Winter 2019

"Prices change when events are different from what the market has expected them to be." - Peter Bernstein

A Recovery Year What a difference a year can make. In our Winter Investor Letter last year, we noted the S&P 500 Index was up nicely for the first three quarters of 2018 before declining over 13% in the fourth quarter resulting in a negative return for all of 2018. In the conclusion to the earlier Investor Letter we believed much of the worst-case scenarios were priced into the market and we expected better returns in 2019. Well, better returns we got and the gains exceeded even our own expectations. For 2019, the S&P 500 Index was up 31.5%. As seen in the chart at right, most asset classes generated very good returns for the year rewarding patient investors.

The return of the S&P 500 can be broken down into three components: earnings growth, the change in the market valuation, and the dividend yield. The chart to the left shows the returns for each of these components for the S&P 500 Index, with the expansion of the forward P/E ratio, inherently a measure of investor sentiment, as the most significant factor contributing to returns last year. S&P 500 Index

earnings growth for 2019 is projected to be 1.1% (companies have yet to report fourth quarter results) and the weighted dividend yield for the S&P 500 for 2019 is 2.3%. The increase in the valuation multiple that investors placed on stocks last year accounted for ~90% of the total return as the forward P/E ratio grew by 28.2% versus the total return of the market of 31.5%. Essentially, the market increase was entirely attributable to a recovery in valuations (S&P 500 P/E Ratio) from the selloff of 2018 as investors dismissed the risk of a near term recession. This is in stark contrast to 2018 where the market experienced high earnings growth, but a large drop in the forward P/E ratio. Perhaps the greatest recovery in 2019 was in investor sentiment.

A Tale of Two Decades The decade that culminated on 12/31/19 proved to be more rewarding for investors than the prior decade. As illustrated in the chart to the right, the S&P 500 Index generated a total return of 256.7% for the decade of 2010’s. This equated to an annualized return of 13.6%. This compares to the “lost decade” of returns for the 2000’s when the S&P 500 Index return was a cumulative negative 8.2%, or a negative 0.92% per year, including dividends. The 2000’s were marked by two crisis periods – the bursting of the technology bubble in 2000 and the onset of the financial crisis in 2007. Both crises resulted in economic recessions. For the first time since the decade of the 1900’s, the U.S. economy did not experience a recession in the most recent decade. The Central Banks are in the Mix Until the financial crisis that began in 2007, the Federal Reserve’s interest rate policy decision was a topic investors and strategists grappled with regularly. The chart at left displays the Fed Funds target interest

rate which appears ever changing until the end of the financial crisis in 2008. At that time the Fed pegged the Fed funds rate near zero and held it at that level until the end of 2015. Beginning at the end of 2015 and ending in late 2018 the Fed increased the Fed Funds rate by 2.25 percentage points in increments of 25 basis points. As the Fed moved toward normalizing interest rates over the course of nearly nine uninterrupted rate increases, the economy and markets began to have difficulty adjusting to the higher rate environment. The trade/tariff issue beginning in 2018 further stressed companies and financial institutions. With an economy that seemed to shift into a slower speed, the Fed paused the rate increases after the December 2018 hike and embarked on three interest rate cuts beginning in August 2019 through October 2019. It

appears that further movement with rates is on hold pending significant strength or weakness in economic data. The U.S Federal Reserve is not alone in pursuing accommodatiive monetary policy. The Bank of Japan (BoJ) announced additional monetary easing measures late last year. This comes on the heels of the European Central Bank (ECB) also pursuing added monetary easing. And finally, on the first trading day of 2020, the People’s Bank of China (PBoC) announced it would reduce the amount of reserves Chinese banks are required to keep on deposit at the PBoC. This will free up funds for additional lending. As is often said in the U.S., “Don’t Fight the Fed.” Now investors might want to change that statement to “Don’t Fight the Central Banks.” With the Central Banks around the world in an easing posture, this type of monetary stimulus will likely have a positive influence on stocks and economies globally. Trade and Brexit

In mid-January a Phase One trade deal is expected to be signed by the U.S. and China. The Phase One trade deal reduces some tariffs placed on Chinese imports while China has agreed to increase the purchase of U.S. products like agricultural and energy goods. The deal also addresses some of the intellectual property right concerns. From a tariff rate perspective, the phase one deal delays the 15% tariffs that had been scheduled to apply to $160 billion worth of Chinese products. Additionally, the deal means the U.S. will reduce the tariff rate by half to 7.5% on $120 billion of goods that was imposed on September 1. While not a permanent agreement, the market has viewed this news positively and we see the trade talks as a step in the right direction. Brexit, short for British exit from the EU, seems to finally be taking shape. The UK originally voted for Brexit in June 2016. Through many fits and starts, it finally seems Brexit will occur. With Parliament deadlock, Prime Minister Boris Johnson called for a special election. In mid-December Johnson/the Conservative party gained a majority in Parliament and subsequently approved the Withdrawal Agreement Bill. If all goes according to plan, the UK will leave the EU on January 31. On the one hand this may cause some market volatility, but on the other, getting past this uncertainty can be positive for the future. Our view has been and continues to be that cooler heads will prevail, and new trade agreements will be written that will benefit all parties. Market Direction Given the sizeable gains in the equity market last year, investor expectations for returns in 2020 might be muted. Historically though, when returns are strong in a given year, in this case greater than 30% for the

S&P 500 Index, on average returns in the subsequent year tend to be positive as well. The chart at right shows the calendar year return following a year where the S&P Index was up greater than 30% going back to 1926. There are eighteen calendar years where this is the case and twelve were positive. The average return for the eighteen years is 11.4%. While not a guarantee, history reminds us of the upward bias in markets and that strength tends to beget strength.

As we note in the first section of our Investor Letter, much of 2019’s gains came from a revaluation of stocks. Looking ahead, we believe further gains in the market will need to be supported by strength in earnings growth. The forward expectation for S&P 500 earnings growth is for ~9% in 2020. While expectations tend to be reduced as the year progresses, an acceleration of company earnings should be positive for stock prices. Market prices are impacted when unexpected events occur. With some trade issues still on the table, Brexit yet to be resolved, this being an election year, and the conflict with Iran, events may occur that likely result in the equity market not rising in a straight line. With risk, also comes opportunity. A market pullback would not surprise us and, given our view of a continued expansion, would likely serve as an opportunity for investors to add to positions at lower prices. Thank you for your continued confidence in HORAN Capital Advisors. Please be sure to visit us at www.horancapitaladvisors.com and our blog at www.horancapitaladvisors.com/blog for periodic market commentary. Kindest regards, HORAN Capital Advisors HORAN Capital Advisors, LLC is an SEC Registered Investment Advisor.

The information herein has been obtained from sources believed to be reliable, but we cannot assure its accuracy or completeness. Neither the information nor any opinion expressed constitutes a solicitation for the purchase or sale of any security. Any reference to past performance is not to be implied or construed as a guarantee of future results. Market conditions can vary widely over time and there is always the potential of losing money when investing in securities. And its affiliates do not provide tax, legal or accounting advice. This material has been prepared for informational purposes only, and is not intended to provide, and should not be relied on for tax, legal or accounting advice. You should consult your own tax, legal and accounting advisors before engaging in any transaction.