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Valuations, Stock Returns & Interest Rates. June 10, 2017

Before I begin, I thought I’d include a longish quote from The Oracle, to lend perspective –

“Let’s start by defining ‘investing.’ The definition is simple but often forgotten: Investing is laying out money now to get more money back in the future – more money in real terms after taking inflation into account.

Now, to get some historical perspective, let’s look back at the 34 years – to observe what happened in the stock market. Take, to begin with, the first 17 years of the period, from the end of 1964 through 1981. Here’s what took place in that interval:

  • DOW JONES INDUSTRIAL AVERAGE Dec. 31, 1964: 874.12, Dec. 31, 1981: 875.00.

Now I’m known as a long-term investor and a patient guy, but that is not my idea of a big move.

To understand why that happened, we need first to look at one of the two important variables that affect investment results: interest rates. These act on financial valuations the way gravity acts on matter: The higher the rate, the greater the downward pull. That’s because the rates of return that investors need from any kind of investment are directly tied to the risk-free rate that they can earn from government securities. So, if the government rate rises, the prices of all other investments must adjust downward, to a level that brings their expected rates in line.

The increase in equity values since 1981 beats anything you can find in history.” – Warren Buffett in 1999

It sure seems there is a lot of investing wisdom in that quote, right?

Inflation/Interest rates generally headed higher between 1964 and 1981 before Paul Volker, Chairman of the Federal Reserve, started to drop the hammer on inflation in October 1979 and doubled the Fed Funds rate over the next 4 months.  In the 2 years following, inflation rates fell from over 14% to under 5%, and the Fed Funds rate fell from 19% to under 9%, setting up the greatest and most enduring bull run in history.

For clarity, Blue is the effective Fed Funds rate, red is inflation, green is the stock market in the form of the Wilshire 5000.  The impact of lowered interest rates is pretty clear.

Nice to know, but what can that do for me today?

Here’s a more recent Buffett quote – “Measured against interest rates, stocks are actually on the cheap side compared to historic valuations.  But the risk always is interest rates go up, and that brings stocks down.”

How? You might be asking. We’ll get to that in a minute.  But first, was Buffett just blowing smoke?  After all, words are one thing, action another.

Buffett spent around $18 billion on Apple stock in the last year and a half.  That’s a reasonable bet on where he sees interest rates going, at least in the next few years.

I happen to agree.  As I’ve said several times, my view is lower rates for longer.  For interest rates to approach historical averages (Y Charts says that’s 6.1% on the 10-year Treasury) the economy must strengthen.  A lot.

In my view, GDP growth would basically need to double.  I just don’t see any way that can happen in the near term.  So, lower for longer.  My best guess right now is 5 years (or more) below a 3.5% Federal Funds rate, and about the same before we see a 10-year Treasury above 5%.

So, are stocks overvalued?  Some of them, yes.  Some not.  But interest rates are just above historical lows, and that’s supportive of the stock market.

Exactly how do lower interest rates have such an impact on stock valuations?

There are many formulas and concepts available to understand the value of a stock and the impact of interest rates, but as we are looking at things through the lens of Buffett’s tremendous investing brain, let’s use one of the concepts near and dear to his heart – the quick and dirty intrinsic value formula of his chief mentor, Ben Graham.

V = EPS x (8.5 +2g) x 4.4 /  Y

V = Intrinsic Value

EPS = the company’s most recent 12 month earnings per share

8.5 = the appropriate PE ratio of a company that expects 0 growth

g  = the long term (five years) growth estimate

4.4 = the average of high grade corporate bonds in his era (3.6% in our era)

Y = the current yield on 20-year AAA corporate bonds (we’re going to use 10 year Treasuries at 2.2%)

 

Let’s have a look at Apple with current interest rates in play, speculating they will endure for at least a few years more.

Apple EPS = $8.57

Apple consensus 5-year earnings growth (“g”) = 10.12%

3.6% average yield high grade corporate bonds

2.2% 10-year Treasury yield

V = 8.57 x (8.5 + 2(10.12)) x 3.6 / 2.2

= $403.04 projected intrinsic value.

 

The notion here is that at some point, ideally in about 5 years, Apple’s price will reflect its intrinsic value.  There is no doubt in my mind this number was part of Buffett’s process in deciding to buy Apple.  However, it was assuredly NOT the only part.

Even Graham said that this simplified formula shouldn’t be used as the only criteria to decide to invest/not invest, but it is an informative tool to show what can happen to stocks when interest rates rise (or fall).

Now, let’s have a look at see what impact rising interest rates might have on Apple’s intrinsic value.  Let’s use the 6.1% historical 10-year rate from Y Charts.  Let’s pretend investment grade corporate bonds are yielding 1.4% more than Treasuries, just as today.

Apple EPS = $8.57

Apple consensus 5-year earnings growth (“g”) = 10.12%

7.5% average yield high grade corporate bonds

6.1% 10-year Treasury yield

V = 8.57 x (8.5 +2(10.12)) x 7.5 / 6.1

= $302.83 projected intrinsic value, a value reduction of 25%!

 

It’s clear interest rates can have a tremendous impact on stock value.

It’s also clear why Buffett was comfortable spending $18 billion on Apple stock at around $100 per share.

Lastly, it’s an unambiguous statement about his expectations for interest rates, at least for the next several years.

Will he be right?  I certainly hope so.  I’ve been on the same page as Buffett a couple times (Precision Cast Parts and Apple) and it would be great if we were both right here, too.

In sum, with interest rates very low on a relative basis, growing earnings, and no recession currently on the horizon the market can be expected to move higher over the intermediate term (2 – 5 years) – which probably means investors will get more money back in the future in return for dollars invested today.

That doesn’t mean the market is going up tomorrow – I’m about as good at predicting where the market will be 6 months or a year from now as Buffett, which means marginal to no good (barring recession).  But current conditions still favor stocks over bonds.  That is likely to continue until conditions change.

Please share with one friend that can benefit from this information.  Share buttons below for your convenience. 

To Smarter Investing,

Dak

Market Strategist

ACI Wealth Advisors, LLC.

Process Portfolios, LLC. 

This is an illustration and is not a recommendation to buy Apple.  Price paid has an impact on expected returns, and the Graham Formula is just one of many ways to evaluate a stock investment.  ACI uses nearly 2 dozen investment/financial models and several modes of research to identify and evaluate stocks for the Durable Opportunities Portfolio.    Disclosure: ACI owns Apple in the Durable Opportunities Portfolio.

© Copyright 2015
Dak Hartsock

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Dak Hartsock; Investment manager with over 15 years of experience with securities & securities options. Dak has worked full time in the financial markets since 2007. He has more than a decade of operating experience as a business owner & developer, with substantially all personal net worth invested in ACI. He is a graduate of the University of Virginia.

Robert Hartsock; MBA. Bob has over 30 years of senior management experience in diverse markets, products and businesses. He brings an exceptional record that includes management roles in two Fortune 500 companies and leadership of 7,500+ employees. Bob’s career features a specialization in identifying and fixing management and operational problems for multiple companies including leading over a dozen acquisitions, private placements and a public offering. He is uniquely positioned to provide ACI with highly relevant C-Level management perspective. Bob provides operational & macro perspective on investments ACI undertakes for client portfolios. Bob holds degrees from University of Illinois and University of Washington.

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Market Income Portfolio
1. The performance of the broad market over the same time periods is included for both model and live portfolio to help investors understand market conditions present during the period examined by the model and during live investment.
2. Listed Index models and graphs do NOT include transaction, fund or Advisor Management fees as the index model is not available for investment. Live portfolio results include all fees, including Advisor Management fees.
3. Model results do NOT reflect reinvestment of dividends or other earnings. Actual results reflect limited reinvestment of dividends and other earnings, but do not reflect the impact of any applicable taxes which vary by investor and account type (deferred account vs. taxable, etc.).
4. Investing involves risk, including risk of loss and/or principle. While the Index model has historically shown reasonable performance versus the S&P 500 on a risk adjusted basis, there is no guarantee that will continue into the future. Market Income is designed to provide reasonable returns for less risk than the broad market on a risk adjusted basis, and while the firm believes model portfolios are capable of continued outperformance on this basis, there is no guarantee they will do so. Comparisons with the S&P 500 are included to help the average investor understand how an investment in Market Income may differ from investment in an index fund such as an S&P 500 index fund.
5. The model for Market Income is the Chicago Board of Exchange S&P 500 Buy/Write Index or “BXM.” BXM has historically displayed less volatility than the S&P 500 and Market Income. BXM cannot be directly invested in. Market Income does not exactly follow the BXM index model – the mechanics of closing and opening positions differ – BXM opens, closes or rolls positions on the same day every month regardless of the profit or loss in a position – Market Income generally, but not always, waits until after expiration before transacting. Market Income will also close or roll ahead of expiration if the position has a high percentage of profit present in order to capture that gain. Options are generally sold again within a week of the closure of the prior position, but not always, and often new position may be opened the same day the prior position is closed.
Benchmark and index comparisons are made on a best available basis – meaning that both the index model and live performance are believed to be compared with market and the closest possible benchmark for simplicity of comparison. However, there is no guarantee future volatility will be either less than, equal to, or greater than the volatility experienced in the model or the S&P 500 although the firm invests with an eye on reduced volatility vs. the S&P 500.
6. The model portfolio (BXM) utilizes the S&P 500 as its basis. Market Income differs from BXM in that the underlying securities are primarily selected on the basis of “relative” value. This simply means that sectors are compared with one another and Market Income generally invests in the sector or sector(s) trading at the greatest discount or the smallest premium relative to its historical average valuation. Other factors are also considered including sector earnings growth and expected return versus other available sector instruments. Advisor believes this gives Market Income a higher margin of safety than repeatedly investing in the S&P 500 on a rolling basis without regard to value or prevailing economic conditions, while preserving liquidity.
7. The BXM model on which Market Income is based is a non-traded index. As such, results do not represent actual trading or investment and do not reflect any impact that material economic or market factors may have had on the advisors decision making if advisor had been managing live money during the period the model covers, including transaction, fund, or management fees.
8. Market Income also differs from the BXM model in that Market Income seeks to reduce investment during recessionary economic periods while BXM stays invested regardless of economic or market conditions. Advisor believes this will better protect capital vs. BXM model but is materially different than staying invested in all market conditions. This action may cause Market Income to have reduced participation in markets that continue to move up despite Advisors reduction in investment.
9. Advisor clients have experienced results that exceed the performance of the model to date. There is no guarantee Market Income will continue to outperform BXM in the future regardless of Advisor efforts to do so.

Core Equity Portfolio
1. The performance of the broad market over the same time periods is included for both model and live portfolio to help investors understand market conditions present during the period examined by the model and during live investment.
2. Model is a historical back test and includes brokerage and fund fees but does NOT include Advisor Management fees which vary by account size, but in general reduce annual performance by approximately 1.5%. Live portfolio results include all fees, including Advisor Management fees.
Historical back-test means the model portfolio has been tracked on a backwards looking basis prior to the beginning of live investments in order to establish historical risks and results for investment in this portfolio. Back testing has certain inherent limitations as detailed in item #7 below.
3. Model results reflect regular investment of dividends or other earnings. Actual results reflect limited reinvestment of dividends and other earnings.
4. Investing involves risk, including risk of loss and/or principle. While the back tested Core Equity model has historically shown desirable performance versus the S&P 500 on a risk adjusted basis, there is no guarantee that will continue into the future. Core Equity is designed to provide reasonable returns for the same or less risk than the broad market on a risk adjusted basis, and while the firm believes model portfolios are capable of continued outperformance on this basis, there is no guarantee they will do so. Comparisons with the S&P 500 are included to help the average investor understand how an investment in Core Equity may differ from investment in an index fund such as an S&P 500 index fund.
5. The model for Core Equity is built of highly diversified, highly liquid sector and index securities, most frequently low cost ETFs. Core Equity live portfolios do not exactly follow the Core Equity model – variances in investor contributions, withdrawals, and risk tolerances result in measurable drift from the model. Over time, client accounts come closer in line with the Core Equity model.
Core Equity live portfolios may differ from the Core Equity model in an additional material way; when valuations on certain sectors become overly stretched versus their historical average valuations, the Advisor may reduce exposure to those sectors in favor of a sector position which is priced in a more reasonable range in comparison to it’s typical historical valuation. Periodically, Core Equity may allocate a small but measurable percent of assets (up to 5%) in volatility linked instruments in an effort to better manage the portfolio.
These factors may result in greater or less than model performance over time.
Benchmark and index comparisons are made on a best available basis – meaning that both the index model and live performance are compared with market and other benchmarks the
Advisors believe to be suitable for simplicity of comparison. However, there is no guarantee future volatility or performance will be either less than, equal to, or greater than the volatility or performance experienced in the model or the S&P 500 although the firm invests with an eye on reduced volatility vs. the S&P 500.
6. Core Equity invests in diversified components of the financial markets and broad economy by targeting sectors or indices which demonstrate potential for a consistent range of multi-year returns, while seeking a risk adjusted investment profile equal to or lower than the broad markets. These sectors contain a range of equity stocks with an equally broad range of characteristics – some sectors are present in the Core Equity portfolio due to their historically defensive nature, some are present due to their historical growth characteristics, some are a blend of the spectrum between. The intent is to provide a balanced equity portfolio suitable for most investors as an S&P 500 index fund replacement but which seeks lower risk while experiencing, on average, a greater return than an S&P 500 index investment.
7. The Core Equity model results do not represent actual trading or investment and do not reflect any impact that material economic or market factors may have had on the advisors decision making if advisor had been managing live money during the period the model covers, including transaction, fund, or management fees as detailed above in item #2.
8. Core Equity live portfolios also differ from the Core Equity model in that Core Equity seeks to reduce investment during recessionary economic periods while the Core Equity historical model stays invested regardless of economic or market conditions. Advisor believes this will better protect capital vs. model but is materially different than staying invested in all market conditions. This action may cause Core Equity live portfolios to have reduced participation in markets that continue to move up despite Advisors reduction in investment.
9. Advisor clients have experienced results that slightly lag the performance of the model to date. This lag is due to a number of factors, primarily the fact that different clients allocate different dollar amounts to Core Equity at different times. In general, the longer a client has been fully allocated to the Core Equity portfolio, the closer it is to model performance.
The benchmark for Core Equity (The S&P 500) has historically displayed greater volatility (risk) than the Core Equity model or live Core Equity portfolios. This may or may not be the case in the future.

Market Momentum Portfolio
1. The performance of the broad market over the same time periods is included to help investors understand market conditions present during the period covered by live investment.
2. Listed comparison Index graphs and statistics do NOT include transaction, fund or Advisor Management fees. Live portfolio results include all fees, including Advisor Management fees.
3. Actual results reflect limited reinvestment of dividends and other earnings, but do not reflect the impact of any applicable taxes which vary by investor and account type (deferred account vs. taxable, etc.).
4. Investing involves risk, including risk of loss and/or principle. While the closest benchmark for Market Momentum has historically shown reasonable performance versus the S&P 500 on a risk adjusted basis, there is no guarantee that Market Momentum that will continue such performance into the future. Market Momentum is designed to provide reasonable returns for less risk than the broad market on a risk adjusted basis, and while the firm believes the portfolio is capable of outperformance on this basis, there is no guarantee it will do so. Comparisons with the S&P 500 are included to help the average investor understand how an investment in Market Momentum may differ from investment in an index fund such as an S&P 500 index fund.
5. The closest benchmark for Market Momentum is the Chicago Board of Exchange S&P 500 Buy/Write Index or “BXM.” BXM has historically displayed less volatility than the S&P 500 and Market Income. BXM cannot be directly invested in. Market Momentum differs in key ways from BXM – the mechanics of closing and opening positions differ – BXM opens, closes or rolls positions on the same day every month regardless of the profit or loss in a position – Market Momentum targets closing or rolling positions based on technical factors including trend support and resistance. Market Momemtum will also close or roll ahead of expiration if the position has a high percentage of profit present in order to capture that gain. Options are generally not sold again until the underlying investment has moved into an area of resistance but not always; new position may be opened the same day the prior position is closed.
Benchmark comparisons are made on a best available basis – meaning that live performance is believed to be compared with the closest possible benchmark for simplicity of comparison. However, there is no guarantee future volatility will be either less than, equal to, or greater than the volatility experienced in the model or the S&P 500 although the firm invests with an eye on reduced volatility vs. the S&P 500. Market Momentum , like BXM, is an options writing strategy seeking to reduce investment volatility and improve risk adjusted returns for investors.
6. The model portfolio (BXM) utilizes the S&P 500 as its basis. Market Momentum differs from BXM in that the underlying securities are primarily selected on the basis of “relative” value. This simply means that sectors are compared with one another and Market Momentum generally invests in the sector or sector(s) trading at the greatest discount or the smallest premium relative to its historical average valuation. Other factors are also considered including sector earnings growth and expected return versus other available sector instruments. Advisor believes this gives Market Momentum a higher margin of safety than repeatedly investing in the S&P 500 on a rolling basis without regard to value or prevailing economic conditions, while preserving liquidity.
7. The BXM model on which Market Momentum is compared is a non-traded index. As such, results do not represent actual trading or investment and do not reflect any impact that material economic or market factors may have had on the advisors decision making if advisor had been managing live money during the period the model covers, including transaction, fund, or management fees.
8. Market Momentum also differs from the BXM model in that Market Momentum seeks to reduce investment during corrective or recessionary economic periods while BXM stays invested regardless of economic or market conditions. Advisor believes this will better protect capital in comparison to BXM but such action is materially different than staying invested in all market conditions. This action may cause Market Momentum to have reduced participation in markets that continue to move up despite Advisors reduction in investment.
9. Advisor clients have experienced results that exceed the performance of the benchmark to date. There is no guarantee Market Momentum will continue to outperform BXM in the future regardless of Advisor efforts to do so.

Durable Opportunities Portfolio
1. The performance of the broad market in the form of the Dow Jones Industrial Index over the same time periods is included for live portfolio comparison to help investors understand market conditions present during the period covered by live investment.
2. The Index results do not include brokerage, transaction, or Advisor fees. Live portfolio results include all fees, including Advisor Management fees.
3. Actual results reflect limited reinvestment of dividends and other earnings.
4. Investing involves risk, including risk of loss and/or principle. Portfolios compromised of companies matching the profile of those selected for including in Durable Opportunities have historically displayed superior risk adjusted performance to the Index, but there is no guarantee that will continue into the future. Durable Opportunities is designed to provide investment in companies that firm believes meet a stringent set of criteria firm believes reduces the likelihood of permanent capital impairment while allowing investors to participate in investment in companies firm believes will stand the test of time and provide superior long term returns. While the firm believes the portfolio is capable of outperformance on this basis, there is no guarantee it will do so. Comparisons with the Dow Jones are included to help the average investor understand how an investment in Durable Opportunities may differ from investment in a concentrated index fund such as a Dow Jones Industrials index fund. Durable Opportunities is not restricted to investment in industrial companies or in companies with a specific level of capitalization, unlike the Dow Jones.
5. Durable Opportunities is primarily a value driven strategy; when valuations in holdings become overly stretched versus their historical average valuations, the Advisor may reduce exposure to those holdings by either liquidation or hedging, and may re-allocate funds into a holding which is priced in a more reasonable range in comparison to it’s typical historical valuation. Periodically, Durable Opportunities may allocate a small but measurable percent of assets (up to 5%) in volatility linked instruments in an effort to better manage the portfolio.
Benchmark comparisons are made on a best available basis – meaning that live performance is compared with the benchmarks the firm believe to be suitable for simplicity of comparison. However, there is no guarantee future volatility or performance will be either less than, equal to, or greater than the volatility or performance experienced in the Dow Jones Industrials although the firm invests with an eye on reduced volatility vs. the Dow Jones Industrials Index. 6. Durable Opportunties invests in companies firm believes to possess a Durable Competitive Advantage. Such companies are likely to be around for decades, easing the concern of principal return. DCA companies often suffer less in bear markets and usually lead recoveries. These companies allow ACI to build portfolios with minimum expected returns that may be in the mid-single digit range over any 3-5 year period which may provide long term stability partnered with long term growth in equity. There are no guarantees the strategy will be successful in this endeavor.
6. The Durable Opportunities portfolios also differ from the benchmark comparison in that Durable Opportunities reduce investment by hedging or raising cash during recessionary economic periods while Dow Jones Industrial Index reflects 100% investment at all times regardless of economic or market conditions. Firm believes this will better protect capital vs. model but is materially different than staying invested in all market conditions. This action may cause the Durable Opportunities portfolio to experience reduced participation in markets that continue to move up despite Advisors reduction in investment.
7. Advisor clients have experienced results that have lagged the performance of the benchmark to date. This lag is due to a number of factors, primarily the fact that the current high valuation investing environment has made it difficult to identify companies that fit the parameters of Durable Opportunities at a desirable valuation level. Different clients allocate different dollar amounts to Durable Opportunities at different times, which has also impacted the performance of the overall portfolio.

Full Cycle Portfolio
1. The performance of the broad market over the same time periods is included for both model and live portfolio to help investors understand market conditions present during the period examined by the model and during live investment.
2. Model is a historical back test and includes brokerage and fund fees but does NOT include Advisor Management fees which vary by account size, but in general reduce annual performance by approximately 1.5%. Live portfolio results include all fees, including Advisor Management fees.
Historical back-test means the model portfolio has been tracked on a backwards looking basis prior to the beginning of live investments in order to establish historical risks and results for investment in this portfolio. Back testing has certain inherent limitations as detailed in item #7 below.
3. Model results reflect regular investment of dividends or other earnings. Actual results reflect limited reinvestment of dividends and other earnings.
4. Investing involves risk, including risk of loss and/or principle. While the back tested Full Cycle Portfolio model has historically shown desirable performance versus the S&P 500 on a risk adjusted basis, there is no guarantee that will continue into the future. Full Cycle Portfolio is designed to provide reasonable returns for the same or less risk than the broad market on a risk adjusted basis in all phases of the economic cycle by holding risk weighted non-correlated assets, and while the firm believes model portfolios are capable of continued outperformance on this basis, there is no guarantee they will do so in the future. Comparisons with the S&P 500 are included to help the average investor understand how an investment in the Full Cycle Portfolio may differ from investment in an index fund such as an S&P 500 index fund.
5. The model for the Full Cycle Portfolio is built of diversified, liquid sector and index securities, most frequently low cost ETFs and low cost funds. The live Full Cycle portfolio does not follow the Full Cycle model exactly – variances in investor contributions & withdrawals result in measurable drift from the model. Over time, client accounts come closer in line with the Full Cycle model.
Full Cycle live portfolios may differ from the Full Cycle model in an additional material way; when valuations on certain sectors become overly stretched versus their historical average valuations, the Advisor may reduce exposure to those sectors in favor of a comparable position which is priced in a more reasonable range in comparison to it’s typical historical valuation.
These factors may result in greater or less than model performance over time.
Benchmark and index comparisons are made on a best available basis – meaning that both the index model and live performance are compared with market and other benchmarks the
firm believes to be suitable for simplicity of comparison. However, there is no guarantee future volatility or performance will be either less than, equal to, or greater than the volatility or performance experienced in the model or the S&P 500 although the firm invests with an eye on reduced volatility vs. the S&P 500.
6. Full Cycle invests in diversified components of the global financial markets and broad economy by balancing risks with non-correlating or reduced correlation assets in opposition to one another each of which is designed to prosper in some phase of the economic cycle and intended to offset reduced or poor performance in other portfolio holdings.
7. The Full Cycle model results do not represent actual trading or investment and do not reflect any impact that material economic or market factors may have had on the advisors decision making if advisor had been managing live money during the period the model covers, including transaction, fund, or management fees as detailed above in item #2.
8. Full Cycle live portfolios also differ from the Full Cycle model in that the live portfolio may be rebalanced more or less frequently depending on prevailing market conditions. While firm believes this difference positions portfolio for improved risk adjusted performance, it is not clear that this difference results in clear over or under performance versus the Full Cycle model.
9. Advisor clients have experienced results that slightly outperform the performance of the model to date. This outperformance may or may not persist. In general, the longer a client has been fully allocated to the Full Cycle portfolio, the closer it is to model performance.

Fixed Income Portfolio
1. The performance of the broad bond markets over the same time periods is included to help investors understand market conditions present during the period covered by live investment.
2. Listed comparison Index graphs and statistics do NOT include transaction, fund or Advisor Management fees. Live portfolio results include all fees, including Advisor Management fees.
3. Actual results reflect limited reinvestment of dividends and other earnings, but do not reflect the impact of any applicable taxes which vary by investor and account type (deferred account vs. taxable, etc.).
4. Investing involves risk, including risk of loss and/or principle. While the closest benchmark for Fixed Income has historically shown reduced volatility and reasonable performance versus many classes of fixed income investments, there is no guarantee that Fixed Income that will continue such performance into the future. Market Momentum is designed to provide reasonable returns for less risk than the broad market on a risk adjusted basis, and while the firm believes the portfolio is capable of outperformance on this basis, there is no guarantee it will do so. Comparisons with US Aggregate Bond Market and PIMCO Total Return are included to help the average investor understand how an investment in Fixed Income may differ from investment in an alternative index or fixed income fund.
5. The closest benchmark for Fixed Income is the Pimco Total Return Fund. Fixed Income differs in key ways from BOND – including selection of underlying investments and reduced diversification. Benchmark comparisons are made on a best available basis – meaning that live performance is believed to be compared with the closest possible benchmark for simplicity of comparison. However, there is no guarantee future volatility and performance will be either less than, equal to, or greater than the volatility and performance experienced by the benchmark although the firm invests with an eye on out performance.
6. The benchmark may include securities not contained in Fixed Income, and vice versa. Fixed Income currently holds significantly more cash than PIMCO Total Return Fund, a situation likely to continue in the near future. This action may cause Fixed Income to have reduced participation in markets that move up despite Advisors reduction in investment.
7. Advisor clients have experienced results that lag the performance of the benchmarks to date. There is no guarantee Fixed Income will continue to outperform benchmarks in the future regardless of Advisor efforts to do so.

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