Update Summer 2017

Smooth Sailing Ahead?

Key Points

Stocks have been drifting along near record highs and background conditions
remain relatively positive in the near term but seasonal tendencies remain a risk
and volatility has picked up a bit, so investors should be on alert for a pullback.
The U.S. economy continues to glide along, with subdued inflation, providing
what typically has been a good environment for stocks. Bond yields have ticked
higher and some commodities have recovered, signaling expectations for an
elevation in economic growth.
Economic growth around the world has improved and stock markets have gained,
laying the groundwork for globally synchronized economic expansion and
monetary policies returning to more normal conditions.

Stocks sail along

Conditions for stocks appear to be relatively smooth, illustrated by still-low volatility and
major indexes near record highs. Stocks will likely move higher, supported by solid
earnings, low inflation, and a modestly growing U.S. economy, but there are
developments to heed below the surface, including ongoing geopolitical and monetary
policy uncertainties. Keeping a diversified portfolio is important, as is periodic
rebalancing, as a geopolitical blowup, a monetary policy "mistake," or a major political
shakeup could occur with limited warning signs.

As noted, volatilityalbeit still low historicallyhas ticked higher, while sector rotation
has been the name of the game lately. Technology and energy stocks have moved lower
over the past month, while financials and health care have rallied, again illustrating the
critical importance of paying attention to the makeup of your portfolio, and being
mindful of the benefits of diversification.

This rotation, as well as occasional modest pullbacks in the overall indices, appears to be
keeping investor sentiment from getting overly optimistic. This two-steps-forward-one-
step-back movement is what will help extend the long-running bull market and, for now,
help prevent a "melt-up" scenario where the markets go up too much, too fast. As good
as they feel while they are in motion, big, explosive market surges dont tend to end
well.

Economic growth more like a pontoon boat than a speed boat

Earnings are about to come back into focus as second quarter reporting season kicks off.
Expectations are elevated and the recent move higher in stocks has been largely fueled
by a solid earnings picture. While waiting for earnings announcements to begin trickling
in, economic data has been mostly positive and indicative of an ongoing expansion,
albeit a mature one. Investors may be hoping for more of a speed boat look to economic
growth, but it may be that pontoon speed, while not exciting, is likely to be more
beneficial to keeping the bull market going. Modest growth helps to keep inflation in
check and monetary policy fairly loose.

There has been a weakening in some "soft" data as surveys of business and consumer
confidence have flattened out from the post-election growth spurt. Confidence could
remain stalled at current, albeit high, levels if the Trump administration's pro-growth
policy proposals get pushed out in time.

The hard data continues to provide a mixed picture with the labor market continuing to
look strong. The Labor Department reported 222,000 jobs were added in June,
surprising on the upside, while the unemployment rate ticked slightly higher to 4.4%,
although wage growth remained modest as average hourly earnings posted a 2.5% year-
over-year gain.

Further bolstering the economys growth trajectory, the important Index of Leading
Economic Indicators, put out by the Conference Board, continues to indicate further
economic expansion. As can be seen in the chart below, this set of indicators is giving no
sign of growing recession risk.

Source: FactSet, U.S. Conference Board. As of July 3, 2017.

Can the Fed successfully navigate these waters?

This mixed economic picture, combined with the recent retreat in some inflation
measures, has raised the level of uncertainty regarding future Federal Reserve actions.
The Fed is intent on continuing the normalization process, with balance sheet reduction
gaining a share of the spotlight from rate hikes. Interestingly, some foreign central banks
may have aided the Fed in its campaign with more hawkish commentary recently from
the heads of both the European Central Bank (ECB) and the Bank of England (BoE)
helping to push U.S. Treasury yields modestly higher.

Combining the move in yields with a modest rebound in some commodities such as iron
ore and copper may have folks wondering if the reflation story is again gaining traction.
It may be too early to buy into that, especially with inflation readings remaining low, but
it is something to keep an eye on, and could potentially add some more choppiness to
the waters as we sail through the summer months.

Broad economic growth

The first half of 2017 saw the global economy having one of its best years in more than
half a decade. All of the worlds top 20 economies are growing so far this year, a
broadening of growth we haven't seen since 2010, and that is also boosting growth in
emerging market economies as they export more goods.

Receding risks to growth

Another positive for the market is that the populist political and trade risks that loomed
at the beginning of the year have mostly faded as protectionist rhetoric has cooled and
European election outcomes eased worries over a breakup of the Eurozone. Most
encouragingly, world trade is on track to post the best growth since 2010 as we head
into the second half of the year.

This global economic growth has sparked rallies in markets around the world. Global
stocks may continue to rise in the second half of the year as long as earnings growth
continuesalthough periods of pullbacks are expected and healthy in a long-term bull
market. This outlook is supported by broad global economic growth and receding
political risks.

Looking Ahead
The environment for U.S. and global stocks continues to be in decent shape, but some
risks are elevated and the possibility of a pullback exists. A notable potential driver of
bouts of volatility could be U.S. and global central bank policy as they sail toward
monetary policy normalization.

Transformative Growth Leaders Strategy Update

This new strategy was implemented during the second quarter of 2016 and involves a
focused basket of stocks (roughly 15 or so) with the expectation these companies
underlying growth will be faster and superior to that of the overall economy and the
specific markets they operate in. These companies in some way have fashioned new
products and innovative offerings, spawned new industries and sparked change in
consumer and business habits and practices. Most of these companies are household
names, have dominant brands, are leaders in their respective markets and industries,
and in many ways are part of, and indeed have changed, our daily lives.

To manage risk, the Transformative Growth Leaders segment of the portfolio has no
more than a 10% overall allocation.
Since implementation of this stock portfolio, this basket of stocks has gained 24.6% in
value, nicely ahead of the broader market, as evidenced by the S&P 500, which has
generated a 15.7% return over the same time period. A performance table is listed
below:

6/31/2017
Purchase Close Return%
Amazon $716.46 $968.00 35.1%
Apple $93.08 $144.02 54.7%
Costco Wholesale $139.71 $159.93 14.5%
Disney $97.80 $106.25 8.6%
Google $704.98 $929.68 31.9%
Mastercard $89.25 $121.45 36.1%
Netflix $90.84 $149.41 64.5%
Nike $57.04 $59.00 3.4%
Starbucks $55.92 $58.31 4.3%
Tesla Motors $210.20 $361.61 72.0%
Under Armour $37.48 $21.76 -41.9%
Ulta Beauty $285.15 $287.34 0.8%
Visa $74.25 $93.78 26.3%

During the quarter, Ulta Beauty was added to the portfolio after its stock dropped in
value to a more opportunistic buy level. The beauty retailer continues to outshine
struggling peers by doing a few key things right drawing millennials to its stores,
growing an impressive e-commerce business, playing up brand partnerships and rolling
out fun and innovative product lines.

While most headlines tell the tale of retailers struggling to grow foot traffic at brick-and-
mortar locations, Ulta Beauty is proving it knows how to buck the trends. The retailer's
same-store sales, a metric closely watched by Wall Street, rose 14.3 percent for the
latest period, a healthy double-digit jump at a time when many businesses are barely
eking out 1 to 2 percent growth. The company saw 24% growth in net sales the last
fiscal year, with a staggering same-store sales increase of almost 16%. And if that's not
enough, this year's top line is set to grow another 20% above those strong results.

Future outlook letters will include performance updates on this basket of stocks, as well
as periodic in depth looks at specific companies in the portfolio.

Looking forward, while many uncertainties exist in the economy and markets, the fact
remains that the U.S. economy is still expanding, inflation and interest rates remain low
and numerous companies are still growing their earnings. Even in this challenged
environment, really strong market leaders continue to grow and increase earnings.

Amin Khakiani
July 18, 2017