A Most Unusual Year. Positive on 2021 Prospects

We begin our look back at 2020 and forward to 2021 with sincere gratitude for your trust and confidence as stewards committed to your financial well-being and the hope that you, your families, and extended networks have been safe and sound during this period of unprecedented tumult. We are bullish on prospects for continued growth in the year ahead and want to share our perspective on the market, economy, and portfolio performance for the past twelve months as well as our 2021 outlook.

From a performance standpoint, we were gratified with the returns delivered for the year. Our objective is to achieve superior risk-adjusted returns across our growth, growth and income and custom portfolios, appropriately balancing risk and return through prudent diversification and disciplined value assessment. In this regard, the past twelve months presented a particular challenge.

Substantial retail inflows and the growth in passive strategies produced concentrated buying among relatively few well-known, high profile companies. Indeed, nearly half the price return of the S&P 500® Index for the full year was attributable to just five companies: Amazon, Alphabet (Google), Apple, Facebook, and Microsoft. You will notice all are companies defined by 21st century technology, a characteristic that drove 2020 performance momentum and that we expect to advantage the performance of these and similar companies going forward. That said, after observing market cycles for over four decades, we know that industries and investment themes come in and out of favor, making diversification a necessary ingredient to positive long-term performance.

We are already seeing this momentum trend moderating, which supports our view, and our portfolio diversification rules. Over the past three months, the S&P 500® Equal Weight Index, which measures performance of the same 500 companies without regard to market capitalization has outperformed the weighted average by over 800 basis points. This is, in our view, healthy for the overall market and an ideal environment for our knowledge-driven investment philosophy.

The year 2020 began on firm footing. Respectable economic growth, low unemployment, accommodative monetary policy and improving profit margins

underpinned a bright outlook for corporate profits. The market, as measured by the S&P 500® Index, hit an all-time high of 3,386 on February 19th. By March however,

broadening concerns surrounding the impact of COVID-19 and economic fallout from widening lockdowns abruptly reversed positive momentum with the S&P entering bear market territory just 15 days later on March 11th before bottoming on March 23rd; at which point the Index had declined a whopping 35% from its February peak.

Government intervention was swift and decisive. Congress and the Federal Reserve harnessed fiscal and monetary policy tools to sustain spending while providing liquidity to ensure ample availability of borrowing. The results were immediate. Over $3 trillion in stimulus was injected into the economy and interest rates dropped to record lows. Credit spreads narrowed and the economy, which contracted at a jaw-dropping annualized rate of 32% in the Q2, rebounded sharply. By year-end, the economy added over 16 million jobs from the April lows, pushing the unemployment rate to 6.7% while GDP increased at an annualized rate of 35% in the Q3, recovering nearly all of the Q2 decline. Mirroring our confidence in American ingenuity expressed in the midst of historic volatility, Corporate America adjusted quickly to a work-from-home regime and profits were stronger than anticipated by most. The markets responded enthusiastically, rising 66% from the March lows to end the year with a gain of 16%.

Unsurprisingly, market gains were concentrated in those sectors either unaffected, less affected or benefitting from lockdown orders and related changes in consumption patterns. Digital transformation, a theme we have prioritized for years, accelerated as did penetration of e-commerce alternatives. Consumer discretionary companies benefited from heightened focus on the home. These two sectors currently represent nearly 40% of the market and each rose over 30% for the year, accounting for 80% of the overall market advance. Financials, energy, industrials, and materials all lagged with energy a standout loser, down 24% for the period.

Over the next 12-18 months, we expect market gains to continue but to significantlybroaden to include companies that will benefit from additional stimulus and a gradual return to normal operating conditions with wider distribution of therapeutics and vaccines. The above average corporate earnings growth that we expect through the end of 2022 should provide ample support for market gains without further extending valuation levels. The S&P 500® Index is currently trading at 22.3 times projected 2021 earnings and 19.0 times the 2022 forecast - the prospect of nearly 20% earnings gains projected for the next 8 quarters, should be supportive of sustained positive price momentum, particularly in light of benign inflation and negative real interest rates. We see upside in the S&P 500® to 4500 over the next 12-18 months with a trading range of 3600 - 4900, suggesting an extremely favorable current risk-return profile.

While our constructive view on the market rests primarily on our expectation for sustained above average earnings growth over the next year or two, low interest rates and, relatedly, low inflation also support higher-than-average PE ratios, particularly for fast- growing companies. So, we are monitoring inflation and have noted important upticks in commodity prices across the board ranging from agricultural inputs such as corn, up 65% over the past 9 months to industrial metals like copper, which is currently trading at multi-year highs, up 70% over the past year. Notwithstanding the euphoria associated with electric vehicles, oil is up 44% since October. As a result, ten-year treasuries have rebounded from an all-time low of 0.55% to just over 1.15% as of this writing. Inflation expectations, while remaining low, have doubled from 1.00% to 2.05% since August 2020. Our view may change, but we think the tailwind from continued stimulus coupled with the pent-up demand built up during the lockdown will trump inflation concerns.

We would also note that while employment has risen and the unemployment rate has fallen, the labor force participation rate remains 9% below peak. Accordingly, the most important cost input - labor - should experience only modest cost pressure. In summary, we do not see material risk to our valuation thinking or return expectations until the 10-year bond trades up to 3.0% on a sustained basis, a level which we believe would produce a 15-18% correction from current prices.