Karp Capital Management Financial Focus

1st Quarter Report

Positioning Your Financial World in the Global Economy
April, 2017

State of the Union

Riding the Market

Now that we have a President Trump and not the candidate, we’re seeing shifts in policy focuses that will change investment themes as his presidency progresses. We’re already seeing less of a focus on the populist messaging of improving infrastructure and widening health care coverage. His preliminary budget focus has been defense spending with very little attention to infrastructure. The American Health Care Act did nothing to expand coverage, yet was trumpeted by the president. These shifts are what will reorient the focus of investors as the Trump rally loses momentum and more of the agenda is called into question.

Small cap stocks had a tough time in the first quarter of 2017, but finished off outperforming the broader market indices towards the end of the quarter. The movement of these more aggressive stocks suggest that investor confidence is changing course. Meanwhile, the S&P 500 which is dominated by large companies, ended the quarter with its best performance since the end of 2015. It looks like market sentiment has moved past the failed effort of health care reform in favor of optimism for comprehensive tax reform. Republicans are under pressure to deliver a legislative victory. Also, in order to gain bipartisan support, a large infrastructure spending program may be included in the tax bill. Together, these initiatives have refocused investors on President Trump’s pro-growth agenda.

The Federal Reserve kept on pace with its projected rate hikes, signaling to the markets that the economy can handle marginally higher rates. Even countries where deflation was a main concern have seen their bond yields rise in tandem with the U.S. as international economies look to be picking up steam. The pace of global growth, a key driver of U.S. exports, is starting to improve which has been dormant for more than two years.

The overall fundamentals of the economy are strong, and have been improving since the end of last year. The record-breaking streaks of gains are definitely welcome, but investors need to keep in mind the potential for drops and dips in the market. You need to maintain a balanced, risk-adjusted portfolio to help you weather inevitable volatility, especially if you’re closer to retirement. We’re monitoring the traceable macroeconomic trends that help guide asset growth and help tune out the noise. Alongside an allocation of mixed asset-classes and sectors we’re looking for opportunities internationally to add to clients’ portfolios as the global economy is set for continued growth. In this installment of Karp Capital Financial Focus we will discuss what’s driving growth, the headwinds the economy faces and new global opportunities.

In This Issue:

State of the Union

Market Performance

Zero to One Hundred – Real Quick

The Sweet Spot

Governing is Hard

April Fools

Feeling Good

International Orange

Fueling Clean Growth

First I Was Afraid, I Wasn't Diversified

Housing Sector Focus

Even If You're Not a Rockefeller

Featured Client - Judge Stephen Murphy

_________________

Contact Peter

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Market Performance

Here are the performance numbers for the major indices as of 3/31/2017: (total return)

March
2017

Latest
3 Months
Latest
6 Months

2016
% Change

The
Close

Dow Jones Industrials
-0.72%
4.56%
14.28%
13.42%
20,663.22
Standard & Poor’s 500
-0.04%
5.53%
10.12%
9.54%
2,262.72
NASDAQ Composite
1.48%
9.82%
11.99%
7.50%
5,911.74
Russell 2000
0.13%
2.47%
11.52%
21.31%
1,385.92
MSCI EAFE
2.87%
7.39%
6.66%
1.51%
1,792.98
Long Term Treasury Bonds
-0.55%
1.43%
-10.45%
1.31%
Gold
-0.86%
8.64%
-5.87%
8.10%
$1,249.13

U.S. stocks had their best first quarter in four years (S&P 500 +6.07%). Stocks generally outperformed most other asset classes, led by emerging markets (11.5%). In Q1, tech (+12.6%) and consumer discretionary (+8.5%) led, while energy (-6.7%) and telecom (-4.0%) lagged. For the quarter, performance was better for large companies vs. small companies, with large caps (+6.0%) beating mid (+5.2%) and small (+2.5%).
Sources: Thomson Reuters; WSJ Market Data Group, Dow Jones & Co., BTN Research, BofA ML.




Zero to One Hundred – Real Quick

During the first quarter of 2017, the major equity indices experienced the most record closes since January 1987. It took the Dow Jones Industrial Average 24 days to go from 20,000 to 21,000. These quick and sizable gains extended the post-election rally and continued the boon to equities.

It took until March 21st for the S&P 500 to experience a 1% decline, breaking a streak that lasted over 100 days. With an already improving economy and promises of deregulation and tax cuts, investors put the money to work that they had sitting on the sidelines. Even those who are apprehensive about what the Trump economy entails seem to have turned a little more bullish than they were leading up to the election. Consumers are more optimistic than any year since 2000, according to the latest University of Michigan survey. The survey of small business owners conducted by the National Federation of Independent Business showed that optimism jumped from 94.9 last October to 105.9 during January, remaining at 105.3 in February, making the first two months of 2017 the two most optimistic readings since December 2004.

The Sweet Spot

Wolves of Wall StreetThe Federal Open Market Committee (FOMC) raised key interest rates by 0.25% to 0.75%, to get more in line with rising long-term market rates, and the prospect of sustained inflation. Even though Fed Chair Janet Yellen said that three interest rate hikes were possible in 2017, she also signaled that 2% is not a firm ceiling on inflation. This means that the Fed is not overreacting to rising inflation but is showing confidence in economic growth. January’s gain of the Consumer Price Index (CPI), which measures what consumers pay for both goods and services, marks the largest monthly increase in consumer prices since February 2013. Year-over-year, the CPI has risen 2.5% — the largest 12-month increase in nearly five years. The continued strength in the labor market and consumer spending, which has sent inflation closer to the Fed target rate of 2.0%, give support to potential further rate increases. The bottom line is that Yellen is cautious and does not want to rattle the financial markets. After all, the cost of money just went up and rising interest rates can prove to be a headwind for economic growth. It looks like the Fed might be succeeding, as both the stock market and treasury bonds rallied and interest rates settled down a bit since the latest interest rate hike. The yield on the 10-year bond is under 2.50% while the yield on the 30-year bond is now 3.11%.

The major take-away of this Fed meeting is that the market pretty much got its Goldilocks outcome - a rate hike that acknowledges improvement toward the Fed's objectives, to control inflation and promote maximum employment, and a reiteration that the committee still thinks a gradual normalization path in the Fed Funds rate will be warranted for the right economic reasons. The Fed is exhibiting confidence not seen in a long time. While the action in the banking sector and the overall market is constructive, we are at the beginning of a Fed tightening cycle. Fed tightening cycles tend to invert the yield curve at some point. Inversion occurs when long-term treasury rates fall below short term rates, signaling that investors think economic growth will wane. An inverted yield curve has preceded every one of the past five recessions. Even though the yield curve did steepen somewhat from a short-term perspective after the presidential election, it has been flattening quite a bit in the past three years as the economic expansion has aged. The yield curve says a lot about the backbone of the economy, the banking sector. Banks really like a steep yield curve environment as they can borrow short (tied to short-term rates) and lend long (tied to long-term rates). A steep yield curve means the banking business is more profitable at a time when actual loan demand is falling. Data from the Federal Reserve show commercial and industrial loan growth cooling off dramatically. This slowdown in lending is coming at a time of rising business and consumer confidence. This is a phenomenon that we are monitoring and contrary to supporting economic growth.

Governing is Hard

The Next BattleThe candidate Trump seems to have been buoyed above all his rivals because of his populist messaging and dramatic focus on national security issues. His repetitive promises to Make America Great Again, in part, was a promise to dismantle a lot of the regulations from the Obama administration. He talked of literally building a better America, lifting hopes that infrastructure spending would not only improve America’s roads and bridges but also stimulate the economy and put money in the hands of the working class. After the election, his win resulted in the Trump Rally; equity markets spiked with the anticipation of a more corporate-friendly economic environment and increased government spending.

Things are not turning out to be as facile for the President, even with the Republicans controlling Congress. Many items on President Trump’s economic agenda have taken a back seat to the austerity measures promulgated by Republicans since the financial crisis. Trump’s national security agenda is being shot down by federal courts and so far the first attempt to pass major legislation, the American Health Care Act, was defeated by Republican infighting. The thing that has been touted as the first action item of the new Congress will turn out to be one of the harder pieces of legislation to bring to fruition.

The politics and repercussions of such huge reforms are complicated, as Democrats found out in 2010. It will be difficult for the House to placate the far-right members of the party while still having a palatable bill for the moderates who are already facing pressure from constituents well before midterm elections. Because of the recalcitrant attitude of some members of Congress, repealing and replacing the Affordable Care Act (Obamacare) has been taken off the legislative agenda for the foreseeable future.

These roadblocks are sure to dampen the market’s expectations on what is possible to achieve under this new administration. Investors are going to start re-evaluating which part of the agenda has carte-blanche and which parts will be politically difficult to achieve. The House Freedom Caucus will surely prove to be an obstacle for Paul Ryan as any demand coming from the caucus will rattle Republicans in more competitive districts. With health care reform off the table, the senate will need Democratic support to pass any sizeable tax cuts. Since the attempt to offset cuts with spending has already been curtailed, any measures that will increase the deficit will need 60 votes in the Senate; Republicans have 52. Either there will be a conclusion to congressional gridlock or we’ll continue treading the same water we have for years. We are cautiously optimistic. Republicans at this point have a choice between a budget-neutral tax reform plan that is limited in size, or a go-for-broke plan with a 10-year tax cut that is not subject to budget neutrality.

We’re focused on aspects of the domestic economy that are poised to do well independent of major shifts in fiscal policy, such as commodities, cyclical stocks, technology and manufacturers. While political news dominates the headlines, it’s important to remain focused on your goals and keep the larger trends in mind. The news can move the markets, but your long-term goals remain the same. Managing risk is key to meeting your goals and avoiding some of the volatility in the markets.

April Fools

As we approach April 18th (tax day this year) be extra cautious of phishing email scams. The IRS received reports of an increase in email scams that focus on CPA firms. These scams seek to steal password information. The phishing email uses the name of a legitimate tax preparer. The email contains a PDF attachment claiming to be a secure file and/or a hyperlink. In any event, you wind up at a phishing site that asks for your email address and password. It is prudent not to share your passwords with anyone. Never open attachments or click on links from suspicious sources. Furthermore, the IRS will never call to demand immediate payment using a specific payment method such as a prepaid debit card, gift card or wire transfer. Generally, the IRS will first mail you a bill if you owe any taxes. The IRS might call to alert you to the fact you will get a notice in the mail and you will need to act by a specific date. If contacted do not give out any information but do request the name and the phone number of the person calling. Do not fall for the ultimate April fools’ joke.

Feeling Good

Modern ShoppingConsumers are feeling good and they’re the main drivers behind growth in the economy. In fact, 70% of gross domestic product (GDP) is influenced by consumer spending. Household debt, as a percentage of GDP, is near a 10-year low and consumer spending is at an all-time high, showing that consumers, in general, are feeling pretty good about their current financial picture. It’s been a long, slow recovery but there are reasons to believe that better times are ahead. With low interest rates helping homeowners reduce their mortgage payments and the low price of gasoline keeping money in the pockets of Americans, we’re seeing positive effects on consumer behavior. After years of job growth and recovery, the numbers illustrate that consumer confidence is high; retail sales are rising, despite rumblings from some retailers struggling to keep up with an increasingly internet-based economy.

In March, the Conference Board Consumer Confidence Index (CCI) generated the highest reading seen since December 2000. This may translate to several quarters of positive performance and economic growth, though there’s concern that this type of growth can run concurrent with inflation, devaluing savings and income. The question is, will the Federal Reserve be able to get ahead of inflation without stymieing economic growth? So far, the Fed has signaled that the economy can handle rate increases to head off concerns of inflation.

We believe the U.S. consumer will continue to spend. Over the last year we have been adding selective consumer companies and as a core holding the Consumer Discretionary exchange traded fund (XLY) to clients’ portfolios. Housing is set to take another leg higher given the pending home sales numbers. We should see modest gains in sales over the next few months, perhaps returning to the highs reached in April last year. Looking further ahead into the second half of 2017, a sustained increase in pending home sales requires mortgage applications to pick up very soon. We think this is a decent bet, given easing lending standards and strong employment gains.

International Orange

Brexit and MayThe lack of economic growth in international markets has been a concern of investors and central banks alike. 2016 was a year of drastic measures to stimulate economies suffering from deflation. Central banks even went as far as to lower rates to below 0%. Worries about slowing growth in China spooked many investors away from the continent as a whole. Nationalism rose around the world, first with Brexit then with the election of Donald Trump, resulting in uneasy relationships with long-time allies, mainly continental Europe.

The Dutch elections broke the trend as voters steered away from the populism that had overtaken much of the western world. France, too, will have their moment of truth as Marine le Pen hopes to take la Patrie down the same path as the U.S. and U.K.

Yet, economically speaking, 2017 is shaping up to be much different than the last few years for international markets. Europe is showing signs of being in an early stage of an expansion cycle. The German Bund followed the U.S. Treasury higher to escape from negative yields and inflation in the U.K. is reaching targets set by the Bank of London.

With the United States leading the world in a rising-interest-rate environment, we can expect the dollar to maintain its strength among its peers. It’s because of this we’ve been adding exposure to various international markets to take advantage of both growing economies and our own domestic strength. As the economic leader of continental Europe, Germany has been an attractive avenue of growth. Germany is still experiencing trouble with its European counterparts, particularly ongoing struggles with Greece adhering to agreed-upon austerity measures. On the other hand, Spain and Portugal are showing signs of strength and their governments are bringing sovereign debt levels more in line with regulations set by the European Commission. Uncertainty around the Brexit has kept us away from the U.K. as global markets are assessing the impacts of removing one of the largest trading partners from the European Union.

In February 2017, Chinese imports were greater than in February 2016, even though exports were down. This is because China is moving from an export-driven economy to an import-focused economy fueled by domestic demand. This not only helps the United States’ balance sheet but also smaller, export driven economies around the world.

Global industrial indicators have consistently surprised to the upside since last fall, with Purchasing Managers Index (PMI) in Europe and China hitting multi-year highs, largely as a result of policy action. We'd be surprised if this momentum is sustained for the whole year, but the outlook for the next couple of quarters is favorable as a driver for short term stock market performance. Buoyed by rises in commodity prices and increased demand from developed nations, emerging markets have been some of the fastest growing markets in 2017. We’re adding to our position through a variety of ETFs (exchange traded funds) to take advantage of multi-national growth.

Fueling Clean Growth

After the election, there was uncertainty about the future of renewable energy and its prospects for growth. It’s no secret that the Republicans have a more favorable view of the oil, gas, and coal industries than the Obama administration had. Trump’s focus on rolling back to the good old days while pandering to his base is a tax on our environment. Coal should continue to lose share in the U.S. even after regulations are lifted. It’s important to recognize that coal faces several challenges that deregulation won’t fix. Numerous technology improvements have compelled many U.S. power plants to make the switch from coal.

Saudi Arabia, the almost literal king of oil, is set to invest billions of dollars in renewable energy. Its hope is to export more of its oil and save money at the same time, a double benefit for an oil-exporting country. The price of renewables keeps falling and the price of oil remains relatively stagnant, regardless of OPEC’s efforts. The ongoing price battle between old and new keeps us from investing too heavily in energy of both sorts.

First I Was Afraid, I Wasn't Diversified

At the most fundamental level, investment decisions are determined by two factors: risk and return. While investors may have different goals for portfolio returns and varying appetites for risk, the objective is consistent; maximize returns relative to risk. This is best accomplished through diversification, but constructing a portfolio with a variety of assets does not mean this has necessarily been achieved. Correlation is the key. Correlation, in the finance and investment industries, is a statistic that measures the degree to which two securities move in relation to each other. A composition of assets with low or negative correlation is quintessential for effective diversification. The U.S. stock market is comprised of multiple economic sectors, and these sectors may generally move in the same direction as the market over time, but they do not move in unison with one another.

Retail, telecommunication and energy have failed to keep up with bullish market gains in 2017, which was charged by technology and health care sectors. Expectations for a specific company, sector, or industry can be derived from economic indicators, but indicators can be misleading and trends can expire. Investing heavily in areas of large expected gains can produce large profits, but hedging through diversification in a variety of companies and sectors is prudent and necessary.

Diversifying equity investments in international markets is another useful strategy to minimize risk. International growth is often a factor of the region and the size of an economy. Diversifying by regions and by developed vs. developing markets can help achieve gains in a variety of market environments.

In addition, an asset allocation mixed with fixed income and equities is a very effective way to minimize portfolio risk. Typically bull markets move in line with increasing interest rates, and as interest rates increase the value of bonds decrease. During any time period returns can be higher for either fixed income or equity investments, but because of the negative correlation between the investment types, a combination of both assets will significantly minimize volatility in a portfolio.

One or two sectors can drive the gains in any given index, especially if the gains are significant enough. Exposure to those sectors will boost the performance of your portfolio, but because of how indices are weighted, a well-diversified portfolio won’t always keep pace with the markets in the short term. Focusing on month-by-month numbers can be risky. An investment strategy should align with long term goals, not current market trends, and investment goals should be risk-aware. If you’re young and starting your portfolio, by all means, overweight your investments in equities and focus on aggressive growth. You have a lot of time to make up for any negative outcomes from high volatility. If you have an expectation to use your hard-earned savings in the near to intermediate future, your focus should be on risk-adjusted returns and the steadiness of just income. Give us a call to discuss your risk tolerance and investment goals.

Housing Sector Focus

Housing SectorThe numbers continue to reflect steady, slow growth in which sales appear to be restrained by extremely tight inventories. We consider this to be a bullish situation for the new home market, which has been showing signs of improvement in recent months. Sales were up 5.3% year over year, its highest level since September 2007. Regardless of the short-term swings in the number of transactions, the fundamentals point to a decent spring for the housing market. The inventory of existing single family homes for sale stands at a record low of just 3.8 months, seasonally adjusted, compared to the 30-year average of seven months. As a result, prices are rising strongly, with year-over-year gains averaging 6.3%. Even after the post-election increase in 30-year mortgage rates to 4.5%, people who can qualify for a mortgage are heavily incentivized to act. We suspect the rise in mortgage rates will only mildly hurt home sales because many potential home buyers realize that mortgage rates are still at attractively-low levels and will only rise in coming years as the Fed raises interest rates. That means buying a home now is still likely to be a better deal than waiting and paying even higher mortgage rates later. No other asset offers the tax advantage of home ownership. It seems reasonable to assume that had more homes been available more would have been sold, and we are far away from the soaring inventories that accompanied and eventually ended the great housing boom 12 years ago.

New home sales have remained strong in recent months at just slightly below the 9-year high posted in July 2016. For sellers, the turnover rate remains favorable, with the average home staying on the market for just 45 days, and 42% staying on the market less than a month. The question going forward, however, is whether higher mortgage rates will dent new home demand. Home builders are extremely optimistic as seen by the February National Association of Home Builders’ Housing Market Index which reached a new 12-year high. In addition to homebuilder ETFs, we’ve been adding exposure to real estate ETFs for clients’ portfolios.

Even If You're Not a Rockefeller

Charity GivingLast month David Rockefeller, the last grandchild of Standard Oil baron John D. Rockefeller, died at age 101. His death marks a last living link to an age of robber barons-turned-philanthropists whose fortunes still shape our nation. The man that started it all—John D. Rockefeller—started out in 1855 as a 16-year-old assistant bookkeeper in Cleveland, Ohio. By 1911, he controlled 70% of America's oil refining. The Supreme Court eventually broke his company into 34 separate pieces. Those pieces became worth more than the original whole. By the time Rockefeller died in 1937, he was worth the equivalent of $340 billion in today's dollars. The Rockefeller family had always been generous. John D. Rockefeller always made it a point to give away a specific percentage of his monies every year. He endowed the University of Chicago with a nondeductible gift equal to $2 billion in today's dollars. He founded Rockefeller University, the Rockefeller Foundation, and made major gifts to Central Philippine University and Spelman College. Rockefeller’s son, John D. Jr. continued to take advantage of charitable deductions for his own philanthropy. He gave more than half a billion dollars to charity over his life, over double the nearly quarter billion he gave to his own family. He donated the land for New York's Museum of Modern Art and the United Nations headquarters, and gave generously to renovate Colonial Williamsburg in Virginia. Time, taxes, and descendants have whittled down the Rockefeller fortune. Forbes magazine estimates the family is worth "just" $11 billion today. Ironically, two of the family's charitable funds have announced that they will be selling all their fossil fuel investments as part of their commitment to fight climate change. You might not have the riches of the Rockefellers, but we know you want to protect and make the most of your monies. We suggest prudent planning and enriching your soul by doing good for others. Call us to talk about donating appreciated stock to your favorite charity.

Featured Client - Judge Stephen Murphy

Murphy - AlibiKarp Capital would like to congratulate our client Stephen M. Murphy on his recent appointment as a judge to the San Francisco County Superior Court bench. Stephen was an attorney in San Francisco for over 34 years, the last 19 as a sole practitioner representing employees in civil rights litigation. He graduated from the College of the Holy Cross in Worcester, Massachusetts and the University of San Francisco School of Law.

One of Stephen’s most memorable cases ended with a $6.5 million judgment against an employer for discriminating against his client. The accommodations for his client’s agoraphobia were suddenly, and without explanation, terminated, causing the client a nervous breakdown. So far, during his brief tenure on the bench, Stephen has noticed a trend arising from alternative living situations due to the affordability problem plaguing the city. Many San Franciscans are seeking restraining orders against housemates, oftentimes because people are living with several strangers just to afford a place to live.

Outside of his successful legal career, Stephen has also published several books. His published works include both fiction and non-fiction. His first novel, Alibi, is a novel inspired by a murder trial he worked on while clerking for the justices of the New Hampshire Superior Court. The sequel, About Power, features the same protagonist, attorney Dutch Francis. Other works include compilations of interviews with bestselling lawyer novelists and books of photography. Stephen’s books are available on amazon.com and blurb.com.

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Contact Peter

All of us at Karp Capital Management thank you for your continued support. It is a privilege to help you, your family and friends reach financial goals. Please remember that we appreciate your support and we’re flattered when you refer your family and friends. If you know someone that would enjoy our commentary on the market, please share the newsletter with them. If they would like to receive our quarterly commentary please direct them to sign up for the email edition at karpcapital.com/news.

If you have any questions on the analysis above, or would like to review your portfolio’s performance, please call us at 877 900 Karp. We wish you happiness, good health and prosperity in the New Year!

Peter Karp
Peter C. Karp

Karp Capital Management Corporation
Registered Investment Advisor

Mailing Address: 2269 Chestnut St., #308
San Francisco, CA 94123

Office Address: 221 Caledonia St.
Sausalito, CA 94965

P: (415) 345-8185 F:(415) 869-2832
peter@karpcapital.com
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If you no longer wish to receive the Karp Capital Management Financial Focus newsletter, please contact us to be removed from our mailing list. Although information in this document has been obtained from sources believed to be reliable, we do not guarantee its accuracy, completeness or fairness, and it should not be relied upon as such. All opinions and estimates herein, including forecast returns, reflect our judgment on the date of this report and are subject to change without notice. Such options and estimates, including forecast returns, involve a number of assumptions that may not prove valid. Further, investments in international markets can be affected by a host of factors, including political or social conditions, diplomatic relations, limitations or removal of funds or assets, or imposition of (or change in) exchange control or tax regulation in such markets. The past performance of securities or other investments does not necessarily indicate or predict future performance, and the value of investments. This document may not be reproduced without our written consent. Securities offered through Infinity Financial Services, member FINRA/SIPC. Karp Capital Management is not an affiliate of Infinity Financial Services.