November 26, 2018

“Many shall be restored that now are fallen and many shall fall that are now in honor.” - Horace

When Roman lyric poet Horace wrote this famous passage over 2000 years ago, he was actually commenting on the use of words themselvesi. However this observation pertains to many things in life including the movement of stocks within the stock market. Of course, ‘many’ does not mean all (for either the popularity of stocks or words). However, the stock market data on the next page shows that his statement accurately captures the collective experience for groups like ‘value’ vs. ‘growth,’ and large caps vs. small caps.

Before we get into the historical market data, I want to provide commentary that may aid your review and awareness of some common investor mistakes. As you know, the various segments of the market do not move in lock-step. There are always segments that are performing relatively well as well as those that can at times draw scorn and ridicule from investors. The question is how can we as investors capture the favorable returns and avoid too much exposure to the segments that prove costly to own? There are no easy answers but studies reveal that in the aggregate investors and most active managers realize returns that are below the appropriate benchmark(s) (usually one or more market indexes) to which their results should be measured against. I believe the primary reason that this tendency persists is due to the fact that investors often chase performance. In other words, they figure out what segments (or individual stocks or industries, etc.) are doing well and allocate accordingly. This approach can clearly work as long as the trends that drew them into those segments remain intact. That can be an extended time, but as the data will show, there is a strong tendency for the best to become nearly the worst and vice versa.

Often it is not that the companies that investors love turn into lousy businesses. Rather, it is more likely that the winners decline because their valuation significantly adjusts from being unsustainably too high to much less so. On the other hand, the dogs often don’t become great businesses but they may re-price from ‘going out of business, all sales are final’ to ‘it looks like they are going to be okay again.’

Most of the time, the S&P 500 has a price to earnings (PE) ratio between 8x on the low side to 30x on the high side. For simplicity sake let’s tighten those bands to 10x to 25x. Ignoring any change in earnings, if the market goes from being priced at 10x earnings to 25x then each $1.00 invested grows to $2.50. Conversely going the other way means that each $1.00 shrinks to $.40 (a decline of 60%).ii We believe that if you initiate your purchases when the broad market trades above 20x (let alone 25x) that it is unlikely that you will enjoy strong returns and more likely that your returns will be sub-par. Conversely if you invest at 12x, you might very well experience a decline in value initially, but the likelihood of realizing favorable returns over the long-term is quite high. Of course when you factor in growth in the market’s aggregate earnings, cumulative increases in share price can be quite large. That is why we like to pay reasonable prices and then largely ‘let the winners run.’ However, a combination of strong earnings growth and significantly increased valuation can also cause investors to become overly confident and make purchases at very lofty valuations. Now let’s look at some historical data to see how different segments have performed over time both on an absolute basis and relative to other market segments.

The table below shows the performance for several major U.S. indices. In the top half the data show the returns for the S&P 500 growth and value, the Russell Midcap growth and value and the Russell 2000 (small cap) growth and value from year end 1987 through year end 2002. The bottom half shows the annual performance for these same indices from year end 2002 through year end 2017 (e.g. 15 years each). All figures in red indicate years when the growth sleeve underperformed the value sleeve.

Index name 12/31/88 12/31/89 12/31/90 12/31/91 12/31/92 12/31/93 12/31/94 12/31/95 12/31/96 12/31/97 12/31/98 12/31/99 12/31/00 12/31/01 12/31/02

S&P 500 Growth Index 11.95 36.40 0.20 38.37 5.06 1.67 3.13 38.13 23.97 36.53 42.16 28.25 -22.08 -12.73 -23.59 S&P 500 Value Index 21.68 26.13 -6.85 22.56 10.52 18.61 -0.64 36.99 21.99 29.98 14.67 12.72 6.08 -11.71 -20.85

S&P 500 growth - value -9.73 10.27 7.05 15.81 -5.46 -16.94 3.77 1.14 1.97 6.55 27.48 15.52 -28.16 -1.02 -2.73

Russell Mid Growth 12.92 31.48 -5.13 47.03 8.71 11.19 -2.16 33.98 17.48 22.54 17.86 51.29 -11.75 -20.15 -27.41 Russell Mid Value 24.61 22.70 -16.08 37.92 21.68 15.62 -2.13 34.93 20.26 34.37 5.08 -0.11 19.18 2.33 -9.64

Russ Mid growth - value -11.69 8.78 10.95 9.11 -12.97 -4.43 -0.03 -0.95 -2.78 -11.83 12.78 51.40 -30.93 -22.48 -17.77

Russell 2000 Growth 20.37 20.17 -17.41 51.19 7.77 13.37 -2.43 31.04 11.26 12.95 1.23 43.09 -22.43 -9.23 -30.26 Russell 2000 Value 29.47 12.43 -21.77 41.70 29.14 23.77 -1.54 25.75 21.37 31.78 -6.45 -1.49 22.83 14.02 -11.43

Russ 2000 growth - value -9.10 7.74 4.36 9.49 -21.37 -10.40 -0.89 5.29 -10.11 -18.83 7.68 44.58 -45.26 -23.25 -18.83

Index name 12/31/03 12/31/04 12/31/05 12/31/06 12/31/07 12/31/08 12/31/09 12/31/10 12/31/11 12/31/12 12/31/13 12/31/14 12/31/15 12/31/16 12/31/17

S&P 500 Growth Index 25.66 6.13 4.90 11.01 9.13 -34.92 31.57 15.05 4.65 14.61 32.75 14.89 5.52 6.89 27.44 S&P 500 Value Index 31.79 15.71 7.41 20.80 1.99 -39.22 21.18 15.10 -0.48 17.68 31.99 12.36 -3.13 17.40 15.36

S&P 500 growth - value -6.13 -9.57 -2.51 -9.79 7.13 4.30 10.40 -0.05 5.14 -3.07 0.77 2.53 8.66 -10.51 12.08

Russell Mid Growth 42.71 15.48 12.10 10.66 11.43 -44.32 46.29 26.38 -1.65 15.81 35.74 11.90 -0.20 7.33 25.27 Russell Mid Value 38.07 23.71 12.65 20.22 -1.42 -38.44 34.21 24.75 -1.38 18.51 33.46 14.75 -4.78 20.00 13.34

Russ Mid growth - value 4.64 -8.23 -0.55 -9.56 12.85 -5.88 12.08 1.63 -0.27 -2.70 2.28 -2.85 4.58 -12.67 11.93

Russell 2000 Growth 48.54 14.31 4.15 13.35 7.05 -38.54 34.47 29.09 -2.91 14.59 43.30 5.60 -1.38 11.32 22.17 Russell 2000 Value 46.03 22.25 4.71 23.48 -9.78 -28.92 20.58 24.50 -5.50 18.05 34.52 4.22 -7.47 31.74 7.84

Russ 2000 growth - value 2.51 -7.94 -0.56 -10.13 16.83 -9.62 13.89 4.59 2.59 -3.46 8.78 1.38 6.09 -20.42 14.33 Source: Vanguard (VIFI) Figures in red indicate that 'growth' underperformed 'value'

The table immediately below shows the growth of $1.00 for each of these indices over select time frames. The first period is the 15 years 1988 through 2002, then the next 15 years, 2003 through 2017. I also included five shorter periods, namely 1994 through 1999, 2000 through 2006 and 2007 through 2017 as well as the bear markets of 2000-02 and October 9, 2007 through March 9, 2009. In some sub periods, ‘growth’ (G) outpaced ‘value’ (V) including in the bear markets. In some periods, large caps (the S&P 500) performed best and in others mid or small caps performed best. Our key takeaway is that leadership does in fact change, so we believe diversification by region, market cap and other attributes is prudent. G V G Bear 1 Bear 2 1988-02 2003-17 1994-99 2000-06 2007-17 2000-02 10/09/07 - Index name Growth $1 Growth $1 Growth $1 Growth $1 Growth $1 Val of $1 3/9/09 $1

S&P 500 Growth Index $7.52 $4.72 $4.40 $2.07 $2.83 $0.52 $0.50 S&P 500 Value Index $6.79 $4.53 $2.79 $2.72 $1.97 $0.74 $0.37

Russell Mid Growth $6.66 $5.60 $3.36 $2.56 $2.66 $0.51 $0.43 Russell Mid Value $7.70 $5.94 $2.24 $3.42 $2.36 $1.10 $0.38

Russell 2000 Growth $4.31 $5.45 $2.33 $2.50 $2.58 $0.49 $0.42 Russell 2000 Value $7.48 $5.31 $1.82 $3.55 $1.98 $1.24 $0.39

Sources: Vanguard (VIFI) & Thomson Reuters Figures in BOLD = preformed best

4969 US Highway 42, Suite 1600 // Louisville, KY 40222 D 502.329.2371 // T 844-542-1834 // F 502.329.2072 www.harmonywealthpartners.com Raymond James & Associates, Inc., member New York Stock Exchange/SIPC

Notice that when a change in leadership occurs it can last for several or more years. However when there is a significant expansion in things like the price to earnings (PE) ratio that this can translate into very heady gains (much greater than the change in the underlying earnings themselves) that draw investor attention and interest. Conversely when valuation contracts sharply that adjustment can easily offset growth in underlying earnings. The problem is investors have a tendency to invest in securities after they have performed well and to sell securities after they have performed poorly. However the precursor for future outperformance is often underperformance in the recent past and vice versa.

We have been in this business a long time, and it truly surprises us how little some things, including marketing practices, change. Specifically, we get a tremendous amount of unsolicited emails that tout ‘actively managed solutions’ that have performed really well. The entreaty is, ‘we have some hot hands here, your clients will be impressed by our results, send us their money.’ Often there is no mention of their funds that are not working well (why should there be as no one wants to buy into the laggards). It’s as though there is little recognition that chasing performance doesn’t work or that leaning into the wind to buy the segments that are selling at a big discount does, in fact, work. While it may not translate into increases in money flows, we believe it does work in terms of managing risk and harnessing intermediate and long-term returns. We know that at times our diversified approach and propensity to stick with some of our losers doesn’t feel comfortable. However, our charge is to help you earn competitive returns over long periods of time without taking imprudent (performing chasing, ‘this time is different’) risks. Of course, we are not suggesting that you can’t get healthy returns in stocks that have already performed well. Obviously we believe you can. But if a security has gone up from $5 to $100 you won't get any of that 20-fold rise - only the future change.

“People are always asking me where the outlook is good, but that’s the wrong question. The right question is: Where is the outlook most miserable?” – Sir John Templeton

There is an old saying that investors make their returns at the time of purchase, not at the time of sale. So how do you get the good result (e.g. the returns from at or near the bottom)? First stay the course - if you sidestep (because it feels right/less risky) you can EASILY miss the easy money. Second, lean into the wind. Buying what feels good is easy; buying when the news is bad isn't easy. We are passionate about helping you adhere to this disciplined, time-tested approach to managing risk. Lastly, I used these quotes from Horace and John Templeton in January 2016. I am re-introducing them, because they are timeless and because many of you engaged us after that time so it’s likely that most of you may not have seen that letter from nearly 3 years ago. The chart below shows the 2019 PE for a number of major country stock indices based upon 2019 estimated earnings.

2019 PE by country, October 2018, source: Bloomberg

We observe that none of the PE ratios for these major markets strike us as dangerously high, but several including those in Europe and Asia, look quite attractive. A combination of earnings growth, dividends and even a modest rise in PE ratios could translate into healthy investment returns over the intermediate term. The table immediately below shows the PE ratio for the Shanghai Composite stock market over the past roughly 15 years. The high and low ranges are large and presently the PE ratio is toward the low end of its range. It is roughly at two-thirds of this longer-term average. This suggests that ‘the outlook is poor’ (e.g. investor expectations and sentiment are low) which could mean that investment gains might be favorable in coming years. Time will tell.

Shanghai Composite, Median PE ratio, source J.P. Morgan

In summation, bull markets begin at the point of extreme pessimism and low valuations and end at maximum optimism and valuation. Most of the time conditions like valuations and investor confidence are well inside the extremes that result in market tops and bottoms. Nevertheless, perspective about where conditions lie along a broad continuum is a worthwhile exercise.

Happy holidays to you and all whom you love and care about. We hope this season is particularly happy for you.

W. Richard Jones, CFA Senior Vice President, Investments

i Just for fun, I think the word ‘fiendish’ is likely to curry favor, while the popular term, ‘at the end of the day’ will go out of style. ii Of course, the market doesn’t actually swing from peak to trough and trough to peak valuations overnight (although sometimes it seems like that).

The S&P 500 is an unmanaged index of 500 widely held stocks that is generally considered representative of the U.S. stock market. The Russell Midcap consists of the bottom 800 securities in the Russell 1000 index as ranked by total capitalization. Russell Mid-cap Value Index measures the performance of those Russell Mid-cap companies with lower price-to-book ratios and lower forecasted growth values. Russell Mid-cap Growth Index: Measures the performance of those Russell Mid-cap companies with higher price-to- book ratios and higher forecasted growth values. The Russell 2000 Index is a small-cap stock market index of the bottom 2,000 stocks in the Russell 3000 Index. Russell 2000 Value Index measures the performance of those Russell 2000 companies with lower price-to- book ratios and lower forecasted growth values. Russell 2000 Growth Index measures the performance of those Russell 2000 companies with higher price-to-book ratios and higher forecasted growth values. The Financial Times Stock Exchange 100 Index, also called the FTSE 100 Index, FTSE 100, FTSE, or, informally, the "Footsie" / f tsi/, is a share index of the 100 companies listed on the London Stock Exchange with the highest market capitalisation. The CAC 40® is a free float market capitalization weighted index that reflects the performance of the 40 largest and most actively traded shares listed on Euronext Paris, and is the most widely used indicator of the Paris stock market. The DAX is a blue chip stock market index consisting of the 30 major German companies trading on the Frankfurt Stock Exchange. The Nikkei measures the performance of 225 large, publicly-owned companies in Japan from a wide array of industry sectors.The Hang Seng Index or HSI is a market capitalization-weighted index of the largest companies that trade on the Hong Kong Exchange. The SSE Composite Index also known as SSE Index is a stock market index of all stocks (A shares and B shares) that are traded at the Shanghai Stock Exchange. The KOSPI Index is comprised of 200 of the largest and most liquid issues traded on the Korean Stock Exchange. The Taiwan Index is a stock market index comprised of companies traded on the Taiwan Stock Exchange. Sensex is composed of 30 of the largest and most actively-traded stocks on the BSE, providing an accurate gauge of India's economy. Inclusion of these indexes is for illustrative purposes only. Keep in mind that individuals cannot invest directly in any index, and index performance does not include transaction costs or other fees, which will affect actual investment performance. Individual investor's results will vary. Past performance does not guarantee future results. Any opinions are those of the author and not necessarily those of RJA or Raymond James. The information has been obtained from sources considered to be reliable, but we do not guarantee that the foregoing material is accurate or complete.