the depths of the COVID-19 crash.

Where to go from here?

Overall, while technological advances certainly provide efficiencies in the research process, we believe the human element is an essential component to selecting investments that meet client objectives.

Any readers that are significantly exposed to ETFs or other passive index funds may be well served to seek more active portfolio management, particularly in this current market environment.

-FBB Research Analyst, Zach Weiss, CPA

All opinions expressed in this newsletter are not intended to be a guarantee or forecast of future events, do not constitute a solicitation to buy or sell securities nor are they a complete description of our investment policy, the markets, an investing strategy or any securities referred to in the newsletter. Opinions expressed herein are not intended to be used as investment advice and are subject to change without notice based on market and other conditions. Different types of investments involve varying degrees of risk, and there is no assurance that any specific investment will either be suitable or profitable for a client’s or prospective client’s investment portfolio, and no one should assume that any information presented here serves as the receipt of, or a substitute for, personalized individual advice from FBB Capital Partners, its research team or its portfolio managers. The value of investments and the income from them may fluctuate and can fall as well as rise.

[1]https://www.investopedia.com/articles/basics/04/022004.asp#:~:text=Therefore%2C%20it%20implies%20the%20market,dissertation%20in%20the%201960s.

[2] https://www.morningstar.com/insights/2019/06/12/asset-parity

[3] https://www.bloomberg.com/news/articles/2019-12-19/analyst-jobs-vanish-as-a-perfect-storm-hits-wall-street-research?sref=GMK1Qp68

[4] https://www.wsj.com/articles/how-todays-tech-run-differs-from-the-dot-com-bubble-11580750439

[5] https://www.franklintempleton.ca/download/en-ca/common/i27as3dl/ARMCA_BE-What-Matters-Most-The-Case-for-Active-Risk-Management.pdf

The Road to Recovery

Dear Clients and Friends,

As we celebrate Independence Day, we are reminded of the many freedoms that have been restricted since the onset of the Covid-19 pandemic. Celebrations of life, graduations, weddings, retirements, and funerals have been postponed indefinitely. We have even had to restrict those more routine liberties that many of us took for granted such as going to a ball game, eating at a favorite restaurant, or hopping on a plane for a family getaway.

Speaking of travel, many of us are choosing to hit the road this summer instead of flying, and in many ways, we see consumer choices as driving the road to recovery for jobs, the overall economy, and markets.

The road to recovery has already taken many twists and turns. Since the beginning of the year, broad markets declined 34% from the peak before recovering more than 20% in the second quarter of 2020—the fastest bull market in history. Meanwhile, oil prices and short-term Treasury rates journeyed into negative territory (one of many “firsts” this year), and job losses continue to compound resulting in the highest unemployment rate since the great depression. We continue to expect the unexpected as the pandemic unfolds, but we have rising confidence that markets and the economy will gradually improve.

Markets Follow the Fed

With Jay Powell behind the wheel, the U.S. Federal Reserve has played a major role in helping the economy and markets find their way. After reducing the Fed Funds rate to nearly zero in March, the Fed said it would provide financing including loans of up to $2.3 trillion to consumers, employers, financial firms, and local governments in a series of efforts to blunt the pandemic’s economic impact.

Don’t fight the Fed, a well-known investor mantra, seems alive and well at this point in time. The current bull market began on March 23 when the Fed announced these stimulus programs. During the second quarter, the Fed executed several creative and much-anticipated stimulus packages that included buying corporate bonds and junk bond ETFs (exchange traded funds) in an effort to support credit markets and investor sentiment.

We expect the Fed to keep interest rates low for one to two years, but we think sustained rates below zero are unlikely as the idea of ultra-low rates has proven disappointing. European markets have experimented with negative interest rates for years, but the region’s growth remains sluggish.

Portfolio Management in the Time of COVID

The Bear Scenario: As events unfolded in the second quarter, we saw a slew of contradictory signposts that suggested the possibility of a slow and difficult recovery. Amid the dissonance, we asked ourselves tough questions about another potential leg down for the economy and markets. Would a second COVID wave lead to additional quarantines and reduced economic activity? Would the first wave of lockdowns and job losses lead to a slippery slope as people and companies fall into bankruptcy?

The Bull Scenario: On the other hand, the skies could open and the road to recovery could become much more manageable if we see additional federal stimulus and if COVID testing, treatments, and hospital protocols boost consumer confidence. Ultimately, the bull market scenario will rely upon the successful discovery and administration of an effective vaccine. At the moment, we believe that this more favorable scenario may start to play out in 2021.

As we wrestled with these scenarios during a hectic second quarter, our primary goal was protecting client investments from additional losses. We executed on this strategy by maintaining cash levels, reducing equity positions in companies tied to the economic cycle such as banks and industrials, and adding to defensive holdings in healthcare and consumer sectors. We also added to technology companies that are demonstrating growth even during the pandemic. In addition, we continued to selectively purchase fixed income where we continue to favor short term Treasury bills and corporates.

What’s next?

We are rolling our defensive posture into the third quarter as we anticipate a handful of milestones that could create some turbulence on the road to recovery. In mid-July, banks will likely report potential credit losses that may disappoint investors. Then in late July, fiscal stimulus checks may run out if the government fails to enact additional legislation supporting unemployed people or offering back to work bonuses. By the end of the third quarter, we anticipate rising credit concerns as distressed consumers hit deadlines to pay back loans.

While things may get bumpy in the near term, we do expect the economy to recover in time. When a vaccine seems more imminent and we can see a path towards its ultimate execution, consumers and businesses will feel more confident, which should translate into greater hiring. Eventually, more jobs should generate more cash available to recycle back into the economy, which should eventually alleviate credit concerns.

Looking ahead, we plan to gradually transition our defensive posture toward re-deployment of capital into new investments that we feel will have more upside ahead. We look forward to entering the second half of the year as the economy and markets recover, committed to our core investment principles and ever mindful of your goals and objectives.

Wishing you a Happy Fourth of July and a safe summer,

Michael Bailey, CFA
Director of Research

Michael Mussio, CFA
President

Note: The CARES Act previously enabled taxpayers to waive Required Minimum Distributions (RMDs) in 2020, while also allowing those affected by COVID to return RMDs already taken by extending the “60-day Rollover” deadline. Last month, the IRS expanded this relief by extending the deadline to return all un-wanted distributions to August 31. Please call your Portfolio Manager at FBB Capital Partners to discuss whether this new provision is relevant to your individual needs and objectives.

All opinions expressed in this newsletter are not intended to be a guarantee or forecast of future events, do not constitute a solicitation to buy or sell securities nor are they a complete description of our investment policy, the markets, an investing strategy or any securities referred to in the newsletter. Opinions expressed herein are not intended to be used as investment advice and are subject to change without notice based on market and other conditions. Different types of investments involve varying degrees of risk, and there is no assurance that any specific investment will either be suitable or profitable for a client’s or prospective client’s investment portfolio, and no one should assume that any information presented here serves as the receipt of, or a substitute for, personalized individual advice from FBB Capital Partners, its research team or its portfolio managers. The value of investments and the income from them may fluctuate and can fall as well as rise.

April 20, 2020

Investment Management in a Bear Market

A “Bear Market” is defined as a decline of 20% or more in the equity markets. Importantly, the definition of a Bear Market is different from that of a Recession, which is defined by two consecutive quarters of economic contraction in Gross Domestic Product. The two events typically overlap with one another. However, stock prices are typically a “leading indicator” of an economy’s overall economic health, leading into (and out of) a Recession. In other words, stock prices are likely to show signs of an imminent Bear or Recession (or the demise thereof) prior to other economic indicators such as employment and GDP.

Bear Markets naturally occur at the conclusion of a business cycle—which, at their peak, are typically indicated by full employment, rising wage pressures (inflation), rising interest rates, and a deceleration of GDP growth. The actual trigger for a decline in stock prices varies from cycle to cycle. Yet these typical indicators are almost always present.

In the Dot-com bubble, it was over-valuation and speculation highlighted by the events that followed September 11, 2001. The Great Recession was plagued by over leverage, coupled with a credit and liquidity crisis. And today, we find ourselves in the midst of a Bear Market (that is certain to become a Recession) as a result of a global pandemic that has brought human movement and the economy to a halt.

Even though the circumstances have varied in these most recent business cycles, the common indicators noted above were present during each of them.

Investing through severe market corrections will test the mettle of an investor who has endured a loss of capital within a short period of time. One day, you wake up and you’re thinking about the purchase of a new car, a summer vacation, or a new appliance for your home. The next day, you watch your account balances decline and not only do you have less money than you did the day before, but you feel like you have less money, which jets any further thought of new purchases. This negative “wealth effect” is a common byproduct of any recessionary cycle.

Personal consumption accounts for 70% of the U.S. economy. When we stop spending (or slow it way down), that directly impacts corporate profits, which leads investors to value stocks at even lower prices, which further magnifies the sudden loss of wealth – a vicious negative feedback loop.

The good news about Bear Markets is that we are presented with new opportunities to invest in great businesses—typically at much cheaper prices than their Bull Market trading days. Sometimes these corrections lead to once-in-a-lifetime buying opportunities for long-term investors.

Bear Markets are an especially great time for new investors to get started. If you are new to investing, you likely had limited exposure to the stock market downdraft – so the wealth effect had little impact on you. Now you are at liberty to start building positions in the market with index funds or individual companies at cheaper prices. (U.S. News & World Report: How to invest in a bear market as a beginner.)

Unfortunately, doing so is often very difficult and it takes not only courage but a lot of nose holding to deploy one’s hard earned capital as prices are in free fall. The best way to tackle this is to buy some now, wait another week or two and as prices go down (or up) buy a little bit more, and do the same two weeks after that. By dollar cost averaging into the Bear this way, you are building long-term positions in indexes or companies that you intend to own over the long-term without worrying about where the bottom may lie.

Warren Buffett, the most successful and famed investor of our lifetime, draws on our own consumerism to explain why it is best to buy stocks as prices fall. Buffett loves hamburgers, and when the prices of hamburgers go down, he says he naturally buys (and eats) more hamburgers.

Let’s extend this to something you like or get enjoyment out of – maybe it’s shoes, or cars, or trips to Florida – if the price of those things fell by 30%, you would likely get very excited by the “deal” you were getting and, naturally, you would want to buy more. Alas, as investors we behave in an opposite fashion: When prices of great enterprises fall by 30%, we often feel miserable and behave irrationally. We forget that prices are likely to trade higher in 12 to 18 months, and instead of buying “on sale” we tend to want to sell at lower prices. Dollar cost averaging can help us invest through this behavioral trip up and allow us to focus on the longer term at a time when short-term market pain is pervasive.

Once the Bear bottoms and we emerge on the other side, thoughtful investors will re-evaluate the positions they’ve added to and revisit their overall asset allocation. Weightings to both will certainly have drifted during the correction and rebound. We recommend that you take stock of where your new portfolio risk lies and adjust accordingly. Of course, if you need help with  Investment Management or any of these items having a conversation with a fee-only registered investment advisor may also prove to be a well-timed investment!

Michael Mussio, CFA
President

All opinions expressed in this newsletter are not intended to be a guarantee or forecast of future events, do not constitute a solicitation to buy or sell securities nor are they a complete description of our investment policy, the markets, an investing strategy or any securities referred to in the newsletter.  Opinions expressed herein are not intended to be used as investment advice and are subject to change without notice based on market and other conditions. Different types of investments involve varying degrees of risk, and there is no assurance that any specific investment will either be suitable or profitable for a client’s or prospective client’s investment portfolio, and no one should assume that any information presented here serves as the receipt of, or a substitute for, personalized individual advice from FBB Capital Partners, its research team or its portfolio managers. The value of investments and the income from them may fluctuate and can fall as well as rise.

April 1, 2020

A Light at the End of the Tunnel: Risk Management

Dear Clients and Friends,

As families adapt to more limited lifestyles in order to reduce the spread of the coronavirus, businesses are seeing less buying and selling activity, which is weighing heavily on the economy. Stock prices reflected this negativity by contracting 20% in the first quarter. In the face of deteriorating fundamentals, we anticipate a long journey ahead, but we are also looking for signs of light at the end of the tunnel.

In our last client letter on March 20, we discussed some of the fiscal and monetary tools that governments are using to offset the economic effects of the coronavirus. Since then, the President has signed a $2 trillion stimulus package, including cash that should reach individual bank accounts within weeks.

The stimulus may have eased some investor concerns, at least in the short term. We previously noted a daily pattern of 1,000-point moves in the Dow, but the fiscal stimulus may be giving investors some respite from this volatility. Part of the major market declines in late March stemmed from investor panic that many travel and tourism-related companies would fail. This panic was calmed, in part, by a rescue package for the commercial airline industry, which was already working through the challenges related to the manufacturing slowdown of Boeing’s 737 Max—and, now, plummeting air travel.

Down the street from the White House, the Federal Reserve has executed on multiple strategies for improving the “plumbing” underlying our financial system. One way to gauge the Fed’s actions is to look at its balance sheet: The Fed prints money to buy Treasuries and other securities, and its balance sheet is now more than $5 trillion (compared to less than $4 trillion at the end of last year).

As the executive and legislative branches work to offset the health and economic implications of the coronavirus, additional bad news continues to seep in. Virus cases and hospitalizations are rising sharply, particularly in urban areas such as New York. More states, including MD, VA, and DC are establishing “stay-at-home” orders, which will likely slow the virus’s spread and keep people from working. We have been watching the labor market as a gauge for determining the depth and duration of the COVID-19 recession. So far, initial weekly jobless claims data suggest that more than three million Americans are currently unemployed.

Where does the Recovery Begin?

While fundamentals are likely to worsen before they get better, we are starting to look for signs of light at the end of the tunnel. Starting with healthcare, we are seeing a sharp increase in virus testing, including rapid diagnostics from Danaher, which should help identify patients and slow the spread of the disease.

Drug treatments appear unlikely to give an immediate boost to curbing the virus, but there are hopeful possibilities, including an older anti-malarial drug and a new anti-viral from Gilead that could have clinical data in May. Other heavy-hitters such as Johnson and Johnson, Roche, and Sanofi are working on vaccines that could prevent a recurrence of the pandemic next year.

Our sense is we need to turn the tide on the virus before the economy recovers. If testing, treatment, and quarantines bend the curve of new cases, we could start to see more people going back to work and recycling money back into the economy—likely several months from now.

Investing for the Long Term

Our investment process during this bear market has included keeping an extra cash buffer and exiting stocks that are either expensive or have a large exposure to an economic downturn. At this point we are using cash to buy more of the high-conviction stocks that we already own, and we have a “shopping list” of new companies we’d like to add to our portfolio at reasonable prices.

As a result of the market declines and sales, most client portfolios are “underweight” equities relative to their long-term “targets” or “allocations.” In the coming weeks, months, and quarters ahead, we plan to gradually add back equities according to long-term target allocations. In broad terms, we will be looking to add more large-cap, U.S. companies on the equity side as well as high quality corporate bonds.

We anticipate that Europe and emerging markets will struggle to recover from the coronavirus. While China, Korea, and Japan are seeing a rapid improvement from the virus (and stock market outperformance for China), we see longer-term challenges for demographics and earnings volatility that give us pause.

Turning to the bond market, we believe that investment-grade corporate bonds offer an attractive alternative to either low-yielding Treasuries or higher risk emerging markets bonds. Depressed commodity prices and a rising dollar are becoming a toxic combination for many emerging markets issuing debt in greenbacks.

By next quarter, we are anticipating more light at the end of the tunnel. For now, we continue with Risk Management and seek out opportunities in the midst of extreme uncertainty. With cash waiting to be deployed, we will stay on track with our investment process looking to allocate capital toward companies with durable earnings growth and balance sheets that will allow them to handle the uncertainty that lies ahead. We remain committed to our core investment principles as we focus on capital preservation and attractive growth opportunities, while being ever mindful of your goals and objectives.

Holding the health of you and your families in our thoughts,

Michael Bailey, CFA
Director of Research

Michael Mussio, CFA
President

Note: The new fiscal package has extended Federal tax filing, payment and first quarter estimate deadlines to July 15th. Please keep in mind the deadline for your state return may be different. Additionally, the legislation has made 2020 Required Minimum Distributions from retirement accounts optional. If you have regularly scheduled distributions (monthly, quarterly etc.) that you would like to adjust, please reach out to your portfolio manager for assistance.

All opinions expressed in this newsletter are not intended to be a guarantee or forecast of future events, do not constitute a solicitation to buy or sell securities nor are they a
complete description of our investment policy, the markets, an investing strategy or any securities referred to in the newsletter. Opinions expressed herein are not intended to
be used as investment advice and are subject to change without notice based on market and other conditions. Different types of investments involve varying degrees of risk,
and there is no assurance that any specific investment will either be suitable or profitable for a client’s or prospective client’s investment portfolio, and no one should assume
that any information presented here serves as the receipt of, or a substitute for, personalized individual advice from FBB Capital Partners, its research team or its portfolio
managers. The value of investments and the income from them may fluctuate and can fall as well as rise.

Dear Clients and Friends:

While we are all doing our part to adapt to “social distancing,” the economy and the markets continued their slide this week. As we discussed on our conference call last Friday (available on our website for those who missed it), we have to assume that forthcoming first-quarter data about the spread of COVID-19 and the economy will get worse. As investors struggle to estimate the depth of the impact of COVID-19 on our communities and our economy, markets have responded with intra-day market swings in the order of 1,000+ points.

Fiscal Policy Response
We did not spend much time on the conference call last week speculating on the fiscal and monetary responses out of Washington. Today we have more clarity on both.

This week the president signed a bill that will provide economic relief to workers to the tune of $100 billion. Additionally, Congress is working on a plan that could be passed as early as next week with headlines claiming up to $1 trillion (and whispers of more aid to come) of economic relief to family, friends, and neighbors working in industries impacted most including restaurants, hospitality, airlines and manufacturing. There is no appetite in Washington to see weekly and monthly payroll numbers dip into the 100s of thousands without an economic backstop that is likely to include checks at first—and possibly followed by tax holidays later. Private institutions are stepping up too, waving payment deadlines for utility bills, rent, credit facilities, and extending health insurance for furloughed workers.

The next phase will target specific industries – many of them mentioned above. Efforts will be made to provide guarantees and liquidity to assist small, privately held businesses, as well as large, publicly held businesses to stay afloat during this uncertain time.

It will be a real challenge for the small restaurateur who operates 10 locations to remain solvent and staffed when no one is leaving their home. Small business owners will need to make real-time decisions regarding staffing and closures

On the other end of the spectrum is a business like Boeing, which serves an imperative role in the U.S. and global economy. No one has a desire to see Boeing and its 17,000 suppliers go out of business. Similarly, the tens of thousands of workers across the travel and hospitality industry from airlines to hotels are not businesses that our economy can afford to see fail.

We suspect that we will learn the details of these lifelines in the coming days, but potential outcomes could include protective debt measures that result in the federal government taking stakes in the equity of some of the most vulnerable industries, providing loan guarantees on outstanding lines of credit, or possibly the issuance of warrants that would allow the government to enter and exit an equity position down the road. It’s worth noting that, while necessary, some of these measures would likely be extremely dilutive to current equity owners.

Monetary Policy Response
Long-time clients will recall our analogy that the markets are the plumbing of the U.S. and global economy. Most of the time, markets are relatively benign: Water moves where it is supposed to move to various faucets throughout the home via the water lines at a comfortable temperature and then back down through drains of the system. Occasionally, instead of a minor clog in the system (think Flash Crash of 2010), uncertainty elevates dramatically, liquidity tightens up, and the pipes get gummed up throughout the system. During these periods risk assets fall, and market participants expect those sorts of hiccups. However, other parts of the market that are supposed to be more stable (the bond market) tighten up too, and there can be wide variances between the price at which something is quoted to buy or sell from where the expectation of its real (or recent) value lies. We refer to this as a “market dislocation,” which is what we experienced this week in the Treasury, Municipal and Corporate credit markets.

With rates already at zero, the water pressure in our pipes was already quite high. Then the Federal Reserve, together with other global central banks, stepped into the bathtub on the second floor with a firehose pointed down the drain. Liquidity is the medicine they hope will work like a “snake” to flush the entire financial system and ensure smooth operations on the other end of this global crisis.

Our expectation is that, over time, these actions will buy time for markets to settle and begin to operate smoothly again. In the meantime, pricing variances—or dislocations—will continue to provide opportunities in the credit markets not seen since the financial crisis. We have already begun to take advantage of these dislocations to purchase short-term bonds at attractive prices that have not otherwise been available in years.

FBB Positioning
As we sort through the current volatility, we continue to weigh risk and reward for both stocks and bonds in our Financial Planning. We entered the current bear market with a bit more exposure to defensive stocks and cash. Some of our long term defensive holdings are seeing rising demand in the current crisis, including Clorox (bleach and disinfectants), Amazon (grocery deliveries to the home), Danaher (working to get high speed COVID-19 testing deployed), and Google (using technology to track the virus).

Each step of the way, we have reviewed the potential for market moves, while also assessing which companies might perform better or worse than the overall market. Our process during this market downturn began with a review and sale of low-conviction stocks that we felt were either expensive or overly exposed to cyclicality of the economy at large. We will also continue to look for opportunities to add high-quality, defensive securities such as Berkshire Hathaway.

This week we sold our holdings of international stocks, both in developed and emerging markets, as well as our emerging market bond funds. Our investment view was that, at current prices, we see more downside for international markets as countries in Europe and elsewhere are dealing with their own challenges related to the virus and whose banks are not as well capitalized as ours in the U.S.

Looking ahead, we will continue to gradually increase our equity exposure. At this point, we feel that equity markets are pricing in a full recession, and we are starting to see opportunities to purchase individual equities at reasonable prices. Where appropriate, we are considering additions to our portfolios in e-commerce, which we believe will continue to experience high demand into the future, and property casualty insurers, which tend to generate consistent results even in an economic downturn.

In conclusion, we see great challenges and opportunities in the midst of this market dislocation. We continue to look for investments where near-term investor concerns may mask high-quality businesses trading at discounted levels. Although we are being patient, we believe the current market conditions will continue to provide buying opportunities that will reward long-term investors. Again, we appreciate your confidence and trust in the FBB team, and we encourage you to reach out to your portfolio manager if you have additional questions pertaining to your specific asset allocation and financial situation.

Sincerely yours,

FBB Capital Partners’ Investment Committee

All opinions expressed in this newsletter are not intended to be a guarantee or forecast of future events, do not constitute a solicitation to buy or sell securities nor are they a complete description of our investment policy, the markets, an investing strategy or any securities referred to in the newsletter.  Opinions expressed herein are not intended to be used as investment advice and are subject to change without notice based on market and other conditions. Different types of investments involve varying degrees of risk, and there is no assurance that any specific investment will either be suitable or profitable for a client’s or prospective client’s investment portfolio, and no one should assume that any information presented here serves as the receipt of, or a substitute for, personalized individual advice from FBB Capital Partners, its research team or its portfolio managers. The value of investments and the income from them may fluctuate and can fall as well as rise.

Dear Clients and Friends,

As we continue to follow developments related to the coronavirus and its impact on markets, we’ve received lots of client questions about what’s happening, what’s next, and how FBB is positioning portfolios. We hope the following will help you understand our current thoughts:

How long will the coronavirus continue to affect the markets?

We expect the markets to continue to be volatile until we can measure the impact of the virus more accurately. More accessible testing will contribute to an acceleration of this process. Following that, economic data scheduled for release over the coming 4-6 weeks should begin to provide a clearer picture on the real economic impact.

Could the virus push the U.S. into a recession?

Since the virus is pressuring both supply and demand, our sense is we could see a recession beginning with the April quarter, since we’ve yet to see any meaningful economic impact to jobs and growth from the virus through mid-March.

How do stocks usually react in a recession?

In the past 11 recessions, stocks have declined, on average from peak to trough, about 30%. These figures include the last two recessions, the dot com bust in the early 2000s and the financial crisis of ‘08-09, which were much deeper market corrections on the order of 50%.

How are broader stock and bond markets performing?

As of Friday March 13th, the S&P500 in price terms has declined (20%) from a peak on February 19, 2020. However, over the past year the broader market is down (3.5%). Bonds have helped with portfolio diversification as baskets of short-term U.S. Treasury bills have returned about 3% over the past year. In the past 18 months we’ve had essentially two bear markets (late 2018 and early 2020) as well as one major bull market (calendar 2019). Despite these major up and down moves, the S&P500 is only down (7.5%) from September 2018 levels.

What’s going on with interest rates?

The Federal Reserve cut interest rates last week and may do so again on March 18. These rate cuts, coupled with rising global demand for safe-haven securities such as government bonds, are pushing bond prices up and yields down. We expect yields on U.S. Treasury bonds to remain at or below 1% for some time, suggesting that investors may start to view bonds as insurance and diversification for stocks, rather than as a source of significant income. Global monetary policy has been evolving day to day, we continue to monitor their activities particularly related to short-term (overnight funding) measures.

What’s next for the economy and markets?

Our base case scenario is that a worsening virus pressures supply and demand enough to trigger an average recession, which could push equities down by another 5% to 10%. However, we could also see a more rapid recovery for the economy and markets—what some are calling a “v-shaped” recovery. If supply and demand struggle to recover for an extended period, we could see more downside (closer to a 50% decline).

How is FBB positioning as we move through these market challenges?

We entered this downturn with a fairly defensive posture, having trimmed some expensive tech stocks tied to the global economy, such as Palo Alto Networks (PANW). As markets began to decline in February, we sold another stock, CME Group (CME), which seemed to have overly optimistic expectations. We also added to our position in Berkshire Hathaway (BRK), because we believe Warren Buffett will use his company’s balance sheet to buy high-quality assets trading at a discount (as he did during the 2008-2009 recession). In early March, we expected markets to fully price in a recession and we took additional equity exposure off the table by trimming our technology hardware and media holdings. When we feel that broader markets have fully priced in the risk of a recession, we will look for opportunities to increase equity investments.

Summary

Over the next few weeks, investors will attempt to digest mountains of data, which will either signal the next leg up or down for markets. We have laid out a base case for what may happen with the virus, the economy, and stocks. However, we remain flexible and vigilant as market dynamics change. We believe this challenge will pass, and we remain committed to keeping clients invested in high quality stocks and bonds that can help offset inflation and build wealth for retirement goals.

We believe the current market moves may create additional opportunities for FBB clients. There are several companies on our “buy list” that we will continue monitor in hopes of purchasing high quality businesses at relative discounts to their intrinsic valuations.

Finally, we would like to once again thank you for your trust and confidence in the FBB team as we work to be responsible stewards of your capital. As schools and events are closed over the course of the next couple of weeks, we will be moving to more phone calls than in-person meetings, we appreciate your assistance in making this happen.

We wish you and your loved ones safe and healthy days ahead.

Sincerely yours,

FBB Capital Partners’ Investment Committee

All information contained in this document is obtained from sources believed to be accurate and reliable. All opinions expressed in this newsletter are subject to change without notice and are not intended to be a guarantee or forecast of future events. This document does not constitute a solicitation to buy or sell securities nor is it a complete description of our investment policy, the markets, or any securities referred to in the newsletter. Opinions expressed herein are not intended to be used as investment advice and are subject to change without notice based on market and other conditions. No client or prospective client should assume that any information presented here serves as the receipt of, or a substitute for, personalized individual advice from FBB Capital Partners, its research team or its portfolio managers.The value of investments and the income from them may fluctuate and can fall as well as rise. Past performance is not a guarantee of future results.

Dear Clients and Friends,

During the first two months of the year many investors were surprised to see stock prices rise amid rising geopolitical risks. However, the expanding coronavirus finally caught up with investor sentiment late last week as broader U.S. markets declined ~8% since last Friday. While there is no question that the virus is a new risk factor that will likely depress earnings during the first half of this year, we believe that much of the current uncertainty will pass and investors will look through to more normalized growth in late 2020 and into next year.

One way to estimate the potential impact of coronavirus to the markets is to review the effects of prior global health scares. Looking back at eight global health emergencies that have rattled markets since 1956, over the nine-month periods (inclusive of the three months prior to and the six months after authorities declared a global health crisis), on average stocks increased approximately 6%. With the S&P500 presently down 7% from a late January high before the virus made headlines, if the 2020 virus plays out like historical examples, we may be nearing a bottom.

We should also consider patterns of market corrections that could stem from any risk factor, domestic or international. Historically, markets fall about 5% every ten weeks. We haven’t had this kind of market move since August, suggesting the S&P500 was perhaps overdue for some downward volatility.

We see relative winners and losers as companies deal with the worsening coronavirus. Product-oriented companies (Pepsi, Clorox, Johnson and Johnson) likely will refill depleted inventories, but Asian-focused leisure and service companies (hotel, gaming, cruises, airlines) will likely lose profits this year and go back to trend next year. We also see greater risk for more expensive stocks, which generally carry high expectations of steady growth. So far this year we have sold some expensive technology shares and reduced exposure to utilities that were trading well above historical averages.

Looking ahead at markets and positioning, we suspect that stocks will start to recover over the next few months, in-line with historical patterns. It is possible that we have yet to see the bottom, but we expect the virus to eventually wind down as investors pivot to more favorable trends such as slow-and-steady economic growth, a truce in the trade war, and a Fed that’s ready, willing, and able to cut interest rates if necessary.

As markets recover, we’re taking a blended approach of keeping equities at long-term allocations, but also favoring defensive stocks such as staples, REITs, and utilities. We continue to look for investments where short-term corrections may lead to more attractive prices for high-quality businesses. As always, if you have questions about your allocation to risk assets, we encourage you to reach out to your portfolio manager directly. Thank you for your continued trust in the FBB team.

Sincerely yours,

FBB Capital Partners’ Investment Committee

All information contained in this document is obtained from sources believed to be accurate and reliable. All opinions expressed in this newsletter are subject to change without notice and are not intended to be a guarantee or forecast of future events. This document does not constitute a solicitation to buy or sell securities nor is it a complete description of our investment policy, the markets, or any securities referred to in the newsletter. Opinions expressed herein are not intended to be used as investment advice and are subject to change without notice based on market and other conditions. No client or prospective client should assume that any information presented here serves as the receipt of, or a substitute for, personalized individual advice from FBB Capital Partners, its research team or its portfolio managers.The value of investments and the income from them may fluctuate and can fall as well as rise. Past performance is not a guarantee of future results.

Dear Clients and Friends,

As we wrap up 2019 and look ahead to a new decade, we see reasons to stay optimistic, but we also remain vigilant for new and old risks that may emerge at unexpected times. On one hand, we see bullish trends, as interest rates and trade policy seem to favor stocks. However, we also worry about elevated investor sentiment, with stocks up 31% in 2019.

We wonder if stocks have gone too far, too fast, pulling forward earnings expectations to be realized in 2020, or could we perhaps be in a “melt-up” scenario that often precedes a recession. On the other hand, if risk factors that have been weighing against sentiment have faded, perhaps equities still have room to run.

We will dig into these themes and compare declining risks with rising investor sentiment. After weighing the good and the bad, we come away with a balanced approach to 2020; we continue to favor U.S. stocks, but with a defensive bias.

More ups than downs

Let’s take a quick look back at what drove the historic 2019 rally. For reference, 2019 was the second-best year for the S&P since the dot-com boom of the late 1990s.

Last year started out with a bang, as stocks rallied from a nearly 20% decline that bottomed in late December 2018. Investors entered 2019 worried that the Federal Reserve would continue to raise interest rates, thus putting a damper on the economy and depressing stocks. Early in 2019 the Fed took rate hikes off the table and hinted at cuts, which led to a swift rise in stock prices.

Stocks hit a couple of bumps in the spring and summer as U.S. / China trade tensions worsened and export-related manufacturing began to sputter. At the same time the bond market signaled a looming recession as long-term interest rates fell below short-term rates. However, in the fall and early winter, movement towards a trade truce, steady domestic consumption, and more favorable signals from the bond market boosted stocks, including a 9% return for the S&P500 in the fourth quarter.

What could go wrong?

Coming off a 30%+ year with relatively low volatility, investors might fall into a complacency trap as falling risks create a sensation of blue skies ahead. However, we prefer to take a more dispassionate view of both risks and upside drivers heading into 2020. Let’s take a quick look at some downside scenarios before turning back to more optimistic possibilities.

As mentioned above, the late 2019 move in stocks might look or feel like a melt up, which has, in the past, foreshadowed a last gasp for equities before a recession and bear market. Let’s dig a little deeper into what might cause a slowdown in the economy and corporate profits to see if this downside scenario might play out.

We worry about excesses triggering the next recession, similar to the dot com and real estate bubbles that led to prior downturns. Stocks are modestly expensive, but valuations suggest to us that we have yet to enter bubble territory. We’re more concerned about excess corporate and government borrowing, although low interest rates suggest minimal near-term risk here.

Other recession triggers could include lower factory output or an oil price spike that trickle down to depress consumer spending. Currently, manufacturing surveys seem stable, and oil supply shocks seem unlikely with U.S. shale oil adding flexibility to global production.

A final downside risk could be rising investor worries that the 2020 elections trigger new corporate regulations. While this political risk could materialize, we place low odds on Congress issuing regulations that stifle corporate earnings. Still, we expect increased volatility during this election year as investors parse out the economic ramifications of a shifting political landscape.

What could go right?

Having walked through some downside scenarios, let’s look at the other side of the coin. A big upside driver in 2020 could be a steady and massive unwinding of tariffs and related uncertainties for imports and exports. Trade barriers may continue to fall between the U.S. and China, while an updated NAFTA treaty could improve trade throughout North America. Additionally, the European Union could gain greater clarity around the UK’s exit.

Lower tariffs and higher global trade could set off a synchronized growth recovery, especially in export-heavy regions, such as Europe and Asia. This trade rebound scenario could be good for U.S. stocks—and even better for equities in higher trading regions.

We see upside potential for the U.S. economy and stocks as we look at other macro factors. U.S. markets could continue to benefit from a “Goldilocks scenario” in which plentiful jobs and low inflation support a stable economy, potentially nudging corporate earnings growth to the higher end of investor expectations (~10% in 2020). The icing on the cake for equities could come from low interest rates, which may continue to make stocks and dividends relatively more attractive than bonds.

Positioning for 2020

We have a bit of optimism and pessimism heading into 2020, as we see some of the upside scenarios listed above offsetting some of the risk factors. While at the moment the Fed has paused, we believe there is room to cut interest rates further, should the trade war heat up. We also expect an evenly paced and steady economy to produce a modest ~5% growth rate for earnings. Earnings growth, coupled with a 2% dividend yield and stable investor sentiment, suggests high single-digit stock returns in 2020.

Our balanced view of the economy, earnings and valuations suggests keeping full equity allocations, but over-weighting defensive stocks within diversified portfolios of securities and individual bonds. As we enter a new decade, we remain committed to our core investment principles and ever mindful of your goals and objectives.

With Warm Wishes for the New Year,

FBB Capital Partners

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As we head into the New Year, a few important announcements:

First, please note that the SECURE ACT has become law. There are a number of changes that this legislation has on retirement savings and accounts. The two most prevalent for FBB clients are as follows:

1. If you were born after July 1, 1949 the rules affecting your Required Minimum Distributions from your IRA or other retirement accounts have changed. The required age is now 72 years old (versus the prior age of 70 ½).
2. If the beneficiaries on your IRAs or other retirement accounts include people other than your spouse, then their distribution schedule has dramatically shrunk. Previously, non-spouse beneficiaries could take distributions over the course of their lifetimes. Under the new law, non-spouse beneficiaries are required to take distributions within a 10-year period. This could have significant tax implications to your heirs.

Your portfolio manager will be reviewing the potential implications of the SECURE Act on your financial situation through the course of our normal review schedule. However, as always, if you have any immediate concerns, we encourage you to reach out to your portfolio manager directly.

Second, please keep an eye out on your Inbox for details about the first of two conference calls we will be hosting with our friend Greg Valliere. Greg will help us discern how the primaries and the current political climate may affect markets in 2020. The first call is scheduled for Wednesday February 12th, additional details to follow.

Finally, please note we once again expect a couple of revision cycles for 1099s this year. As such, we advise against filing taxes early.

The information contained herein is provided for educational purposes only. Opinions expressed herein should not be construed as investment advice and are subject to change without notice based on market and other conditions. FBB Capital Partners cannot guarantee that your investment goals or objectives will be met. All investments carry some degree of risk, including the risk of loss of principal.

Dear Clients and Friends,

The arrival of fall reminds us of vacations winding down and kids heading back to school. With this in mind, we thought of the quote above, which encourages schoolchildren to do their homework. However, judging from financial news headlines this year, the quote might also apply to central bankers and trade negotiators as they attempt to pass their own economic tests.

A theme of “try, try again” continued to play out in the third quarter as the Fed cut interest rates twice and as U.S. ~ China bilateral trade talks ebbed and flowed, moving markets up and down along the way. We believe that policy makers will keep trying to meet their interest rate and trade policy goals as we close out 2019, likely driving additional market volatility.

Down and back again

As we wrote in our August 6th letter, investors hoping for a quiet summer got a rude awakening as the Fed and Chinese trade policies rattled markets. In early August, broader markets declined ~6% from a late July peak on a double whammy of bad news. First, the Fed in late July cut interest rates by a quarter point, but investor frustration grew as the Fed signaled a cautious stance toward future rate cuts. Second, the White House added new Chinese tariffs and labeled China a currency manipulator.

Despite the bad news early in the third quarter, markets rallied to a nearly 2% total return for the three-month period on improving investor sentiment. In September, the Fed cut rates another quarter point and the White House both delayed tariffs and announced plans for additional negotiations with China.

Defensive positioning

During the quarter, two economic warning signs prompted us to continue our move toward more defensive portfolio positioning. Slowing trade volumes depressed demand for product exports and drove manufacturers to anticipate declining production for the first time in three years. What’s more, the bond market grew cautious as 10-year Treasury bond yields fell well below 3-month Treasury yields in late August. This so-called yield curve inversion can suggest slower economic growth ahead.

Speaking of the bond market, we’ve also seen some unexpected choppiness in a corner of the market that rarely draws investor attention. In mid-September, investor concerns rose amid a shortage of cash and surging interest rates on short-term loans banks make to each other overnight. The Fed quickly added temporary funding for these overnight repurchase (or repo) agreements, reducing volatility. Still, we continue to watch the repo market for any spillover effects to other asset classes.

Amid these new warning signs, we reduced our exposure to stocks that could decline if interest rates continue to fall and if tariffs keep rising. During the quarter, we exited Charles Schwab & Co. (SCHW) because lower interest rates may pressure the company’s earnings. We also sold an auto parts retailer Genuine Parts (GPC) and a semiconductor company Microchip Technology (MCHP) as both could see volatile trade policies and slowing global growth impact their own earnings growth.

Weighing risk and reward

As we look ahead to upside and downside scenarios for markets, we see both risks and potential rewards. On one hand, rising risk factors suggest a defensive stance. However, on the other hand, slow and steady economic growth suggests becoming more fully invested.

Our sense is policy makers will continue to “try, try again” as they take on tough economic problems, often with one hand tied behind their backs. The Fed is working with a very limited toolbox as it tries to juice up economic growth by taking interest rates from low to really low. Central banks in Europe and Japan keep trying (to date unsuccessfully) to use low or negative rates to spark economic growth, suggesting a tough road ahead for the Federal Reserve.

On the trade front, economic theory tells us that tariffs often create more losers than winners. The economic reality is that rising U.S. and China tariff barriers have led to a cooling off in global trade. Within this challenging framework, new policy decisions by the Fed and among trade officials could create additional market volatility.

However, when looking at broader economic measures, such as employment, wages, consumption and stock valuations, we come away a bit more cautiously optimistic that companies will continue to grow earnings and stocks will chase those higher profits. The non-manufacturing services sector continues to grow, as low interest rates encourage consumption and as trade-related pressures remain minimal.

Specifically, we expect the U.S. economy to grow around 2% this year and next, while profits (and stocks) likely increase in the mid-single digits or more. While we remain vigilant that a recession could throw off our base case assumptions for growth, at this point we see few near term warning signs of an impending slowdown. A view of slow, but durable growth is leading us to consider redeploying some of our defensive cash toward high quality defensive equities offering attractive valuations and rising dividend yields.

As central bankers and trade officials continue to ‘try, try again’, we anticipate additional market volatility ahead. However, our broader view of the economy, earnings and valuations suggests cautious optimism as we see opportunities to own attractive stocks, bonds and other securities. As we enter the final stretch of the year, we remain committed to our core investment principles while being ever mindful of your goals and objectives.

With Warm Wishes for Fall,

FBB Capital Partners

All opinions expressed in this newsletter are not intended to be a guarantee or forecast of future events, do not constitute a solicitation to buy or sell securities nor are they a complete description of our investment policy, the markets, an investing strategy or any securities referred to in the newsletter.  Opinions expressed herein are not intended to be used as investment advice and are subject to change without notice based on market and other conditions. Different types of investments involve varying degrees of risk, and there is no assurance that any specific investment will either be suitable or profitable for a client’s or prospective client’s investment portfolio, and no one should assume that any information presented here serves as the receipt of, or a substitute for, personalized individual advice from FBB Capital Partners, its research team or its portfolio managers. The value of investments and the income from them may fluctuate and can fall as well as rise.

Dear Clients and Friends,

The summer break from market volatility was nice while it lasted. As you have likely seen, global stock markets have become more volatile in recent days, ending a stretch of gradually rising markets throughout most of June and July. While these periods of volatility are fairly common, this particular downturn came on rapidly and may be leading investors to review their assumptions. This letter provides our thoughts on the latest market volatility and reviews how FBB is managing portfolio risk.

To recap recent market action, broader markets fell ~3% on August 5th, capping a rough stretch of about six trading days since July 26th, where markets fell a total of ~6%. As we moved through the July Fourth holiday with high stock prices and relatively low volatility, investors expected to hear good news as the summer rolled on. In particular, markets likely anticipated favorable outcomes for: 1) corporate earnings, 2) trade negotiations with China, and 3) Federal Reserve actions.

Unfortunately, one out of three wasn’t good enough for markets as confusing language from the Fed and spiraling uncertainty regarding China trade policy offset a favorable corporate earnings picture. During a 24-hour period between July 31st and August 1st, investors got a double whammy as the Fed downplayed future interest rate cuts, followed by unexpected news of additional 10% tariffs on Chinese goods coming into the U.S.

The last straw was news on August 5th of a declining Chinese currency, potentially in retaliation to the pending 10% tariffs. Investors seem more focused on these future concerns, rather than the recent past results from corporate America as second quarter earnings are exceeding estimates by ~5%.

If you feel like you’ve seen this movie before, you’d be right, sort of. In late 2018, markets declined nearly 20% on investor fears of more restrictive Federal Reserve policy. Then in May, broader markets fell ~7% on concerns that new Chinese tariffs would depress economic activity. The one difference between the last two downturns and the current one is speed, since the prior corrections took weeks or months, while the latest move has played out over roughly a week’s worth of trading. These past three periods of market volatility share several themes: The Fed, trade disputes, and historical regularity. Our base case scenario is an expectation that we will see more of the same over the next few quarters as these themes continue to play out.

We could see market choppiness leading up to a meeting of central bankers in Jackson Hole in late August as well as heading into another possible Fed interest rate cut on September 18th. On trade, we expect additional market volatility as the U.S. and China build up and then possibly tear down trade barriers. Finally, we look to historical patterns of market volatility as a reminder that stock market declines of 5% or even 10% are not uncommon.

So, should investors worry about a ‘hurricane season’ of uncertainty with the Fed, China, and volatility? While markets could be choppy over the next several months, we are cautiously optimistic as we focus on the bigger picture: a stable economy, improving earnings, and reasonable stock valuations.

In general, we are seeing a soft landing for the US economy as the trade dispute, so far, is mostly impacting export-oriented manufacturers. Trends in business confidence, hiring, jobs, and consumer confidence will be key to gauging a manageable slowdown for the economy. Additionally, we’ll be watching interest rates and the yield curve for clues on how the bond market views the health of the economy.

Over the past several months, FBB has been positioning portfolios toward a more defensive posture. However, at the same time we continue to look for opportunities as great businesses become cheaper during these market swoons.

With that in mind, we’ve maintained a more cautious stance in recent months with above-average cash levels and a preference for defensive stocks at this point in the cycle. Recent purchases include drug companies, property casualty insurers, and cell phone tower REITs. These sectors generally have less exposure to the economy than, for example, banks, heavy equipment companies or commodity-sensitive firms.

We continue to look for investments where near-term dislocations may mask a high-quality business trading at a discounted valuation. We believe the current market moves may unveil additional opportunities for FBB clients.

Sincerely yours,

FBB Capital Partners’ Investment Committee

All information contained in this document is obtained from sources believed to be accurate and reliable. All opinions expressed in this newsletter are subject to change without notice and are not intended to be a guarantee or forecast of future events. This document does not constitute a solicitation to buy or sell securities nor is it a complete description of our investment policy, the markets, or any securities referred to in the newsletter. Opinions expressed herein are not intended to be used as investment advice and are subject to change without notice based on market and other conditions. No client or prospective client should assume that any information presented here serves as the receipt of, or a substitute for, personalized individual advice from FBB Capital Partners, its research team or its portfolio managers. The value of investments and the income from them may fluctuate and can fall as well as rise. Past performance is not a guarantee of future results.

Dear Clients and Friends,

Markets have been on a tear in 2019, up 19% through the end of June. Still, many investors are feeling less than excited about the rally—perhaps because the ascent has only taken us back to where we left off last September, immediately prior to the late 2018 selloff. This round trip has felt a bit like a sabbatical.

So, what’s driving this market ”sabbatical” for 2018-19? We would argue that investor fears around trade disputes with China and Federal Reserve policy have driven most of the volatility over the past nine months. As we look back at the second quarter of 2019 and look ahead to the remainder of the year, we believe China and the Fed will continue to dominate investors’ attention.

Unfortunately, we see additional market volatility as these themes play out, but we also remain confident that U.S. equities will remain attractive amid 1) a soft economic landing, 2) modest improvement in corporate earnings, and 3) reasonable valuations. This letter explores some of these themes in greater detail and reviews FBB’s market positioning as China, the Fed, and volatility continue to drive investor sentiment.

April and June were Pretty Good, but What Happened in May?

Broader equity markets were up a modest 4% in the second quarter, as stocks finally recovered from the downturn of late 2018. However, this favorable quarterly performance comes at the end of a few volatile months as stocks rose in April, fell in May, and bounced back again in June.

China and the Fed fueled much of the monthly volatility. Between January and late April, investors cheered as the Fed moved from tightening (raising interest rates) to a more neutral stance. Then in early May, the White House proposed a new round of tariffs on China, which led to a sharp downturn amid worries that a trade war could lead to a recession or a decline in corporate profits. However, the Fed in June seemed more willing to cut interest rates amid a worsening trade war, again providing investors bullish confidence.

Cautious Optimism

So what’s next for markets as we look ahead to the second half? We expect a bit more volatility on the interplay between China, the Fed, and investor expectations. With stocks back to all-time highs, our sense is investors expect some moderation in the U.S. – China trade dispute, as well as one (or several) more Fed rate cuts.

Markets moved positively on news of a pause in tariffs and reset in negotiations between the U.S. and China at the G20 Summit. We still expect the Fed to cut interest rates by a quarter of a point at its next meeting on July 31 with potential for another rate reduction later in the year

However, despite concerns of a global economic slowdown, we remain cautiously optimistic on stocks as we take a broader view beyond these two issues.

As mentioned above, we see a gradual economic slowdown rather than a hard landing. We see full employment, low inflation, Fed rate cuts, and consumer confidence offsetting trade disputes, which collectively have the weight to push a recession out to 2020 or later.

We also anticipate a slow-but-steady improvement in corporate earnings beginning in the third quarter on easier comparisons following the 2018 tax cuts. Finally, we see stocks trading right around long-term averages, as measured by price to earnings (P/E) ratios.

Playing Offense and Defense

Given the continual shifting of rate expectations and geopolitical uncertainty, we’ve taken several defensive steps to protect client portfolios, while also playing offense to take advantage of rising volatility. At a high level, we’ve trimmed our equity exposure and added to cash and bonds as a way of reducing downside risk in equities.

Speaking of bonds…A decline in Treasury yields has lowered the total return potential for most bond investors this year. Rather than reaching for yield from risker bond asset classes, we’ve been buying short-term Treasuries and three- to five-year corporate bonds to generate defensive income.

Within stock portfolios, we’ve also sold equities that tend to have more exposure to ups and downs in the economy, such as housing-related financial services companies. At the same time, we continue to own stocks that benefit from rising volatility, such as CME Group (Chicago Mercantile Exchange), which was one of our top performers during the quarter.

We have also increased our position in American Tower, which offers a mix of offense (rising demand for 5th generation wireless technology) and defense (barriers to entry and annual rent increases). Our sense is companies with stable growth, such as American Tower, will maintain premium valuations as markets remain volatile.

The second quarter of 2019 helped markets catch up to prior highs, and at these levels we may see some choppiness as the China and Fed themes continue to play out. However, our broader view of the economy, earnings, and valuations suggest cautious optimism as we see opportunities to own attractive stocks and bonds. As we enter the second half of the year, we remain committed to our core investment principles while being ever mindful of your goals and objectives.

Wishing you a Happy Fourth of July and a relaxing summer,

FBB Capital Partners

All opinions expressed in this newsletter are not intended to be a guarantee or forecast of future events, do not constitute a solicitation to buy or sell securities nor are they a complete description of our investment policy, the markets, an investing strategy or any securities referred to in the newsletter.  Opinions expressed herein are not intended to be used as investment advice and are subject to change without notice based on market and other conditions. Different types of investments involve varying degrees of risk, and there is no assurance that any specific investment will either be suitable or profitable for a client’s or prospective client’s investment portfolio, and no one should assume that any information presented here serves as the receipt of, or a substitute for, personalized individual advice from FBB Capital Partners, its research team or its portfolio managers. The value of investments and the income from them may fluctuate and can fall as well as rise.

Dear Clients and Friends,

From the headline above, you may be thinking we have our seasons confused. We’re referring to the economy and markets, which we believe have gone from running hot to something closer to room temperature. We view this as a welcome change.

As Northern Trust’s chief economist, Carl Tannenbaum, put it, “With a strong job market, modest exposure to trade, and easy financial conditions, the American economy is better positioned to settle comfortably at a lower level.” Additionally we see the hot equity markets of 2017 and the first quarter of 2019 gradually moving back to more normalized trends for the balance of the year.

As a quick refresher, markets surged in 2017 on expectations of the tax cut package, which eventually played out in above-average GDP and earnings growth in 2018. Last October, the Federal Reserve seemed determined to hit the brakes on the economy by raising interest rates, following comments from Fed Chairman Jay Powell that we were a “long way from neutral.” Despite the hard, year-end sell-off, we closed out 2018 with equities down only modestly, as investors turned their sights to slower economic growth in 2019 and the potential for further downside amid Federal Reserve actions.

By the end of December, Powell had started to signal a more dovish outlook for interest rate hikes in the year ahead. Investors embraced the announcement, and stocks snapped back sharply in the first quarter of 2019—even as the economy downshifted from hot to warm.

What’s the Bond Market Telling Us?

While we generally focus on the headline-grabbing stock market in these quarterly letters, we thought we would spend a minute on the less flashy (but nonetheless significant) bond market. Investors look to the bond markets widely as a gauge of the health of the overall economy, specifically focusing on Treasury bond yields. If the economy has stable inflation and steady growth, investors generally expect to earn more (in the form of higher interest rates) for a bond that will mature several years out versus one that would mature sooner. This logic—and the buying and selling that reinforce it—creates an upward-sloping yield curve (most of the time). However, when the economy appears to show signs of weakness, longer term bond yields may fall below short-term rates, creating a downward sloping curve—sometimes also called an “inverted yield curve.”

Historically, when the yield curve inverts, as measured by the difference between 2-year and 10-year Treasury bond yields, the inversion has foreshadowed a recession (typically 12-14 months out). During the first quarter of 2019 the yield “curve” took the shape of a ladle, with the 2-, 3-, 5-, and 7-year Treasuries offering lower yields than the 1-year.

So, what does this partially inverted yield curve mean for the economy, bonds, and stocks? In general, we think the yield curve is telling us that bond investors are split about the next move in the economy: Some expect a recession, while others see modest growth ahead. Our sense is that 2- to 7-year bond yields may remain low for some time. Regardless of the drivers, the oddly-shaped yield curve likely suggests some choppiness ahead for stocks as investors debate the timing of the next recession.

What’s Next for Stocks?

Corporate profits appear headed for a year-over-year decline of 3-4% in the first quarter—decidedly worse than last year’s blistering profits growth of more than 20% in three of the four quarters. We expect corporate profits to recover modestly in the second quarter, but we’ll be watching closely. A profit recession is considered to take place when earnings decline for a period of 6 months or more and can be another sign of a broader economic downturn ahead.

For now, we’re sticking with our forecast from our last client letter in that a sharp stock market recovery in early 2019 will lead to a period of more gradual market upside for the second and third quarters. However, we still expect rising stock market volatility at the end of the year as investors debate the timing of the next recession.

In terms of positioning, we’ve generally moved most portfolios to a more defensive stance favoring bonds, cash, and Treasuries. Within equities, we have been making a slow migration toward more defensive stocks. Our recent stock purchases have included electric and renewable utilities, defense companies (which tend to be counter-cyclical), and healthcare insurers. We continue to view this modestly defensive position as reasonable. At this point in the cycle, we want to capture some economic and profit growth, while also remaining cognizant that we could see a recession in the next year or two.

As the calendar turns from a harsh winter and hot markets, we embrace the opportunity to shift toward warmer weather and a warm economy, ever mindful that cool days often come with the spring season. As the year unfolds, we continue to be committed to our core investment principles and your objectives.

With Warm Wishes for Spring,

FBB Capital Partners

Please keep in mind if there are people in your life who you think would benefit from a conversation with us, please let us know.

All opinions expressed in this newsletter are not intended to be a guarantee or forecast of future events, do not constitute a solicitation to buy or sell securities nor are they a complete description of our investment policy, the markets, an investing strategy or any securities referred to in the newsletter.  Opinions expressed herein are not intended to be used as investment advice and are subject to change without notice based on market and other conditions. Different types of investments involve varying degrees of risk, and there is no assurance that any specific investment will either be suitable or profitable for a client’s or prospective client’s investment portfolio, and no one should assume that any information presented here serves as the receipt of, or a substitute for, personalized individual advice from FBB Capital Partners, its research team or its portfolio managers. The value of investments and the income from them may fluctuate and can fall as well as rise.

Dear Clients and Friends,

Instead of three French hens and a partridge in a pear tree, investors suffered three corrections and a bear market leading up to the holidays and New Year’s Eve. While the broader markets have taken away some of the holiday cheer with a -13.5% fourth quarter performance, we remain cautiously optimistic amid a landscape of steady economic growth and stock valuations that look increasingly attractive. This letter will dig into the reasons for this quarter’s disappointment and look at what a recovery might look like in the New Year.

The Grinch Stole the Santa Claus Rally

Anxiety surrounding trade wars, a slowing economy, and a Federal Reserve dishing out tough medicine drove broader markets into 10% correction territory in late October, again in late November, and a third time in early December. The final insult came just as shoppers were wrapping up holiday purchases around a Fed meeting on December 19. The meeting confirmed an anticipated interest rate hike but disappointed investors by signaling further tightening measures in 2019. The announcement was enough to drive stocks into bear market territory on Christmas Eve with major indices down 20% from recent September highs. U.S. small caps also declined ~20% in light of a possible recession and the threat of rising interest rates weighing heavier on the sales and less secure balance sheets of smaller capitalized companies.

Factors that drove U.S. stocks lower in the fourth quarter also weighed on global markets. Fears over central bank tightening, rising tariffs, economic deceleration abroad, and political disputes in the UK, Italy, and France, drove European stocks down 11%.

Emerging markets, which have struggled for some time, managed to outperform developed markets, but still declined 6%. Commodities were also volatile. Oil prices fell 35% in the fourth quarter on fears of overproduction and slowing demand ahead of an anticipated recession.

A 2019 Performance in Three Acts

As volatile as 2018 was, we believe that 2019 could prove to be equally challenging. There could, however, be a silver lining. Since World War II, back-to-back declines in the S&P500 have occurred only twice, and both during multi-year downturns (1970s stagflation and the dot-com bust of the early 2000s).

Markets may remain choppy in 2019, as stocks potentially experience three separate phases: recovery, stabilization, and volatility ahead of a possible recession. We generally see the recovery and stabilization phases as supportive of stocks, while pre-recession jitters may weigh on sentiment.

Before we look at upside and downside scenarios for stocks, let’s examine the underlying market drivers—namely GDP growth and corporate profits. Tax cuts helped boost U.S. economic growth to about three percent in 2018. However, as the fiscal stimulus wears off and the trade war takes a bigger bite, we anticipate a slowdown in economic growth in 2019. While slower year over year, it is worth noting that the expected pace of growth at 2.5% is still above the prior decade’s trend (below two percent).

While the economy may hum along in 2019, corporate profits are another story. Tax cuts sparked a blistering 20% rise in company earnings in 2018. This year, we expect that stable tax rates and rising tariff expenses will yield corporate profit growth about one-third of last year’s rate.

Continued growth for the economy and for profits could add fuel to a recovery that may have begun on December 26, when broader markets rose around five percent (including a 1,000-point day for the Dow). From a timing perspective, we’ve seen a recent pattern of stocks going up about the same number of weeks that they went down. If this pattern persists for a full recovery, we could be looking at a 17% return between December 31 and late March.

Moving beyond a possible recovery, investors may take a closer look at quarterly earnings, as stocks enter a more stable phase. If profits grow seven percent in 2019, and investors view stock valuations as reasonable, we could also see additional upward momentum in the five to 10% range for stocks.

While the early part of 2019 may see upside for markets, we could see a more cautious end to the year, as investors begin to worry more about a potential recession. We’ll be watching the bond market (particularly two- and 10-year Treasury yields) and manufacturing surveys for clues as to the potential timing.

Managing through the Volatility

We’ve been gradually taking a more defensive posture over the past quarter, and we expect to continue this shift ahead of the next turn in the economy. Our general strategy will be to continue adding high quality government bonds, while trimming stocks that rely on rapid GDP growth and adding capital to more defensive sectors.

On the bond side, we think yields may stabilize at or slightly above current levels on perhaps two more Fed rate hikes in 2019. With this in mind, we’ve been buying Treasury bonds with maturities inside five years that offer yields above the S&P500’s dividend yield. We’ve funded bond purchases by trimming equities in areas that would be most sensitive to a global economic slowdown (such as semiconductors).

We’ve also added to sectors that generally outperform just ahead of recessions (energy stocks) and those that historically generate steady results during a downturn (defense contractors). Looking ahead, we also favor utilities, which should avoid volatility related to an ongoing tariff war, as well as REITs, which tend to become more attractive toward the end of a Fed tightening cycle.

As we say farewell to a challenging 2018 holiday season for markets, we look forward to a New Year that has the potential for more favorable outcomes. We expect to navigate 2019’s twists and turns guided by our core investment principles while being ever mindful of your goals and objectives.

With Warm Wishes for a Happy New Year,

FBB Capital Partners

Please note that we expect Charles Schwab and TD Ameritrade 1099 deliveries to go through several revisions again this year. Additionally, there are a couple of portfolio positions which may generate K-1’s. Given the typical late timing of these items (March), we advise against filing your 2018 tax returns early. Please contact your portfolio manager with any questions.

All opinions expressed in this newsletter are not intended to be a guarantee or forecast of future events, do not constitute a solicitation to buy or sell securities nor are they a complete description of our investment policy, the markets, an investing strategy or any securities referred to in the newsletter.  Opinions expressed herein are not intended to be used as investment advice and are subject to change without notice based on market and other conditions. Different types of investments involve varying degrees of risk, and there is no assurance that any specific investment will either be suitable or profitable for a client’s or prospective client’s investment portfolio, and no one should assume that any information presented here serves as the receipt of, or a substitute for, personalized individual advice from FBB Capital Partners, its research team or its portfolio managers. The value of investments and the income from them may fluctuate and can fall as well as rise.

Dear Clients and Friends,

Your FBB team spent the holiday weekend giving thanks for the gifts of family and friendship. We also had plenty of conversations around the Thanksgiving dinner table about current events, including the latest market swoon that has dragged the S&P500 down to break-even levels for the year.

While we are optimistic that stocks remain an attractive asset class for investment, we have fielded several good questions about the current volatility. The comments below summarize our current views, which highlight near-term concerns for stocks and broader themes supporting a thesis that we believe will fuel higher corporate profits and equity prices.

Why are markets red in the face?

Broader U.S. equity markets have been choppy since early October on rising geopolitical concerns that appear to be trickling down to individual companies. At the macro level, large markets such as Germany and Japan have experienced slowing economic growth which could be temporary (although a Chinese lending slowdown hints at more meaningful deceleration).

Additionally, the economic impact of a bilateral trade war between the U.S. and China continues to mount for both sides, and some experts believe tariffs could knock a full percentage point off U.S. GDP growth if future rounds of tariffs go into effect. We’ll be watching a summit between the Presidents of China and the U.S. later this week for signs of where the trade war is headed.

Investors are translating these macro pressures into lower stock prices for many companies that rely on steady economic growth to fuel profits. Technology, industrial and consumer discretionary stocks have declined 12-15% since early October (compared to a ~10% hit to the S&P500) as investors worry that a slowing economy will darken the profit outlook for these cyclical industries. Making matters worse, some large companies, such as Apple, have signaled slower demand for consumer products, adding fuel to the fire for investor sentiment.

Will investors be seeing green by year-end?

Is there any way out of this mess? Our short answer: Yes. However, we see more volatility ahead as we approach the next recession. In the near term, we see a modest rebound for markets into early 2019 as investors balance fears of a slow-down with increasingly attractive valuations.

Looking at valuation, the S&P500 is now trading at about 15 times next year’s profits, roughly in-line with the average valuation since 1990. If markets are fairly priced, then our sense is that stocks should respond to economic and profit growth. Leading economic indicators and manufacturing surveys still suggest meaningful growth, while future corporate profits could expand by 8-10% over the next two years. Our belief is investors will come around to viewing an approximate 10% total return for stocks as attractive, especially at current levels.

What’s next?

While we expect a modest rebound in stocks over the next few months, we’re also preparing for the next turn in the economic cycle. As the Federal Reserve continues to hike interest rates into 2019 and the next recession approaches, we could see more modest growth for both the economy and for profits.

Our investment strategy at this point in the cycle is to gradually move into more defensive equity sectors, while also considering a modest shift to bonds. We favor a gradual approach, because we expect a modest rebound in equity markets followed by a period of volatility as the economy slows.

As this letter goes to print, markets are digesting Black Friday sales, and Cyber Monday e-commerce is heating up. While October and November have been choppy periods for investors, we feel that steady economic growth will lead to more green than red (for stocks) as we approach year end.

If you have specific questions you would like to address, your Portfolio Manager would be happy to speak with you.

With warm wishes for a Happy Holiday,

FBB Capital Partners

All opinions expressed in this newsletter are not intended to be a guarantee or forecast of future events, do not constitute a solicitation to buy or sell securities nor are they a complete description of our investment policy, the markets, an investing strategy or any securities referred to in the newsletter. Opinions expressed herein are not intended to be used as investment advice and are subject to change without notice based on market and other conditions. Different types of investments involve varying degrees of risk, and there is no assurance that any specific investment will either be suitable or profitable for a client’s or prospective client’s investment portfolio, and no one should assume that any information presented here serves as the receipt of, or a substitute for, personalized individual advice from FBB Capital Partners, its research team or its portfolio managers. The value of investments and the income from them may fluctuate and can fall as well as rise.

Dear Clients and Friends,

Well that was quick. Following a fairly smooth ride in the third quarter, volatility came back abruptly in early October as fears of rising interest rates and a worsening trade war have upset the markets. Still, despite the latest decline in investor sentiment, we expect opportunities ahead as markets reflect on stable fundamentals elsewhere, such as surging corporate profits, steady GDP growth, low inflation, and plenty of jobs to go around.

Why are markets falling?

The S&P500 fell about 7% between September 20 and October 11 on fears that two forces are squeezing profits: rising interest rates and rising costs of the trade war. Investors are likely drawing a straight line from potentially lower profits to lower stock prices. However, let’s unpack these two risk factors to see if there’s more bark than bite here.

Rising rates: Our sense is investors were fairly comfortable with the Federal Reserve’s gradual approach to higher interest rates as a way of taking its foot off the gas (monetary stimulus). However, a big move up in 10-year treasury bond yields over the past week may have jolted some investors into panic mode. Investors may have wondered if much higher rates are coming much sooner, suggesting the bond market could hit the brakes on the stock market’s forward progress.

While investors are feeling squeezed on one side with rising rates, they are also feeling more pressure on another front from a worsening trade war. Similar to the interest rate dynamic, most investors over the past few months seemed to view rising trade war risks as manageable, especially for US companies which tend to trade less than their European or Asian peers.

However, the last few days brought a string of profit warnings from companies such as Micron Technology (semiconductors), PPG (paints), Ford, Fastenal (industrial distribution) and LVMH (luxury). These comments likely led investors to a logical conclusion that a little pain now could mean a lot more pain over the next year for profits.

How significant was this week’s drop and what’s next?

In the grand scheme of things, this week’s reversal seems more like noise rather than a signal, in our view. Historically, broader markets decline between 5 and 10% every 2 to 8 months. The last correction was in the February-March timeframe, suggesting we were about due for another round of bumpy markets.

Market volatility always feels uncomfortable and this one fits the pattern. However, we are taking this week’s move in stride and putting the stock market in a broader context of what’s working. As mentioned above, we believe steady economic growth can support rising corporate profits, which should drive equity performance.

We believe companies can expand sales a bit faster than GDP growth, say in the low to mid-single digits. Companies are improving efficiencies and buying back stock, which gives us comfort in roughly 10% earnings growth over the next year or two. We generally see stock prices tracking next year’s earnings growth and if this pattern continues we would expect the broader market to rise about 10% in 2018 and perhaps a similar amount in 2019. Dividends continue to add nearly 2%, suggesting a bit more upside.

So when could markets turnaround? We may see stocks trade in a range during a choppy earnings season over the next few weeks as CEO’s grapple with investor concerns over rising rates and rising costs from the trade war. However, coming out of earnings season we get to the mid-term elections in early November. Historically, stocks have struggled to make gains ahead of mid-term elections, but then we generally see upside post-election. 2018 could fit into this pattern.

What is FBB doing amid the current volatility?

We continue to diversify and rebalance as markets present us with changing dynamics and opportunities. As markets moved up late in the third quarter we looked to add some equities that have less sensitivity to the economic cycle, in case we start to see some cooling. Additionally, as market valuations moved up over the past few weeks we screened portfolios for stocks that could use some pruning.

Now that markets and valuations have come down, we are also looking to add to companies that have durable growth drivers and attractive risk / reward profiles. We are currently looking in the ecommerce, technology, and banking industries in particular, and we hope to share our equity portfolio changes with you in our next quarterly update letter. Separately, we are also taking advantage of rising bond yields by adding new corporate and municipal bonds with higher yields.

As this letter goes to print, markets appear to be stabilizing. Our sense is we will continue to see stabilization over the coming weeks and perhaps a Happy Halloween surprise. As we head into a crisp Fall weekend, we look forward to monitoring market developments and managing client portfolios for long-term performance and income.

If you have specific questions you would like to address your Portfolio Manager would be happy to speak with you.

With best wishes from your FBB team,

FBB Capital Partners

All opinions expressed in this newsletter are not intended to be a guarantee or forecast of future events, do not constitute a solicitation to buy or sell securities nor are they a
complete description of our investment policy, the markets, an investing strategy or any securities referred to in the newsletter. Opinions expressed herein are not intended to
be used as investment advice and are subject to change without notice based on market and other conditions. Different types of investments involve varying degrees of risk,
and there is no assurance that any specific investment will either be suitable or profitable for a client’s or prospective client’s investment portfolio, and no one should assume
that any information presented here serves as the receipt of, or a substitute for, personalized individual advice from FBB Capital Partners, its research team or its portfolio
managers. The value of investments and the income from them may fluctuate and can fall as well as rise.

Dear Clients and Friends,

Skeptics who decided to “sell in May and go away” missed out on the market’s best quarter since 2013, as corporate profits surged and rising trade barriers failed to slow a resurgent U.S. economy. The third quarter of 2018 felt a lot like 2017 with quarterly stock market performance moving decidedly higher.

The S&P 500 rose ~7.6% in the third quarter—well above the first-half performance when shares were up only ~3%. The impressive equity performance in the third quarter came as a relief to many investors who were concerned that geopolitical events would torpedo markets over the summer. Rising tariffs and contentious trade negotiations led many to worry about slowing economic growth and rising inflation.

Meanwhile, a rising U.S. dollar drove a currency meltdown in Turkey, leading to fears of global contagion across emerging markets. Currencies and equity markets in Argentina, Russia, and elsewhere declined in sympathy. Equity investors took these challenges in stride, as they continued to place capital in high-quality domestic assets with improving fundamentals and reasonable valuations.

Keeping a Close Eye on Mid-terms and the Fed

As we look ahead to near-term catalysts, we are focusing on the U.S. mid-term elections in early November. On average, stock markets tend to trade sideways in the 10 months preceding a mid-term election and then outperform in the three months following election day. With the S&P500 having climbed more than 10% into early October, we may be looking at a more modest post-election ascent this time around.

In September, the Federal Reserve hiked the federal funds rate for the third time this year, while hinting that the U.S. central bank has taken its foot off the gas. The announcement validated that, at least for this cycle, the Federal Reserve is no longer in the business of stimulating our economy by maintaining unusually low interest rates.

As we move into the Fed’s December 19 meeting, investors are wondering whether another rate hike will lead to an economic slowdown. Our sense is that the U.S. economy will be able to digest another two or three interest rate hikes before we see a noticeable slowdown (although sectors such as housing may feel the pain more quickly).

How are we positioning?

With the U.S. economy growing 4.2% in the second quarter and ~3% growth likely in the second half of the year, we remain comfortable with our exposure to cyclical companies, as they typically outperform in a growing economy. We are generally at or above market weight for cyclical sectors such as financials and industrials, and we continue to look for new investments in technology and a newly-formed sector called communication services, which includes internet, media and telecom companies such as Alphabet and Verizon. This new sector dramatically changes the composition of the consumer discretionary and technology sectors, while eliminating the former telecommunications sector.

Our interest in buying companies that are economically sensitive supported our follow-on purchase of Roper Technologies (ROP) during the third quarter. Since our initial purchase of the industrial company in 2009, we have been impressed by management’s ability to consistently generate growth above investor expectations. Over the years, Roper has distinguished itself by acquiring poorly-run industrial companies and converting them into profitable investments. Over the next four years, the company plans to invest $7B in this arena, which will likely increase the company’s profits and boost investor sentiment.

While we continue to add new growth-oriented stocks, we are cognizant that the U.S. is in the latter stages of an economic cycle. As the next slowdown approaches, we are mapping out strategies for portfolio stability. Rising rates continue to make high-quality Treasuries and corporate bonds more attractive. As longer dated bonds mature or cash awaits investment, we are adding both short-term Treasuries and high-quality medium-term corporate issues to bond portfolios, while minimizing the duration of longer dated bonds. As we discussed in last quarter’s letter, we believe that the attractiveness of these shorter-term opportunities within fixed income will persist as interest rates rise.

As we look forward to the changing seasons and cooler temperatures, we begin to reflect on what’s important to us. We want to take this opportunity to thank you for the confidence you place in the FBB team. We sincerely appreciate your trust and will continue to do our best to earn it. As always, if you have friends or family members who you think would benefit from a conversation with us, it would be our pleasure to speak with them.

With Warm Wishes for Fall,

FBB Capital Partners

All opinions expressed in this newsletter are not intended to be a guarantee or forecast of future events, do not constitute a solicitation to buy or sell securities nor are they a complete description of our investment policy, the markets, an investing strategy or any securities referred to in the newsletter.  Opinions expressed herein are not intended to be used as investment advice and are subject to change without notice based on market and other conditions. Different types of investments involve varying degrees of risk, and there is no assurance that any specific investment will either be suitable or profitable for a client’s or prospective client’s investment portfolio, and no one should assume that any information presented here serves as the receipt of, or a substitute for, personalized individual advice from FBB Capital Partners, its research team or its portfolio managers. The value of investments and the income from them may fluctuate and can fall as well as rise.

Dear Clients and Friends:

As the calendar rolls to July, we’re starting to notice that we’re “halfway there,” perhaps in more ways than one. With the first half of the calendar year behind us and contractionary monetary policy closing in on a three-year anniversary, we are looking back on the second quarter within the broader context of the economic and market cycle, with a focus on the Federal Reserve.

Since 2015, the Fed has hiked interest rates seven times, most recently last month. Given recent economic data, we anticipate six more rate hikes by the end of 2020. In our view, the second quarter of 2018 reflected cautious optimism among investors as the Fed reached its “halfway” point in its contractionary efforts. At FBB, we are looking ahead to anticipate how markets will perform in the latter stages of this Fed tightening cycle.

Getting Better

In early January, we anticipated a tug of war between wages and taxes. Thus far, we’ve seen wage concerns weigh on markets in the first quarter, while benefits of the tax cuts boosted equities in the second quarter. Broader markets rose 3.4% in the second quarter, providing many investors a sigh of relief after the nearly 1% decline in Q1. Recall that higher than expected wage inflation, combined with a stock market “melt up” that ended in late January, led to choppy markets for the remainder of the first quarter.

In contrast, inflation and market volatility both subsided in the second quarter, as investors focused on economic growth, inflation, and a jobs market – all of which were neither “too hot,” nor “too cold.” This “Goldilocks” narrative and 20%+ quarterly profit growth (driven partly by tax cuts) muted rising concerns of a trade war and gave investors more comfort to buy stocks, pushing markets modestly higher.

FBB took advantage of rising markets to harvest gains for larger positions and reduce holdings in stocks that had moved higher in the short term but that may face challenges longer term. One such reduction was Microsoft, as the stock’s multi-year gains created an oversized position. Notably, Microsoft remains one of FBB’s top holdings. Over the long term, we believe that cloud computing will continue to drive the company’s growth.

On the other hand, we reduced clients’ positions in Amgen, because the stock price rose despite looming generic competition for older drugs—specifically for white-blood cell production (Neulasta) and rheumatoid arthritis (Enbrel), which we believe will hurt the company over the long term. We also did some buying in the quarter, swapping into durable growth healthcare and retail stocks (Johnson & Johnson, TJX Companies) at attractive valuations. For Johnson & Johnson, sales of a new cancer drug have exceeded investor expectations, while TJX continues to improve on its execution in the discount retail space and the recent rollout of HomeSense, a brand that will likely compete with Crate and Barrel.

What’s Next for the Fed, Economy and Markets?

With Q2 in the rear-view mirror, we are turning our sights to the next phase of Fed actions and potential impacts during the remainder of 2018 and beyond. We expect steady economic growth to gradually push unemployment down and inflation up, keeping the Fed on track to boost interest rates two times in the second half of 2018. Our sense is this pattern will continue with three more rate hikes in 2019 and culminating with a final hike in 2020.

Certainly, the expanding possibility of a trade war that slows economic growth could lead the Fed to stray from its “glide path” and slow the forecasted rate increases. At this point, however, we expect the U.S., China, and Europe to negotiate trade deals and dial down the protectionist rhetoric. Under-performing stock markets in China and Europe this year may send policy-makers a sign that the private sector disapproves of the rising trade barriers. What’s more, trade war proposals may die down after U.S. mid-term elections.

Livin’ On a Prayer

If a major trade war disintegrates and the Fed has a clear line of sight toward higher interest rates, we see reason for a more optimistic outlook. Higher interest rates should slow the economy as borrowing costs rise for employers and home buyers. In the current cycle, we expect the Fed’s current snail’s pace with measured quarter point hikes to continue, likely allowing equities to continue to perform well, while also making bonds more attractive.

How are We Positioned?

With the rise in interest rates, short-term Treasuries and high-quality corporate bonds with maturities inside five years have become more attractive. Our preference for quality directs us to seek corporate bonds within defensive sectors such as consumer and utility companies with solid balance sheets and stable cash flows.

As clients, friends, and your team at FBB look forward to Fourth of July fireworks and backyard barbeques, we continue to favor stocks and sectors that benefit from an economy firing on all cylinders. This has us hunting for high quality companies with reasonable valuations in the technology, industrial, and financial sectors.

With the dog days of summer approaching, we continue to monitor the temperature of the markets and investor sentiment, while remaining flexible to deal with surprises as they emerge.

With Warm Wishes for Summer,

FBB Capital Partners

*****

Please note that FBB’s Client Vault technology will be transitioning in the quarter ahead. Keep an eye on your e-mail Inbox for instructions on how to access your new client vault via your desktop or mobile device.

The information contained herein is provided for informational and educational purposes only, and nothing contained herein should be construed as investment advice, either on behalf of a particular security or an overall investment strategy. Information in this document is provided is based on available data and opinions as of the date shown. FBB Capital Partners cannot guarantee that your investment goals or objectives will be met. All investments carry some degree of risk, including loss of principal.

Dear Clients and Friends,

After a spectacular 2017, the first quarter of 2018 has reminded us that the market can—and often does—move in unexpected ways. Just as top seeded teams in the NCAA tournament are sometimes lulled into a false sense of first-round security, so too were investors, as markets started the New Year with continued upward momentum from 2017.

In our January newsletter, we discussed potential upside from tax cuts and downside risk from wage growth. Both of these themes came into play early in the year. In January, we saw an exuberant market rallying behind tax cuts and earnings growth, and by February, concerns over wage inflation came more into focus, triggering a market sell-off and a return of volatility. New worries have emerged with the potential for a trade war or a “tech wreck” overshadowing the balance of the year. Still, we remain confident that steady economic growth and rising profits will lift markets above current levels by year-end.

What happened?

Broader markets were down slightly for the quarter, but there was plenty of choppiness along the way. The late 2017 tax cuts drove what some investors called a “melt up” in December and January, as stocks chased rising earnings and profit expectations. By February, the “melt up” became a “melt-down” (not dissimilar to UVA’s dramatic rise and fall), after fears of rising wages and inflation pushed stocks into the red and the volatility index (VIX) higher.

Some investors spent much of 2017 betting successfully that the VIX—sometimes referred to as the “fear index”—would remain low. Those investors bet that low volatility would continue making money in 2018. However, the spike in volatility in late January and early February spurred a rush for the exits, leading to forced selling amid a broader market correction of 10% from recent highs. Markets stabilized a bit in late February and early March, but the roller coaster ride continued in late March on fears of a tech sector decline and a potential trade war. Data security concerns for social media companies prompted investors to reconsider the attractiveness of the previously top seeded FANG stocks (Facebook, Amazon, Netflix, and Google), while protectionist measures directed toward China raised geopolitical concerns. Our sense is investors will continue to wrestle with both of these themes into the second quarter.

During the quarter, we continued to add to sectors benefiting from a growing economy and rising rates, while reducing our exposure to sectors that may struggle this year. We trimmed our real estate (Cohen and Steers REIT) and utility holdings (Eversource), as high dividend-paying stocks in these sectors often lose momentum in a rising interest rate environment. We also added to more cyclical sectors including technology (Visa) and financials (PNC), as they tend to benefit from growing numbers of business transactions (payments processors) and higher rates (banks).

What’s next?

Will the rest of the year be more like Q1 or 2017? Historically, 10% market downturns take place about every 33 weeks. If history is any indication (which, we acknowledge, is often not the case), we should be “off the hook” at least for some time, in light of the correction that bottomed on February 8 and then again on March 23.

The past quarter has reminded us, that like March upsets, volatility in markets is normal. The lack of volatility in 2017 was, in fact, abnormal. For the balance of 2018, we expect a return of volatility in what we’d consider to be a more typical pattern, as investors battle with the ever-changing dynamics of risk and reward. Will FANG stocks keep under-performing, or do current prices represent incredible bargains for high-growth tech companies? Will protectionism threaten global trade, or will governments dial down the rhetoric and allow GDP growth to continue? We believe both of these debates will wind down in the coming months, as tech companies continue growing and global buyers and sellers see the gains from negotiated trade disputes.

Early thoughts on the next economic cycle

Moving beyond the controversies of the moment, we are starting to think about more meaningful dynamics that could tip the scales toward a continuation of the current bull market or lead to sustained declines ahead of a recession. The themes we outlined in January —taxes and wages— continue to seem most relevant for the time being. While the new tax cuts may give a boost to near-term profits and economic growth, they may actually accelerate the timing of the next recession amid rising budget deficits. What’s more, rising wage growth could trigger inflation, which could further slow economic growth.

With these factors in mind, investors may begin to think about potential timing for the next economic slowdown. When bond markets become bearish on growth, it has historically been a telltale sign of an impending recession. Like an unconditioned team playing late into overtime, the bond market starts to cry uncle when the 2-year and 10-year Treasury bonds trade at the same yield, thus producing a flat yield curve –often an indication that bond markets expect sluggish economic growth ahead. Some analysts project a flat yield curve in late 2019, which could imply a recession by mid-2021.

How are we positioning?

At FBB, we consider a host of scenarios for global markets and for the economy. The recession scenario described above is just one potential outcome. In general, we have a favorable view of markets and economies over the next one to two years, but we are beginning to consider a more conservative stance as we move beyond this period.

With this in mind, we remain comfortable with exposure to both equity and bond markets through the balance of the year. On the equity side, investors may begin to look at corporate profit growth forecasts for 2019, which currently stand at 10%. Even if the growth rate slows and next year’s forecasts come in a bit, we could still see stocks up 5-10% in 2018.

Within equities, we are inclined to continue adding to cyclical sectors, including financials and technology. We believe that rising interest rates, steady economic growth, and reasonable valuations continue to make these sectors attractive. We also see upside from diversifying into U.S. small- and mid-caps as well as international equities. For bonds, we continue to add high quality corporates and municipals with gradually higher yields.

As March Madness winds down, we continue to manage your portfolio with an offensive playbook focused on valuation and quality, while executing a diversified defensive strategy focused on income. As always, we will continue to seek those rare opportunities to press.

With Warm Wishes for Spring,

FBB Capital Partners

The information contained herein is provided for informational and educational purposes only, and nothing contained herein should be construed as investment advice, either on behalf of a particular security or an overall investment strategy. FBB Capital Partners cannot guarantee that your investment goals or objectives will be met. All investments carry some degree of risk, including loss of principal.

Dear Clients and Friends,

As many take time to reflect on a year filled with surprises, we are taking stock of trends that took shape in 2017, some of which may continue to influence investor expectations for the New Year. The bull market of 2017 took many by surprise. While we expect markets to move higher in 2018, our sense is performance may be less dramatic than it was in 2017. Corporate and individual tax cuts, paired with improving economic fundamentals, may drive markets higher than investors anticipate, while wages and inflation may then work to keep markets in check.

Q4 tops off the 2017 bull market

Before jumping into 2018, let’s take a final look at what happened in 2017. Broader U.S. markets returned 6.6% in the fourth quarter, capping a year when the overall market achieved its highest annual return since 2013 (also the first year of a presidential term).

Micro and macroeconomic factors drove investor sentiment in the fourth quarter as low unemployment and inflation likely fueled U.S. GDP growth of 2.5% to 3%. In our view, this steady economic growth, which actually slowed modestly from the third quarter, also helped companies beat quarterly profit expectations and issue relatively favorable forward guidance. Emerging personal and corporate tax cuts also likely gave sentiment a boost.

Economic and financial gains in Q4 seem even more remarkable in light of the U.S. Federal Reserve’s significant changes, which could have spooked investors. Heading into the fourth quarter, investors faced meaningful uncertainty with the prospects of a new Fed chair announcement, a third rate hike for the year, and tightening of the Fed’s balance sheet by year end. However, investors took these changes in stride, perhaps due to incoming Fed chair Jerome Powell’s emphasis on continuity with outgoing chair Janet Yellen’s views.

Within this favorable market backdrop, we continued to refresh the FBB portfolio with companies that we believe can consistently meet or exceed investor expectations. We added Honeywell (HON) during the quarter on a view that investors have yet to fully appreciate the company’s changing business mix and initial indications for 2018 suggest that this investment thesis is playing out.

We also added JP Morgan Chase (JPM) as a way to own a rising interest rate theme with less execution risk than Wells Fargo (WFC), which we trimmed. We also exited Cerner (CERN) as we viewed an unattractive risk / reward profile following a move up in the stock. Outside the U.S., we added to our developed international equity exposure as we take a more favorable view of Europe and Japan, which have finally started to participate in the global recovery.

Focusing on wages and taxes in 2018

As we move from an impressive 2017 to an unknown 2018, our sense is that stocks can deliver low double-digit returns, although wages and taxes may provide upside or downside pressures for 2018.

Our base case for 2018 involves ~11% corporate profit growth, plus 5% for tax cuts, minus 5% for lower investor sentiment, and finally adding 2% for dividends, suggesting a ~13% total return. In a more pessimistic scenario, higher wages could lead into a “cascade effect” of higher inflation, more Fed rate hikes, lower profit margins, lower earnings, and lower stock valuations, threatening a correction in the current bull market.

Meanwhile, subdued wage growth has been puzzling economists over the past few years, as a plummeting unemployment rate should be driving wages solidly higher. It is possible that 2018 could be the year that stubbornly low wages (and inflation) start to take off.

Though wages may be concerning in 2018, tax cuts may more than offset wage and inflation pressures. Bulls predict a ~15% boost to corporate profits from lower taxes, while personal tax cuts drive faster consumer spending. What’s more, tax incentives may lead U.S.-based multinationals to bring overseas cash back home, potentially leading to stock buy backs and acquisitions that could boost markets. However, despite these more optimistic scenarios, we are taking a more moderate approach, predicting a 5% boost to stocks from tax cuts.

While we view wages and taxes as key to understanding 2018, we’re also keeping an eye on potential infrastructure spending that could boost the economy, as well as concerns around geopolitical events such as the UK’s exit from the European Union. Lastly, a weaker U.S. dollar helped American exporters in 2017, but rising interest rates could reverse that trend with a stronger dollar in 2018.

How are we positioning?

Our forecast scenario suggests steady economic growth and modest increases in interest rates in 2018, supporting our preference for pro-cyclical sectors such as technology, financials, and industrials. This steady growth scenario also suggests less enthusiasm for defensive sectors such as real estate, staples and utilities. However, if we view a higher probability of a domestic “wage cascade” described above, we will likely trim U.S.-based equities and step up our modest push into non-U.S. stocks.

Switching over to the bond market, we expect rising rates to make short term bond yields slightly more attractive for new purchases, although our sense is that bonds with 10+ years to maturity may see less upside for yields. That’s because low bond yields outside the U.S. are driving up foreign demand for U.S. bonds, a trend that’s pushing prices higher and yields lower for long-dated U.S. bonds.

As the calendar rolls to a New Year, we will continue to reflect on the trends of 2017 and chart our roadmap for the year ahead, all the while guided by our core investment principles and your evolving goals and objectives.

With Warm Wishes for a Happy New Year,

FBB Capital Partners

A Note on Tax Reform

As you are likely aware the New Year marks the beginning of some big changes to the tax code, and at first look this will impact many of FBB’s clients. While a year-over-year comparison may be difficult to predict (2017 actual vs. 2018 estimate), we encourage you to work with your tax advisor during your 2017 preparation to discuss what adjustments you might consider for the year ahead.

As always, please feel free to coordinate any tax planning issues with your Portfolio Manager at FBB. We’d be pleased to work with you and your tax advisor to help craft a plan as needed.

One Final Note

Once again, we expect there to be multiple revisions to your 2017 1099s, so we advise against filing early.

The information contained herein is provided for informational and educational purposes only, and nothing contained herein should be construed as investment advice, either on behalf of a particular security or an overall investment strategy. FBB Capital Partners cannot guarantee that your investment goals or objectives will be met. All investments carry some degree of risk, including loss of principal.

Dear Clients and Friends,

So far, 2017 has been a good year for investors, with economic and profit growth driving broader markets up 12.4% through September 30. With volatility at historic lows, devastation from Hurricanes Irma and Maria, rising interest rates, and geopolitical threats from North Korea and the Middle East threatening to reverse the market’s momentum, we wonder—Have investors become too complacent?

As we head into the final stretch of 2017 and begin to map out 2018, we are cautiously optimistic that economic fundamentals and steady profit growth will continue to support investment in equities, as long as the current macroeconomic narrative remains intact.

What happened in Q3?

Looking back at the third quarter, improving economic fundamentals drove positive investor sentiment. Expectations for strong economic growth increased as the government made upward revisions to its third and final GDP growth estimate of 3.1%. As a further boost to investor sentiment, companies beat quarterly profit estimates by 4.5% during the July / August reporting season. Finally, throughout the year, steady improvement and strength in the Purchasing Managers Index (PMI), a leading indicator for expansion, fostered expectations that businesses continue to be bullish. Generally speaking, these upside surprises more than offset investor fears of a geopolitical conflict, hurricane damage, and even the threat of a potential default of federal debt. We got a taste of investor concerns in mid‐ August, as the VIX or volatility index—also known as the “fear index”—spiked amid rising tensions in North Korea, but then flattened in early September after White House and Congressional leaders delayed a pending debt ceiling debate.

During the third quarter, we focused on quality and valuation for our equity portfolio, proactively trimming our Apple position in September ahead of a new iPhone product cycle, because we felt that investors had priced a flawless product launch into the stock price. Within technology, we also added to a mid‐cap semiconductor company called Microchip after the stock declined in July on fears of a cyclical downturn in the industry. In August, Microchip reported quarterly results ahead of investor expectations.

What’s next?

Investor sentiment may become a key factor looking forward to 2018. Investors have shrugged off several risk factors so far this year, but we wonder if the trend will continue—especially as stock valuations remain elevated and looming Federal Reserve actions could slow the economy. As of this writing, implied volatility has declined to levels below the historic lows seen earlier this year.

Within the broader fundamental picture, we believe that near‐term economic growth will overcome geopolitical concerns and hurricane recovery efforts to meet investor expectations over the coming year. However, we are increasingly cautious on monetary policy actions. Current stock valuations seem to anticipate few surprises from the Fed, despite three open seats on the Federal Reserve board and questions regarding just how hawkish a yet‐to‐be‐named Chairperson might be. Adding to the uncertainty, the Fed will begin reducing its bond holdings this month and is expected to raise rates in December. One of the key factors in the Fed’s decision to raise rates will be wage inflation. To date, wages and inflation have remained below the Fed’s targets, though a tight job market could lead workers to demand higher wages, boosting inflation and possibly triggering an accelerated schedule of interest rate hikes.

At the market level, we have modest concerns that rising stock valuations this year may limit stock performance next year. The forward price to earnings (PE) ratio for the S&P500 currently stands at 19X, well above the most recent five‐year average of 17X, which suggests that further PE expansion is less likely. However, the silver lining for next year may be continued profit growth (currently estimated at 11%), which could drive stocks higher, even if PE ratios remain unchanged.

How are we positioning?

Ultimately, we view favorable economic and profit growth as the most important drivers of security valuation. As such, we recommend that clients stick with long‐term stock and bond targets in their portfolios. While it may be easy to become complacent as stocks keep moving up, we continue to weigh upside potential against downside risk. This has led us to move more aggressively this year toward rebalancing client portfolios from an overweight equity posture back toward their long‐term allocation targets.

In the recent past, our portfolios have favored domestic securities, because we believe the U.S. has a more stable growth market relative to other countries. Still, we are now considering higher exposure to global markets, in the event that growth in the U.S. slows. European stocks, in particular, could offer upside as the region continues a steady recovery from the 2008‐09 recession.

Looking at our equity portfolio, we are currently overweight defensive sectors such as consumer staples and utilities, while underweight cyclical industries such as technology and financials. We may consider changes heading into 2018, especially if rate hikes seem more likely to help financial stocks, or if we find attractive valuations for higher growth sectors, such as technology. Overall, we continue to favor high quality companies that can grow profits, exceed expectations, and return capital to shareholders.

As many take time to enjoy the fall colors, we will continue to reflect on where we are heading, while looking for opportunities to harvest gains where appropriate and make any final distributions necessary prior to yearend. As always, we will keep an eye out for potential down‐side threats and signs of strength and make portfolio adjustments accordingly.

With Best Wishes for Autumn,

FBB Capital Partners

The information contained herein is provided for informational and educational purposes only, and nothing contained herein should be construed as investment advice, either on behalf of a particular security or an overall investment strategy. FBB Capital Partners cannot guarantee that your investment goals or objectives will be met. All investments carry some degree of risk, including loss of principal.

Dear Clients and Friends,

In the second quarter, buyers bid up the prices of stocks and bonds alike. For their part, stocks gained approximately ~3.1% while equity markets continued to experience subdued volatility. Bond prices also ran higher, as the 10‐year U.S. Treasury yield returned to levels not seen since the Federal Reserve began raising rates 18 months ago. Despite this seemingly tranquil performance, three meaningful conflicts lurk beneath the surface:

1. Stock and bond investors are at odds over the economy’s growth prospects.
2. Wages and inflation remain low, despite an economy nearing full employment.
3. The U.S. Dollar continues to decline, despite improving economic indicators.

While we’re unlikely to solve all of these riddles in our second quarter letter, we do believe that companies will continue to grow earnings in these puzzling times, suggesting that markets may continue to grind higher.

Stocks and bonds not seeing eye to eye

With bond yields declining in the face of Federal Reserve rate hikes in March and again in June, and equity markets advancing, it seems that equity and fixed income investors continue to be at odds. As bond investors began to expect less fiscal stimulus and came to grips with lower inflation, the 10‐year U.S. Treasury yield declined in the second quarter from 2.42% to a low of 2.14%, elevating bond prices.

Stocks and their price to earnings (PE) ratios also increased during the second quarter, suggesting equity investors are more bullish on growth prospects than bond investors. Investors seem to be “buying the dips” more aggressively than sellers are exiting the markets.

Given their differing perspectives on growth, investors in each asset class can co‐exist—for a while, at least. Bond markets are generally focused on broader economic growth, which may be stable in the 2% range (but lower than euphoric post‐election projections of nearly 3%).

Equity investors, on the other hand, are more focused on profit growth, an indicator of broader economic expansion. After nearly two years of sluggish earnings, a recent rebound has stock investors bullish on prospects for future earnings growth, both domestically and abroad.

Inflation and currency also behaving differently

Two additional and unexpected trends we are watching this year are low wage growth and a weakening U.S. Dollar. While a falling unemployment rate might suggest better bargaining power for wages, it appears that a mix of demographics (retiring workers) and a lack of corporate pricing power may be holding back wage increases. This trend has benefited corporate margins, while keeping inflation in check, and may ultimately reduce the number of Fed rate hikes for the balance of the year.

Separately, improving growth in Europe and emerging markets, along with low U.S. bond yields, may be driving demand for the Euro, while lowering the relative value of the Dollar. We believe Europe and emerging markets are finally recovering from the Great Recession, although risks remain for both. A weaker Dollar is beginning to provide some currency relief for U.S.‐based multinational companies who suffered during the Dollar rally of mid‐2014 to late 2016.

So, where to invest?

With these unexpected market dynamics in the background, we took advantage of rising stock markets to exit companies with expensive valuations and struggling fundamentals in retail and apparel, as well as in aerospace and defense. At the same time, we added to equities where we feel secular trends are more favorable—for example, we made investments in software and travel and leisure, focusing on rising demand for cloud computing and for experiences over physical goods.

Outlook for the second half

We’re cautiously optimistic on equities for the second half, as steady economic growth allows companies to focus on growing sales, expanding margins, and beating estimates. We expect this bottom‐up growth to offset global macro risks such as a further decline in commodity prices or an unexpected slow‐down in China amid concerns over real estate prices and debt levels.

If investor sentiment remains stable, as we expect it will, then rising earnings expectations should continue to drive stocks. We expect stocks to perform well during the second quarter earnings season, which heats up in mid‐July.

Within equities, we’ll be monitoring the technology sector this summer, since the group has outperformed so far this year. When compared to the rest of the market, the tech sector is trading at a higher multiple than it has historically. That said, we believe many tech companies are poised to beat investor expectations and continue to raise growth targets, which could support a sustained rally.

As discussed above, we see the stock and bond markets going off‐script this year. While we have a relatively favorable outlook for stocks, in the near term we are a bit more cautious on bonds. We expect interest rates to remain low amid subdued inflation until a likely Fed rate hike later in the year pushes 10‐year Treasury rates closer to 2.5%.

As many take time to celebrate our nation’s independence this coming week, FBB continues to manage your portfolio with a focus on quality, income, and the potential for long‐term outperformance, while remaining ever mindful of risk management. We will continue to keep an eye on new market puzzles that emerge in the weeks and months ahead, while seeking investment opportunities at attractive prices.

With Wishes for Safe Summer Travels,

FBB Capital Partners

The information contained herein is provided for informational and educational purposes only, and nothing contained herein should be construed as investment advice, either on behalf of a particular security or an overall investment strategy. FBB Capital Partners cannot guarantee that your investment goals or objectives will be met. All investments carry some degree of risk, including loss of principal.

Dear Clients and Friends,

As March Madness comes to an end, we can’t help but feel that the markets, which have been running and gunning since the election, are using the last couple weeks of the quarter to take a time out. Typically, a well-used T-O allows players to catch their breath and for teams to assess which offensive and defensive strategies might be most appropriate going forward.

On the heels of a 5% rise in stocks between November’s election and year-end, equities advanced another 6% in the first quarter amid increased investor confidence, faster economic growth, and rising corporate earnings.

Over the past five months, investor sentiment has improved in anticipation of several Trump administration priorities including corporate and individual tax cuts, increased infrastructure spending, and reduced regulation. In theory, these priorities should boost earnings, thereby justifying higher stock prices. The Federal Reserve came off the bench, raising interest rates in March for the second time in three months to moderate some of the economic momentum.

Still, as the first quarter comes to an end, investors may be dialing back their pro-growth assumptions. A failed effort to repeal the Affordable Care Act in late March suggests that Trump’s other pro-business plans may take longer to materialize. This less bullish view of potential fiscal and regulatory policies brought equities down 1% from their early March peak.

A thoughtful approach to risk assets

Risk assets as the post-election mini-bull market played out. We initially proposed that Trump’s pro-business plans could boost corporate earnings by ~20% in a best-case scenario, suggesting stocks could rise up to 20% from the election. However, as stocks stretched past the halfway point of that best-case in early March, we pulled back our risk appetite, viewing the current conditions as more equally balanced toward upside and downside. For clients whose portfolios had grown to levels that exceeded their target equity allocations, we encouraged modest shifts into lower risk assets.

Our more guarded outlook in the quarter drove our decision to sell five stocks across many clients’ portfolios, while only adding two new positions. We exited Novartis, which is struggling to replace an older ‘cash cow’ leukemia drug, while buying Newell Brands, a company we believe to be in the early innings of a transformation into a higher quality consumer staples company.

Watching the Fed, volatility, and Europe

As the post-election momentum subsides, we are taking additional time to review potential catalysts and trends that may impact markets for the remainder of the year. We are keeping our eyes on the Fed, market volatility, and international markets.

The Fed continues to move away from the near-zero rates that helped boost employment and wages (but risked sparking inflation). We expect two more interest rate hikes in 2017, although recent declines in energy prices and the slowdown in Trump’s pro-business agenda may delay execution.

As bond prices continue to depreciate in the face of a rising (and unusually volatile) interest rate environment, our team is taking advantage of opportunities to buy corporate and municipal bonds with short- to intermediate-term maturities. The Fed theme is garnering less attention these days, as markets factor in the potential impact of fiscal stimulus to the economy. However, any surprises coming from Yellen and Co. could be enough to shift bond and stock market volatility markedly higher.

Historically, equities have experienced a 5% correction every 50 trading days. With the last correction taking place just before the November election, we have been adding high quality companies in software, travel and leisure, and asset management, among others, to our list of Top Draft Picks.

Internationally, we are focusing on European elections, which may determine the future of the European Union (EU) and, ultimately, corporate profits and stock prices of European companies. The global populist wave, which began with the UK voting to leave the EU last summer and continued with Trump’s win in November, seems to have stalled out with status-quo elections in Italy and Holland in recent months. French polls also suggest that an anti-EU candidate (Marine Le Pen) may fail to win the top office.

Our sense is European equities could become more attractive if upcoming elections suggest greater stability for the region. We will continue to monitor our weighting to the EU via direct investments and indirect exposure (through multinational companies). In the meantime, our portfolios continue to favor U.S. equities, because we expect relatively faster economic growth at home to drive U.S. profits and stock prices.

As we move from March Madness to baseball’s Opening Day, FBB continues to manage your portfolio with a focus on quality, income, and the potential for long-term outperformance, while remaining ever mindful of risk management. We look forward to stepping up to the plate, taking advantage of any volatility to come in the weeks and months ahead, keeping an eye out for fat pitches at attractive prices.

With Warm Wishes for Spring,

FBB Capital Partners

The information contained herein is provided for informational and educational purposes only, and nothing contained herein should be construed as investment advice, either on behalf of a particular security or an overall investment strategy. FBB Capital Partners cannot guarantee that your investment goals or objectives will be met. All investments carry some degree of risk, including loss of principal.

Dear Clients and Friends,

As we say farewell to a 2016 full of political and economic surprises, we wonder if 2017 will bring more of the same. As we look back on the UK’s decision to leave the European Union (the Brexit vote), the surprising U.S. election outcome, and, now, the Dow Jones Industrial Average approaching 20,000, we are reminded that investors should continue to build fully diversified portfolios that take into consideration a broad range of potential outcomes.

Uncertainty = Volatility

Before we jump ahead to 2017 forecasts, let’s take a quick look at a volatile final quarter of 2016, where broader markets fell 4% ahead of the U.S. election, but then rose nearly 9% post-election, to settle on a 5% net gain for the quarter. We believe this kind of market volatility may continue, and we favor financial companies such as exchanges and online brokers as a way to benefit from market swings.

Early in the fourth quarter FBB trimmed utility and consumer staples holdings on a view that rising interest rates make bonds slightly more attractive compared to these lower-risk , dividend-heavy equities. We also increased our exposure to Internet advertising, and we diversified our real estate holdings by adding a self-storage REIT, as we expect faster economic growth to drive earnings upside for these sectors.

Risk Appetites Growing in 2017

So what are FBB’s forecasts for this year? Our sense is that investors expect the new administration will stimulate more economic growth, either through policy changes or the perception thereof. But what does faster economic growth mean for financial markets? We believe consumers, business leaders, and investors are shifting from risk aversion to risk-seeking behavior as they take advantage of greater economic opportunity.

We believe the Brexit vote and the U.S. election were turning points in this shift to higher risk appetites. Investors, desperate for low risk securities, pushed ten-year U.S. Treasury yields to 1.37%, just after the late June Brexit vote. However, Treasury yields have rallied to 2.55% as of late December, suggesting a decrease in demand for risk-free investments.

Faster growth and rising risk appetites will likely trigger other changes this year. We expect more inflation, as oil prices and wages creep up. We also expect at least two interest rate hikes this year, as Janet Yellen attempts to prevent overheating. Higher U.S. interest rates will likely draw in foreign investment, boosting the value of the Dollar and slowing U.S. exports.

As we think about financial markets in 2017, a risk-on theme suggests growth equities, emerging markets, corporate bonds, and high-yield debt may outperform lower risk securities such as high dividend stocks and Treasury bonds. However, since our time horizon spans several years, we are taking a balanced approach to risk this year.

Our views on dividends are an example of our preference for diversified portfolios. While we have reduced holdings in the utility and consumer staples sectors, we continue to favor dividend paying companies. These investments will pay off in the event that U.S. economic growth fails to accelerate or the Federal Reserve delays interest rate hikes. This diversification should also help to reduce portfolio volatility in the face of any unexpected macroeconomic or political surprises in 2017.

Putting our 2017 themes into practice

As we enter 2017, we favor high quality companies with multi-year growth prospects whose valuation levels do not yet reflect their full growth potential. We believe PNC Bank is an example of one such company well positioned for 2017. Our meeting with PNC’s head of corporate banking this year highlighted the company’s multi-year plan to penetrate new markets outside of its East Coast core. Building on this secular growth theme, we view rising interest rates as a catalyst that will drive PNC’s earnings higher. What’s more, the potential for regulatory relief and faster economic growth may boost investor sentiment and valuation. Finally, PNC’s domestic branch network reduces exposure to a stronger Dollar, a threat that many multi-national companies must continue to contend with.

As we wrap up 2016 and begin to map out 2017 strategies, FBB continues to manage client portfolios with a focus on quality, income, and the potential for long-term out-performance. We look forward to taking advantage of any unexpected volatility in the coming weeks and months as we seek out high quality companies at attractive prices.

With Best Wishes for the New Year,

FBB Capital Partners

The information contained herein is provided for informational and educational purposes only, and nothing contained herein should be construed as investment advice, either on behalf of a particular security or an overall investment strategy. FBB Capital Partners cannot guarantee that your investment goals or objectives will be met. All investments carry some degree of risk, including loss of principal.

Dear Clients and Friends,

Voters and investors are waking up to a surprising outcome from last night’s election, with Donald Trump winning the U.S. presidency and Republicans maintaining the House and Senate. Investors are voting with their feet as seen in volatile U.S. stock market futures. S&P500 futures fell as much as 5% Tuesday night, but have since rebounded and are down only ~2% in pre-market trading this morning, effectively giving back Monday and Tuesday’s market gains.

We believe markets are down because investors are uncertain about: 1) Trump’s policy agenda, and 2) the impact of one-party rule on business. Heading into the election, we believed investors preferred divided government that could slow down new legislation and a president with more of a track record. However, as we’ve seen with the rise of Donald Trump, Bernie Sanders, and the UK’s vote to leave the EU (the Brexit vote), sluggish economic growth is fueling a wave of global populism.

What’s next?

Donald Trump’s victory speech this morning hinted that the President-elect may moderate his views and policy goals. Our sense is Trump’s advisors will encourage the President-elect to follow this line of reasoning.

Even if Trump softens his policy goals, we could still see winners and losers over the next four years. We believe most of healthcare will see a relief rally, with the exception of hospital stocks, which FBB has generally avoided. Rising trade barriers could hurt commodity exporters and retail importers, although the pressures could be isolated rather than widespread. Still, potential Trump tax cuts and new infrastructure spending could stimulate consumption, partially offsetting trade protectionism.

How is FBB responding?

We believe the surprising Trump win will follow a pattern we saw with the Brexit vote four months ago, where markets quickly stabilized after an initial violent reaction. The S&P500 fell about 5.5% from just before the late June vote until just after. However markets rallied 9% in July and August from the post-Brexit lows. Our sense is both the downside and upside will be less volatile following the surprise Trump win.

FBB is taking a cautious approach to managing client assets in the wake of the U.S. election. We believe there may be some investment opportunities amid the current market decline, especially for higher quality businesses that are likely to avoid new laws or regulations. However, we are taking a longer term view as we connect today’s market volatility with the structural impact of rising populism worldwide. As we head toward year-end and begin to think about 2017, FBB continues to manage client portfolios with a focus on quality, income, and capital preservation.

With Best Wishes for year-end,

FBB Capital Partners

The information contained herein is provided for informational and educational purposes only, and nothing contained herein should be construed as investment advice, either on behalf of a particular security or an overall investment strategy. FBB Capital Partners cannot guarantee that your investment goals or objectives will be met. All investments carry some degree of risk, including loss of principal.

Dear Clients and Friends,

Despite a late‐quarter selloff, U.S. stocks saw their best performance of 2016 in the third quarter (up 3.3%), with all three major indices hitting all‐time highs in mid‐August, a feat we haven’t seen since December 31, 1999. Fortunately, this is where the similarities to the euphoric market conditions of 1999 end, as stock valuations remained well below those seen in the Dot com boom of the late ‘90s. Bond yields also reached new lows with the 10‐year U.S. Treasury yield bottoming at a paltry 1.32% in July following the UK’s vote to break ties with the European Union (also known as the Brexit vote). In this client letter, we’ll explore what got us here, what FBB’s been doing, and what’s next as we review the third quarter and look towards
upcoming catalysts in late 2016 and early 2017.

Following a flat 2015 and a volatile first half of 2016, what drove the recent strength in equities? In prior quarters, fears over commodities, China, and Brexit raised global uncertainties. However, in the third quarter steady economic growth and a timid Federal Reserve boosted investor sentiment and lowered the so‐called fear index (the VIX volatility index).

Markets seemed to hold their breath going into the third quarter, preparing for the next series of negative news headlines. But as new risk factors failed to materialize, these dynamics combined to drive a relief rally for stocks. Bond yields also rebounded, as central banks signaled concerns over negative near‐term interest rates.

Moving up the quality curve

We took advantage of the subdued volatility to continue to add high quality companies, while trimming exposure to those with rising risks. During the third quarter, we acquired American Tower, a U.S.‐based cell tower operator with an under‐appreciated growth strategy in emerging markets. We also purchased Arch Capital; a property‐casualty insurer that we feel is in the early innings of gaining share in the fragmented mortgage insurance market.

We kept a balanced approach to equities by offsetting these additions with two sales, McDonalds and T. Rowe Price. We previously favored McDonalds’ management change and new growth strategies, but we believe execution risks are rising and investors are fully valuing the company’s improvements. We exited T. Rowe Price amid a secular shift away from actively managed mutual funds and concerns over performance following a string of portfolio manager departures.

Preparing for earnings, elections, and rising rates

With stocks reaching all‐time highs, investors may wonder if markets are ready for a breather in the fourth quarter. We believe that growth in corporate profits, reduced political uncertainty, and a modest rise in interest rates will fuel a gradual increase in equities. However, meaningful variations to these catalysts could drive stocks above or below our assumptions. Here is our take on these upcoming events:

• Green shoots for corporate profits. Earnings for S&P500 companies declined from April 2015 through at least June 2016, as collapsing oil prices depressed energy sector profits. In fact, investors expect corporate profits to decline again by about ~2% in the third quarter. We believe companies will report that third quarter profits exceeded expectations by about 3 to 4%, resulting in profit growth of 1 to 2% for the quarter. In our view, an end to the corporate profits recession of the past five quarters should help sustain equity valuations.
• Modest post‐election relief rally on tap. We believe the House, Senate, and Presidential elections will result in divided government, likely reducing potential investor fears of one‐party control, which could pose a greater threat to markets. While volatility around the election seems likely, our sense is that the final outcome will drive a slight increase in investor sentiment.
• Another December rate hike approaching. Janet Yellen’s comments during a September Fed meeting suggest to us that the stars are aligned for another December rate hike. From our perspective, we believe that low unemployment, rising inflation, and generally stable financial conditions set the table for Fed monetary tightening. We also believe that investors are prepared for a December rate hike, which should result in a minimal impact on stocks. Higher‐yielding equities may begin to feel pressure in 2017, as investors begin to shift from bond proxies, such as utilities and consumer staples to bonds. We will follow up on this theme during our next client communication.

As we head toward year‐end and begin to think about 2017, FBB continues to manage client portfolios with a focus on quality, income, and the potential for long‐term outperformance. We look forward to taking advantage of any unexpected volatility in the coming weeks and months, as we continue to seek out high quality opportunities within both equities and bonds.

With Best Wishes for autumn,

FBB Capital Partners

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Note: Please keep an eye out on your inbox for further information on the following upcoming events:

• Quarterly conference call in early October.
• On November 3 at 11 am, FBB will co‐host the last of four calls this year with our friend Greg Valliere, an expert in political and economic trends who will help enlighten us on potential investment implications of the presidential election.
• Year‐end conference call in December to review the 2016 and preview 2017.

We have moved! You’ll find that FBB Capital’s Bethesda office at the same address, and even the same suite number, but we have moved into new office space across the hall. Feel free to ask for a tour during your next visit.

The information contained herein is provided for informational and educational purposes only, and nothing contained herein should be construed as investment advice, either on behalf of a particular security or an overall investment strategy. FBB Capital Partners cannot guarantee that your investment goals or objectives will be met. All investments carry some degree of risk, including loss of principal.

Dear Clients and Friends,

As many of our clients prepare to enjoy America’s independence over a relaxing Fourth of July, we at FBB have been parsing through the June 23 “Brexit” referendum in which UK citizens voted for their independence from the European Union. While the dust is still settling, we have been evaluating potential short- and long-term investment implications, while also remaining vigilant for opportunities to own high quality companies at more attractive valuations.

Is the worst over yet?

While global markets sold off sharply in the two days after the referendum, they rallied back in the subsequent three trading days, recapturing much of their initial losses. The FTSE 100 index, which is the UK’s stock index, actually closed higher on June 30 than it was on the eve of the vote—that’s right, higher! Still, investors should be asking if the worst is over. In the next one to two quarters, while the UK political parties vote for new leadership, we feel there will be a good deal of waiting without much happening. We expect the UK economy to sputter—and certainly its internal growth rate to slow. Eventual terms of the divorce with the EU will dictate how the UK’s economy will fare over the long term. The impact on the EU writ large is harder to guesstimate. Potential referendums in other countries who share the common currency could certainly be of more consequence. For now, the only certainty in Europe is uncertainty, and in this environment we continue to maintain an underweight position in European shares.

Looking at the bigger picture to revisit the two most recent market shocks—a China growth scare in August 2015 and a plummeting oil price scare in February 2016— we experienced 10 percent equity market declines in each instance. Relative to these events, the immediate Brexit-related volatility was a more moderate down event (four to five percent), most likely because the UK represents a fairly small part of the global economy relative to China or the energy industry. In thinking through how the Brexit situation will play out, we believe markets will follow a playbook that we have seen play out in the past involving angst and uncertainty at first, a gradual adjustment over days and weeks, and an eventual market reversal to new highs. Our feeling is that investors will focus less on Brexit in the second half of the year and more on upcoming events, such as the U.S. elections and possible Fed rate hikes.

Playing offense and defense amid the latest volatility

As we think about FBB’s investment strategy post-Brexit, we continue to focus on positioning portfolios to play both offense and defense. In terms of offense, we favor some of the global financial exchanges, such as CME Group, which we’ve discussed in prior letters. These commodity exchanges not only pay attractive dividends with high barriers to entry, but also benefit from the rising volatility stemming from the looming UK / EU divorce.

On the other hand, we also like stocks that are more defensive amid macro-driven volatility—for example, United Health Group, a U.S.-focused health insurer that generates approximately 95 percent of its sales from inside the U.S. The company is in the process of exiting unprofitable state health exchanges and gaining share as its competitors remain distracted with controversial mergers. Additionally, United’s non-insurance businesscontinues to drive upside as it digitizes health IT, cuts wasteful drug spending, and manages growing doctor networks that offer low cost, high quality care.

Looking beyond individual securities, FBB continues to manage each client’s portfolio with a focus on quality, income, and the potential for long-term outperformance. During periods of unexpected market turbulence, when high- and low- quality companies trade at similar valuations, we believe our continued focus on quality will lead us to select companies that enable portfolios to “weather the storm.”

While the volatility of the last 12 months seems elevated by recent history standards, as we have written on many occasions, it is in fact much more in line with historic levels. We expect slow global growth and low interest rates to continue to be the investment environment for the next several quarters and we fully expect continued market volatility within that context. Rest assured, we will continue to invest your portfolio in a manner appropriate for your individual needs, goals, and investment time horizon, while keeping a tight leash on the ever-present balance between risk and reward.

With Best Wishes for Summer,

FBB Capital Partners

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The investment committee is pleased to announce several meaningful developments within your team. First, FBB Capital Partners was again named to the Financial Times 300 Top Registered Investment Advisers for the third year in a row. Second, we are delighted to welcome our most recent addition to the FBB team, Payal Vachhani, an investment research analyst. Finally, two additional FBB portfolio managers, Jaime Quiros CFP® and Jane (DeLashmutt) O’Mara CFP®, recently achieved membership as Registered Advisors with the National Association of Personal Financial Advisors, also known as NAPFA.

NOTE: Please SAVE THE DATE for the following upcoming events. Further details to follow via e-mail.

• On July 7 at 4 pm (EST), FBB will host a conference call with clients to discuss our Investment Outlook. Please send questions in advance of the meeting to info@fbbcap.com. The dial in is: (Local) 301-298-1561 / (Toll-Free) 800-719-7514. The access code is: 707517.
• On July 28 at 2 pm, FBB will co-host the third of four calls this year with our friend Greg Valliere, an expert in political and economic trends who will help enlighten us on potential investment implications of the presidential election. Please stay tuned for an email with dial-in information.

The information contained herein is provided for informational and educational purposes only, and nothing contained herein should be construed as investment advice, either on behalf of a particular security or an overall investment strategy. FBB Capital Partners cannot guarantee that your investment goals or objectives will be met. All investments carry some degree of
risk, including loss of principal.

Dear Clients and Friends,

As many of you have likely seen, global stock markets are reacting to a voter referendum that Britain will exit the European Union (EU), the so-called Brexit vote. FBB Capital Partners has been following this situation, as well as other geo-political events as we look to protect clients on the downside, while also watching for upside opportunities. Here are our thoughts on what’s happening with the Brexit vote, and how FBB is responding to the new uncertainty.

What happened?

This morning, the United Kingdom voted 52% to 48% to leave the EU, rattling global capital markets that expected the UK to remain in the EU. In pre-market trading, the S&P500 index is down nearly 4% and oil is off 5%.

How should investors view this volatility? We are framing today’s move by looking at market action over the past week as investors placed bets on the potential outcome of the Brexit vote. Our view is that the S&P500 rose 2% between June 15 and June 23, on the belief that the UK would remain in EU.

Therefore it is not surprising that this morning investors are wiping out that 2% rally and taking the market down another 2%, potentially on fears the European instability could spread and possibly depress earnings for U.S. companies.

Making sense of today’s move

While today may be an emotional day for investors with TVs and trading screens showing lots of red, we prefer to look at facts and data which suggest today’s market is ~1-2% oversold. Here’s the math. On one hand we have the U.S. market down 2% from the pre-Brexit (mid-June levels), described above. On the other hand, we know that U.S. blue chip companies in the S&P500 generate about 3% of their revenue from the UK, according to a financial data provider called FactSet.

Using these data points, today’s move implies that large U.S. companies will lose 2/3 of their UK business, just because the UK is leaving Europe. We view this as an over-reaction, because even if the UK enters a recession, we believe British demand for imports (from the U.S) is unlikely to fall by 2/3.

What’s next? Upside and downside scenarios

Where could we be wrong? Although we view today’s market move as an over-reaction, there are economic outcomes that could be better or worse than our current analysis. In a downside case, we could see a meaningful UK recession following the Brexit vote, as well as rising uncertainty as other EU members, such as France, voice interest in voting to leave the EU.
All information contained in this document is obtained from sources believed to be accurate and reliable.

A splintering European Union could slow global growth and fuel rising demand for safe currencies, such as the Dollar. A stronger greenback would likely depress U.S. exports, global commodity prices and U.S. Treasury rates, while delaying a Fed Funds rate hike for months. In this scenario, we could see U.S. equities fall back to early 2016 levels, when many of these factors were in play.

However, there is another scenario in which markets recover from today’s decline and follow a historical pattern of financial responses to geo-political events. Using data compiled by our friends at Northern Trust, equity markets on average fall by 4% over an 8-day period following unexpected global turmoil, but then fully recover in 37 days.

We also take a longer view of factors driving the market, which support an upside scenario. We believe that over the long term, corporate profits drive stocks. Our sense is today’s Brexit vote may weigh on near term corporate profits, however we believe earnings will continue to grow as we exit 2016 and into 2017, likely driving stocks higher.

How is FBB positioning amid the new uncertainty?

FBB continues to look for opportunities to position client portfolios as we enter a period of rising uncertainty. We believe EU stocks will likely decline more than U.S. investments following the Brexit vote and heading into today’s Brexit results, FBB has kept a low exposure to European equities, despite nominally lower valuations compared to the U.S. EU stocks typically make up more than 20% of global equity indices, however FBB clients generally have a much lower exposure.

What’s more, FBB has taken advantage of the market volatility over the past year by moving up the quality spectrum into stocks with cleaner balance sheets and less operational risk. We believe these moves will help add ballast to client portfolios during times of elevated volatility.

As we look beyond today’s Brexit vote, we see both uncertainty and opportunity. We continue to look for investments where near-term volatility or sentiment changes may obscure a high quality business trading at a discounted valuation. We believe the current market moves may open up additional opportunities for FBB clients.

Sincerely yours,

FBB Capital Partners’ Investment Committee

All information contained in this document is obtained from sources believed to be accurate and reliable. All opinions expressed in this newsletter are subject to change without notice and are not intended to be a guarantee or forecast of future events. This document does not constitute a solicitation to buy or sell securities nor is it a complete description of our investment policy, the markets, or any securities referred to in the newsletter. Opinions expressed herein are not intended to be used as investment advice and are subject to change without notice based on market and other conditions. No client or prospective client should assume that any information presented here serves as the receipt of, or a substitute for, personalized individual advice from FBB Capital Partners, its research team or its portfolio managers.The value of investments and the income from them may fluctuate and can fall as well as rise. Past performance is not a guarantee of future results.

Dear Clients and Friends,

Well, that was interesting. The first quarter of 2016 may go down as the most volatile in recent memory with the S&P 500 down 10% between January 1 and February 11. Meanwhile, investors worried that plunging oil prices were signaling dwindling demand for energy and, potentially, threat of a near-term recession. FBB used the short-lived downturn as an opportunity to continue trimming holdings of lower quality stocks and bonds whose fundamentals were showing deterioration and shifted proceeds into higher quality securities.

Fortunately, equity markets snapped back into positive territory after oil prices bottomed at $26 a barrel in February and rebounded dramatically toward $40 by the end of the quarter. Investors have since realized that global energy demand (including China) remains stable amid falling supplies. Sometimes volatility works in your favor.

What’s driving the volatility?

As we enter the second quarter, FBB believes that several forces are pointing toward macroeconomic changes, including: stabilization of the dollar, slowly rising interest rates, a gradual rebound in oil, and upward pressure on equities to match improving fundamentals.

Together, these forces may sound like a bullish recipe for equities. However, investors may have a hard time finding the right ingredients for success, as markets struggle to predict the timing and magnitude of these macroeconomic shifts, which may generate even more volatility in equity markets for the balance of 2016.

The CBOE Volatility Index, also called the VIX or the fear index, uses current data to predict future volatility. As of this writing, the VIX is currently in the mid-teens, well below late 2015 and early 2016 levels, which were in the mid to high twenties.

Our sense is volatility and the VIX index will revert toward higher long-term averages in the twenties, as investors’ place bets on shifting macro fundamentals. Daily market volatility is likely to remain elevated, although another 20% round trip journey (10% down and 10% up) like the one we experienced in the first quarter is less likely.

One dynamic in particular that may drive greater uncertainty is a changing relationship between oil and stocks. Historically, stock prices and the price of crude oil have been un-correlated. While recent history has shown quite the opposite (as equities and crude oil have traded in lock step), once again (similar to the price level of the VIX) this is not the norm—in fact this is very abnormal. Now that oil and commodities have rebounded from multi-year lows, we expect this abnormal pattern of high correlation to break down.

Another persistent driver of uncertainty this year will be interest rates and their potential path. At the moment, an April Fed rate hike seems off the table and Janet Yellen may be signaling that chances of a June hike are dwindling. As we manage client portfolios, we continue to focus on the timing, magnitude, and impact of the Fed rate hikes, especially for financial services stocks, higher dividend paying companies, and bonds.

Searching for investments benefiting from volatility

With an expectation of rising volatility as a backdrop, we are looking to embrace the uncertainty by seeking out stocks that benefit from a higher VIX index. One such company is CME Group, the former Chicago Mercantile Exchange. We favor CME not only for growth, but also for income. At first glance the stock appears to pay a nominal 2.5% dividend yield; however, if the company continues to pay special dividends (as it has for the past several years), the real yield to investors will be closer to 5%.

Looking beyond individual securities, FBB continues to manage client portfolios with a focus on quality, income and the potential for long-term outperformance. During periods of elevated volatility, high- and low-quality companies often trade at similar valuations, creating opportunities to buy great companies at the same price as mediocre ones. We look forward to embracing volatility in 2016 as we seek out high quality investments at attractive prices.

With Warm Wishes for Spring,

FBB Capital Partners

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Note: Please SAVE THE DATE for the following upcoming events, further details to follow via e-mail:

• On April 7th at 2pm (EST), FBB will host a conference call with clients to discuss our Investment Outlook. Please send questions in advance of the meeting to katie@fbbcap.com. The dial in is: (Local) 301-298- 1561 / (Toll-Free) 800-719-7514. The access code is: 707517.
• On April 27th at 2pm, FBB will co-host the second of four calls this year with Greg Valliere, an expert in political and economic trends who will help enlighten us on potential investment implications of the presidential election.
• Please keep an eye out for an enrollment e-mail with instructions how to access your new FBB client Vault in the weeks ahead.

All opinions expressed in this newsletter are subject to change without notice and are not intended to be a guarantee or forecast of future events. This document does not constitute a solicitation to buy or sell securities nor is it a complete description of our investment policy, the markets, or any securities referred to in the newsletter. Opinions expressed herein are not intended to be used as investment advice and are subject to change without notice based on market and other conditions. Different types of investments involve varying degrees of risk, and there is no assurance that any specific investment will either be suitable or profitable for a client’s or prospective client’s investment portfolio. No client or prospective client should assume that any information presented here serves as the receipt of, or a substitute for, personalized individual advice from FBB Capital Partners, its research team or its portfolio managers.The value of investments and the income from them may fluctuate and can fall as well as rise. Past performance is not a guarantee of future results.

Dear Clients and Friends,

As we write this letter on the last day of the year, the stock market looks poised to end 2015 within a percent or so of where the year began. Moving into 2016, FBB Capital continues to focus on the changing trends of currency, China, and crude oil or as we refer to them, “the three Cs”. While maintaining our position of a “slow and low” domestic economic backdrop, we must keep in mind that meaningful shifts in the three Cs drove significant market volatility in 2015. Though in the end, most domestic equity markets were straddling the zero return level for the year, we still believe positioning investments with an eye toward fundamental movements in currency markets, China, and crude oil, remains a priority for 2016.

The Three Cs

FBB expects a rising U.S. dollar amid fluid changes in global interest rates. U.S. economic growth in the second half of 2015 continued to push unemployment figures lower and wages slightly higher; allowing the Federal Reserve to finally sound the “all clear” in December with the first, of what we believe will be a multi-year string of interest rate increases. At the same time, the Eurozone reiterated its commitment to maintaining an easy monetary policy. This divergence of strategies in the two largest developed markets should lead to continued higher relative interest rates in the U.S. which will likely attract global investors, boosting demand for the dollar. We anticipate that these currency changes may pressure U.S. exporters’ results, while benefiting domestic consumers and European exporters.

In 2016, we expect greater stability within the Chinese economy, which should reduce investor concerns about China-driven equity volatility in the U.S. (It is worth noting that economic stability does not necessarily equate to Chinese stock market stability!) While we are open to opportunities in the Chinese market, we continue to prefer to invest in China through multi-national companies selling to Chinese consumers.

A slowing Chinese economy has generally reduced demand for crude oil and other commodities used to build heavy infrastructure, in addition continued oversupply of many of these same commodities led to the sharp price declines experienced in late 2014 and throughout 2015. In 2016, FBB believes that global supply and demand should move prices closer toward equilibrium, if this occurs, then commodity prices should stabilize. However, a stronger dollar may continue to depress commodity prices somewhat in 2016, putting more pressure on commodity exporters.

Encouraging Economic Framework

Even with potential continued volatility across the three Cs, the fundamental U.S. economic backdrop leads us to believe steady market appreciation is more likely than a bear market in 2016. Stocks and bonds should benefit from consistent economic growth, improving corporate profits, reasonable valuations, and rising interest rates. In addition, we view low and declining unemployment, modest inflation, improving housing indicators and steady growth in services and consumption to likely offset manufacturing weakness thus, fueling another year of slow and low GDP growth.

A steady economic expansion, in our view, will help companies continue to beat quarterly profit estimates by roughly 4-5%, in-line with recent trends. We continue to evaluate not only profitability but also quarterly sales results to ensure the quality of the earnings growth is sustainable.

Rising profits, combined with reasonable relative valuations, should support the equity market in 2016. Large U.S. stocks seem reasonably priced, S&P 500 valuations are presently in line with their European counterparts, while Chinese equities are still more than twice as expensive.

Portfolio Positioning in 2016

FBB maintains cautious optimism entering 2016. As we navigate changes in currencies, China, and crude oil, we anticipate that broader economic conditions remain favorable for investors. We believe that a continued focus on high quality companies with under-appreciated growth drivers is well suited for investors’ portfolios. Based on these themes and our outlook, FBB is positioning clients’ portfolios in the New Year with the following in mind:

• Continue to maintain equity exposure as stocks are likely to outperform bonds in a rising interest rate environment.
• Be mindful of headwinds from a stronger dollar; we are avoiding investing in companies with heavy exposure to export markets, particularly those selling big-ticket items where foreign buyers may delay purchases as their buying power weakens.
• Underweight portfolio exposure to China and crude oil along with other commodities.
• Focus on domestic-oriented U.S. companies, as well as, world-class multi-nationals selling high quality, high visibility products with minimal competition and high barriers to entry.

With Best Wishes for the New Year,

FBB Capital Partners

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Note: Please SAVE THE DATE for the following upcoming events, further details to follow via e-mail:

• On January 14th, FBB will host a conference call with clients to discuss our Investment Outlook (Time TBD).
• On January 27th at 2pm, FBB will co-host the first of four calls this year with our friend Greg Valliere, an expert in political and economic trends who will help enlighten us on potential investment implications of the presidential election.

P.S. As a reminder, your form 1099s should carry all relevant tax information that you need for your 2015 tax preparation (with the exception of K1s). As in years past, we expect the initial delivery by Charles Schwab and TD Ameritrade to occur by mid‐February but with a high likelihood of revisions to follow well into March. Due to these potential revisions, we would suggest avoiding filing early.

All opinions expressed in this newsletter are subject to change without notice and are not intended to be a guarantee or forecast of future events. This document does not constitute a solicitation to buy or sell securities nor is it a complete description of our investment policy, the markets, or any securities referred to in the newsletter. Opinions expressed herein are not intended to be used as investment advice and are subject to change without notice based on market and other conditions. Different types of investments involve varying degrees of risk, and there is no assurance that any specific investment will either be suitable or profitable for a client’s or prospective client’s investment portfolio. No client or prospective client should assume that any information presented here serves as the receipt of, or a substitute for, personalized individual advice from FBB Capital Partners, its research team or its portfolio managers.The value of investments and the income from them may fluctuate and can fall as well as rise. Past performance is not a guarantee of future results.