Cutler Commentary

Market and Equity Income Commentary 1Q 2018

April 06, 2018

Q1-18 Quarterly Review
In our previous quarterly commentary, we stated that “We would be positioning equity portfolios in anticipation of potential volatility heading into 2018.” Perhaps this was astute, but in retrospect, it was a straightforward conclusion from the market behavior of the past year. The rise of Bitcoin epitomized the risk-seeking behavior at the end of 2017, and the subsequent fall of Bitcoin was not a surprise. But even for those who were expecting a market sell-off, the first quarter was full of surprises.
Surprise #1. The return of volatility. When volatility came back, it came back with vengeance. A cottage industry of low volatility financial products had been established in recent years. Many investors positioned themselves for a continued environment of “low vol”, built upon the belief that central bank intervention bolstered equity values and limited negative market swings. On February 5th, wage inflation was reported to be increasing at the fastest rate since June 2009. Rising interest rates were once again a concern. Stocks sold off. And volatility skyrocketed. Most notably, the XIV, an exchange traded note (note: not held in Cutler client portfolios) lost over 90% of its value and was forced to liquidate.1 This was a fund worth over $2 billion in January!
Surprise #2. Lower interest rates. Rates are going up! At least that is what investors see when they read the finance press. However, more accurately, short-term rates have been going up. Long-term rates? Not so much. On March 31st, the 30-year Treasury was at 2.97%. One year earlier it was higher at 3.02%.2 While the Federal Reserve continues to raise rates at the short end of the yield curve, longer-term inflation expectations remain muted. This is good news for savers (money market rates have gone up!) and good news for borrowers (long-term rates are still low!). We believe that interest rates are still supportive for equity prices.
Surprise #3. Investor opportunities. For roughly 15 months, investors didn’t have an opportunity to buy equities. It seemed prices rose on a daily basis. However, the recent sell-off may prove to be an opportunity to build equity positions. The real surprise for investors, is that valuations are lower today than before the 2016 Presidential election. How? Earnings have grown faster than stock prices. Earnings for S&P 500 companies are forecast to be 17% higher in the first quarter than the same period last year. The forward price-to-earnings ratio of the S&P 500 peaked at 18.6 in January. With the subsequent sell-off, this ratio is now at its lowest level since June of 2016, at just over 16 times earnings.3
Cutler’s Outlook
Stocks began the year with an incredible run, but got ahead of themselves. A correction has created a healthier market for the rest of 2018. Yes, there will be noise and “bumps” along the way. Trade rhetoric, geopolitics, and interest rates should continue to be dominate headlines during the year. But, Cutler views global growth as the dominant investment theme. Growth is bullish for international stocks, as well as for US equities. Consider this. In years when the S&P 500 returned over 5% by January 23rd, the median annual return was 11.6%. However, those years also had an average sell-off from the peak of 15%.4 History shows that this year may not be unique. With GDP growth anticipated at 3% plus, reasonable equity valuations, and relatively low interest rates, Cutler believes investors should continue to participate in the equity markets.
Equity Income Commentary
Investors have been increasingly looking at “Factors” when assessing their portfolio exposures. Traditionally, investments have been separated by size (market capitalization) and valuation (value versus growth). Current thought identifies five categories of “alpha” (value add) contributors, called Factors: Value, Dividend Yield, Momentum, Quality, and Low Volatility. One would associate Cutler’s Equity Income strategy with Dividend Yield and Value Factor exposure; attributes which historically show Early- or Mid- business cycle outperformance. Momentum investing has been the dominant Factor, often associated with Late- business cycle returns. While our management of the strategy has not changed, awareness of Factors allows a deeper understanding of market and portfolio dynamics.
Cutler’s Equity Income strategy had a return of -3.92% (gross) and -4.05% (net) during the quarter. After a very strong start to the year, equities sold off into quarter end. The S&P 500 had a return of -0.76%, outperforming Cutler’s strategy. What were the primary contributors to this difference?
Looking at the portfolio attribution, a couple of things stand out. First, Information Technology, the strongest sector for the quarter, outperformed with a quarterly return of 3.18%. Cutler continues to underweight IT (14.8% vs 24.3%) as our dividend-based criteria does not provide exposure to much of the growth-oriented technology stocks. Second, Cutler’s Consumer Discretionary holdings underperformed, but we still have confidence in these holdings. Both McDonald’s (-8.56%) and The Home Depot (-5.41%) had negative returns, however, at this point these companies continue to be core holdings for the portfolio. Both have been executing well in recent years, and we feel continue to be well-positioned. A smaller holding, General Mills, was the worst performing position in the quarter (-23.37%). General Mills announced the purchase of Blue Buffalo pet foods, the cost of which dragged General Mills’ stock lower. In addition, the company’s margins were impacted by inflation pressures associated with higher commodity prices. This will be an important trend for investors to monitor, as mild inflation has eased the path for lower rates and been a large contributor to US economic growth.
The strongest performing positions in the quarter were led by financial and technology companies. BlackRock (+6.01%) and M&T Bank (+8.24%) both had strong quarters. BlackRock has been a strong beneficiary of rising investment assets, while M&T Bank’s performance is more surprising in an environment where the yield curve has flattened. Should the long-end of the yield curve rise, traditional banks are well-positioned to benefit. Intel (+13.58%) and Microsoft (+7.19%) continued the strong trend of technology outperformance as well.

Past performance is no guarantee of future results.  Net performance is pre-tax, net of advisory fees and transaction costs and includes the reinvestment of dividends. All investments involve risk, including possible loss of principal amount invested. Different types of investments involve varying degrees of risk, and there can be no assurance that any specific investment or strategy will be profitable or suitable for a particular investor's financial situation or risk tolerance. Asset allocation and portfolio diversification cannot assure or guarantee better performance and cannot eliminate the risk of investment losses. Source: Morningstar, Advent APX, and Cutler Investment Group.

All opinions and data included in this commentary are as of April 5, 2018, and are subject to change.  The opinions and views expresses herein are of Cutler Investment Counsel, LLC and are not intended to be a forecast of future events, a guarantee of future results or investment advice. This report is provided for informational purposes only and should not be considered a recommendation or solicitation to purchase securities. This information should not be used as the sole basis to make any investment decision.  The statistics have been obtained from sources believed to be reliable, but the accuracy and completeness of this information cannot be guaranteed.  Neither Cutler Investment Counsel, LLC nor its information providers are responsible for any damages or losses arising from any use of this information.
The S&P 500® Index is widely regarded as the best single gauge of large-cap U.S. equities. There is over USD 7.8 trillion benchmarked to the index, with index assets comprising approximately USD 2.2 trillion of this total. The index includes 500 leading companies and captures approximately 80% coverage of available market capitalization.  This index is not available for direct investment.
Best Performing Securities
Average Weight (%)
Security Contribution to Portfolio Return (%)
Intel Corp.
M&T Bank Corp.
Microsoft Corp.
BlackRock Inc.
Bristol-Myers Squibb Company
Worst Performing Securities
Average Weight (%)
Security Contribution to Portfolio Return (%)
General Mills Inc.
Dominion Energy Inc.
Procter & Gamble Co.
Qualcomm Inc.
The Kroger Co.



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These blogs are provided for informational purposes only and represent Cutler Investment Group’s (“Cutler”) views as of the date of posting. Such views are subject to change at any point without notice. The information in the blogs should not be considered investment advice or a recommendation to buy or sell any types of securities.   Some of the information provided has been obtained from third party sources believed to be reliable but such information is not guaranteed.  Cutler has not taken into account the investment objectives, financial situation or particular needs of any individual investor. There is a risk of loss from an investment in securities, including the risk of loss of principal. Different types of investments involve varying degrees of risk, and there can be no assurance that any specific investment will be profitable or suitable for a particular investor's financial situation or risk tolerance.  Any forward looking statements or forecasts are based on assumptions and actual results are expected to vary. No reliance should be placed on, and no guarantee should be assumed from, any such statements or forecasts when making any investment decision.


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