October 11, 2016

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Markets have not been particularly volatile this past quarter. Over the course of this bull market, we have had occasional sell-offs, mostly triggered by political actions (Greece, Brexit, Chinese Revaluation), but for the most part these have been few and far between. On September 30^th, the S&P 500 sat only 1.1% below its all-time high. The Dow Jones Industrial Average similarly was just 2.2% from its all-time high. Bonds are still near their highs; interest rates near their lows. Emerging markets have recovered. Oil is significantly off of its lows.
 
And yet, investors are nervous.
 
Investors seem to distrust the current market, including professional money managers. A September survey of fund managers by Blackrock resulted in an average cash position of 5.5%. In February, this same survey showed average cash of 5.6%, the highest levels since 2001! Professional investors are holding cash as a cushion from a market drop. Interestingly, when investors all increase their cash positions, it has historically been a “buy” signal.
 
Why do investors distrust the market? Perhaps it is the election, which rightfully makes us all nervous. Perhaps it is the Fed, which has continued to hint that an increase might one day be just over the horizon. In our view, it is most likely fatigue. This bull market is nearing 8 years old. The “easy money” has been made, and investors are more concerned with preserving capital, than in modest gains.
 
But, consider this. The S&P 500 is on pace to finish higher for the 31^st year of the past 37. As money managers, we are constantly asked whether clients should raise some cash at these levels. For the short-term investor, sure, go ahead. However, most investors have a time horizon beyond the next 12-18 months. If the past is any indication, the smart decision is to continue to stay invested.
 
Equity Income Commentary
 
After a very strong first half in 2016, Cutler’s Equity Income strategy “gave back” some of the year-to-date’s outperformance in the 3^rd Quarter. The Equity Income Composite returned 1.57% (gross), 1.39% (net), versus the S&P 500 TR at 3.85%. Much of that difference can be attributed to one holding, Bristol-Myers-Squibb (BMY) which was down 26%. BMY suffered a pipeline set-back as their flagship cancer drug, Opdivo, failed to meet testing benchmarks for lung cancer. This ceded to Merck the market dominance in the immuno-oncology space, and Merck’s stock rallied on the news. Pharmaceuticals will always be dependent on drug development, and set backs will occur for any company. However, companies with great balance sheets can weather these challenges. This is largely why we are biased toward companies with strong cash flows and dividends, attributes less dependent on FDA approval!
 
The best performing position this past quarter was Qualcomm, up 28.95%. The next largest contributor was Texas Instruments, a holding also in the semi-conductor industry. The semi-conductor space has been ripe with rumors of consolidation, a development that could create synergies and save costs.
 
Lastly, we should note a material change occurred this past quarter in the S&P 500. Real estate, which had previously been included in the financial sector, is now defined as a separate sector in the benchmark index. Historically, Cutler has not invested into publicly traded real estate, despite the rich dividends frequently available in this space. For example, we sold Weyerhaeuser when it converted to a REIT structure. For now, we continue to hold off and have a 0% weighting versus the benchmark of 3.2%. We are, however, going to look for opportunities in this sector to include in Cutler’s Approved List going forward. If an Approved List position is deemed suitable, it may be added to the portfolio.

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