Performance

Performance background

Performance

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Disclosure

Performance results are based on estimates. For gross and net performance results, see performance table. Commentary section is based on gross performance results only for better comparison to benchmark data. Although the information contained in the commentary sections have been obtained from sources we believe to be reliable, the accuracy and completeness of such information and the opinions expressed herein cannot be guaranteed. Past performance is not necessarily indicative of future results. Different types of investments involve varying degrees of risk.

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FOURTH QUARTER 2018

Hanseatic Market Commentary

Stocks ended 2018 in negative territory, the worst performance since 2008 and only the second negative year over the past decade. The S&P 500 and NASDAQ averages closed the year down 6% and 1% respectively, while small caps lost 12%. Treasury bonds also dropped for the year as did commodities. December was a particularly awful month; the S&P 500 was down 9% and the Dow industrials lost 8.7%, the worst December for the latter average since the Great Depression almost ninety years ago. The S&P 500 had been up 10% in late September before sliding 20% into the Christmas Eve low. By our reckoning, 1946 was the last comparable late year selloff.

Given the strong performance over the first nine months of 2018, it certainly would not have been surprising for stocks to languish some or trade sideways through the last quarter, but recent market behavior has been outside of our expectations. The market declines over the past three months and in December are very low probability events, but that doesn’t change the fact that they have been both costly and stressful.

December in particular has exacted a toll on investor confidence. Investors have yanked $75 billion from mutual funds and exchange traded funds that track stocks during the month, the biggest exodus from stock funds in a single month ever according to Lipper data going back to 1992. Also, according to a recent American Association of Individual Investors recent survey, only 32% of investors expected prices to rise over the next six months.

In addition to performance woes, 2018 was also notable for its extreme volatility. There have been only seventeen extreme overbought readings in the volatility index (VIX) by our measure since 1990. Four of those occurred in the past year making 2018 the most volatile in almost thirty years.

The proximate cause of the most recent selloff was the Fed decision to raise interest rates in late December. While expected, the rate decision and Chairman Powell’s subsequent commentary about its balance sheet reduction program being on “autopilot” conveyed a Fed that was oblivious to market realities and wrongheadedly risking a recession by tightening monetary policy too quickly. Federal Reserve Bank of New York President Williams did a commendable job after the meeting by making it clear that “autopilot” may have been a poor choice of words. But the damage was done. In recent days, however, there has been a shift in the Fed’s rhetoric. Speaking to economists on January 4, Chairman Powell raised the possibility of a pause in the Fed’s interest-rate hiking campaign and an alteration in its balance sheet reduction plans in response to the downside risks investors perceive to the economy. The latest shift in the Fed’s tone is significant. The forward equity market outlook is certainly more positive with a flexible data-driven monetary policy than a Fed that automatically raises rates because that was their plan from a year ago.

Market volatility will likely persist at least in the early part of 2019 as investors digest the multiple forces impacting corporate earnings, interest rates and the economy. Trade policy will likely remain a significant uncertainty. Potential escalation of US-China trade tensions, including more and bigger tariffs, are a key risk to corporate profits as the recent Apple report makes clear. It is likely that more companies with international earnings exposure will also lower forward earnings guidance. There are also significant risks in the European economies that can have a serious impact on the global economy. There are the Brexit and Italy issues of course, but perhaps of more concern is the recent decline of German business confidence measures. If Germany, which is the locomotive of the Eurozone, were to slow then what happens to the rest of Europe?

In the context of all the downside volatility and potential risks, it is understandable that investor sentiment measures are depressed and anxiety increased. On the other side of the coin, there is positive news. A welcome respite from the downbeat of bad news was the December employment report which showed that employers added the most workers in 10 months, wage gains accelerated and labor-force participation jumped. If the job numbers hold up through revisions (next 2 months) this will be the second-best year for employment since 2000. Across-the-board strength in the job market will support further gains in consumer spending, the biggest part of the economy. This is a clear signal that the economy is on solid footing even as the markets fret about a potential trade war and other risks.

Another positive for the economy is that inflation and interest rates remain low. The uptick in wages is not a significant inflation problem and commodity markets have been weak over the last several months. Interest rates are also low. With the recent “flight to quality” rally in bond prices (lower yields), the 10-year Treasury is again trading below the psychological barrier of 3%.

An important positive for the equity market is that valuations have become more attractive. Stock valuations rose to levels well above historical averages as the market advanced over the first three quarters of 2018. But the combination of strong earnings, low interest rates and falling prices have restored P/E ratios to more “normal” levels. Also, stocks at their December lows were down about as much as we have historically seen in non-recessionary bear markets, which is what we believe this is. Non-recessionary bear markets also occurred in 1987, 1990, 1998 and 2011. Technical and sentiment measures are extremely negative, which is a plus from a contrarian viewpoint. Gas prices are down and consumer financial health is more positive than it has been in a long time. Corporate buyback activity is robust, supported by strong corporate balance sheets.

In conclusion, there is no doubt that this has been a challenging time for investors. The kind of market weakness we have recently experienced is alarming and perhaps especially troublesome because there seems to be a disconnect between the fears embedded in market behavior and the quite positive economic and financial environments. Though we cannot rule out more near-term turbulence, we believe there are plenty of catalysts to make 2019 a positive year for stocks.

HANSEATIC QUARTERLY STRATEGY PERFORMANCE AND ATTRIBUTION

ALL CAP GROWTH EQUITY (AG)

The All Cap Growth Equity strategy return was down 21.48%, the Russell 3000 Growth benchmark return was down 16.33%. The strategy’s fourth quarter underperformance was derived from relative underperformance in five of eleven sectors. Utilities, Materials, Staples, and Industrials were the only sectors that were relatively flat during the quarter, from down 0.01% to up 0.02%. Communication Services contributed 1.02% to relative performance. Real Estate and Financials contributed a combined 0.13% to relative performance. Healthcare, Energy, Tech and Consumer Discretionary detracted 2.27%, 2.02%, 1.04%, and 0.99% from relative performance. The portfolio is overweight Staples and Healthcare, and underweight Tech and Communication Services. Cash is about 35%.

ALL CAP GROWTH CONCENTRATED EQUITY (CD)

The All Cap Growth Concentrated Equity strategy return was down 18.43%, the Russell 3000 Growth benchmark return was down 16.33%. The strategy’s fourth quarter underperformance was derived from relative underperformance in four of eleven sectors. Utilities, and Materials were the only sectors that were relatively flat during the quarter, 0% - 0.03% respectively. Communication Services, Industrials, Consumer Discretionary, Staples, and Real Estate contributed 2.01%, 0.36%, 0.35%, 0.29%, and 0.07% to relative performance. Healthcare, Energy, Financials, and Tech detracted 2.56%, 1.79%, 0.78%, and 0.07% from relative performance. The portfolio is overweight Materials, and underweight Tech, Communication Services, and Consumer Discretionary. Cash is about 45%.

ALL CAP TAX EFFICIENT EQUITY (TE)

The All Cap Tax Efficient Equity strategy return was down 18.69%, the Russell 3000 benchmark return was down 14.30%. The strategy’s fourth quarter underperformance was derived from relative underperformance in seven of eleven sectors. Utilities was the only sector that was relatively flat during the quarter -0.03%. Communication Services, Staples, Real Estate, and Materials contributed 0.91%, 0.71%, 0.28%, and 0.04% to relative performance. Energy, Healthcare, Industrials, Tech, Consumer Discretionary, and Financials detracted 2.46%, 1.40%, 1.09%, 0.90%, 0.35%, and 0.11% from relative performance. The portfolio is overweight Healthcare and Tech, and underweight Financials, Communication Services, and Consumer Discretionary. Cash is about 18%.

LATIN AMERICA EQUITY (LA)

The Latin America Equity strategy return was down 8.06%, the Russell Latin America Index return was 0.91%. The strategy’s fourth quarter underperformance was derived from underexposure and a larger than normal cash position. Most notable were Utilities and Consumer Discretionary contributing 1.41% and 0.16% respectively to performance. Industrials, Energy, Materials, Consumer Staples, and Communication Services detracted 3.06%, 2.61%, 2.28%, 0.86%, and 0.67% sequentially from performance. Financials detracted 0.15% and there was no exposure to Real Estate, Tech or Healthcare. The portfolio is overweight Utilities; and is underweight Financials, Staples, and Communication Services. Cash is about 31%.

GROWTH & INCOME EQUITY (GI)

The Growth & Income Equity strategy return was down 13.57%, the S&P 500 Total Return Index return was down 13.52%. The strategy’s fourth quarter underperformance was derived from relative underperformance in four of eleven sectors. Notable were Healthcare, Communication Services, and Financials contributing 0.98%, 0.95%, and 0.54% respectively to relative performance. Industrials, Staples, Utilities, and Tech contributed a combined 0.25% relative performance. Consumer Discretionary, Energy, Materials, and Real Estate detracted 1.34%, 0.62%, 0.56%, and 0.26% respectively from relative performance. The portfolio is overweight Materials and slightly overweight Utilities while it is underweight all other sectors. Cash is about 39%.