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2018 4th Quarter – “A Blown Lead”

2018 started with economic optimism and ended with fear of an economic slowdown. Changes were magnified in the 4th quarter as the financial markets finished the year in a much different state than on October 1st. What was expected to be a normally positive 4th quarter but the month of December was one of the worst since the Great Depression. During the 4th quarter, the SP500 fell 13.5% and 4.4% for the year. Generally, most client equity portfolios did better than the SP500. As stocks fell, the Barclay Bond Index was up 1.6% during the 4th quarter and was unchanged for the year as investors shifted funds to the safety high grade and government backed bonds later in the year. Cash was the best performing asset category returning 1.9% last year.

Qtr. to Date Benchmark

Year to Date Benchmark

Bloomberg Commodity -9.4% -11.2% 90 Day Treasury Bill 0.6% 1.9% S&P500 Total Return Index -13.5% -4.4% Russell Index (Small Caps) -20.2% -11.0% Bloomberg Aggr. Bond 1.6% 0.0%

The reasons for the sharp decline in the SP500 were covered in a recent interview with Laura Hayden, reporter with the Naples Daily News; https://www.naplesnews.com/story/money/business/local/2018/12/28/local-analysts-expects-more-bumps-ahead-stock-market/2431142002/. The blame is largely due to tariffs that are hurting the global economic outlook, the Federal Reserve’s plans to raise interest rates and normalize the balance sheet, and computerized trading, all of which help to explain the sharp decline during the 4th quarter.

Andrew D.W. Hill President & Co-Founder, CFA

Andy Hill has more than 25 years of portfolio management experience.

Andy holds an MBA from Syracuse University and a Bachelor of Science degree from Canisius College. Andy often contributes to Investor’s Business Daily, Naples Daily News, and Fort Myers News Press. He has also appeared on CNBC and FOX.

Highlights: 1. 2018 4th Quarter – “A Blown Lead” 2. Economic Outlook is Slowing, Just How Much? 3. 5 Major Secular Trends- Affecting Society 4. Update on 5G Technology 5. Capital Market Outlook is Not So Bad 6. Investment Strategy-Where to Invest in 2019 7. Our Top Holdings 8. Taxes in 2019 9. Firm Updates

Jennifer R. Figurelli Managing Director & co-Founder

Jennifer Figurelli has 18 years of experience in the trust administration field. Jennifer has a Bachelor of Arts degree in Business Administration from Florida Southern College and a Legal Assistants Certificate from Florida Atlantic University. She also is a graduate of the Florida Bankers Association Graduate Trust School and holds a Series 65 license and Life, Health and Variable Annuity designations.

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Economic Outlook

Economic factors in early 2019

The first quarter of 2019 may be characterized by economic data confirming that an economic slowdown is happening. The big question is, “at what magnitude”? The Institute for Supply Management (ISM) data for December tanked which confirmed manufacturing data which pointed to a sharp decline in recent economic data. Countering the weakening manufacturing data, the employment report for December was much stronger than expected. However, the source of the employment strength was centered on healthcare and bars/restaurants.

To collaborate the ISM data, on January 2nd, Apple announced that sales for 4th calendar quarter would miss expectations by $6 billion or 7%. Weak sales in China and weak sales of new iPhone models were cited as reasons for the negative results. Our speculation is that the new iPhones are too expensive which is partly to blame, in addition to slowing macro-economic conditions. Although we sold Apple from the portfolio some time ago, the decline has spooked investors. Similarly, FedEx has a good barometer of worldwide business activity, and has seen a significant slowdown in international business beginning in December and management has indicated that tariffs are a factor.

The emerging weakness appears to be sourced from a slowdown in global trade due to tariffs, political instability, and the removal of central bank economic stimulation worldwide. The slowdown is more evident in economically sensitive industries and has not showed up in domestically focused consumer related sectors such as retail and healthcare. For example, Amazon had a commentary on a strong holiday selling season which substantiates consumer strength.

The recent drop in crude oil prices has both good and bad implications. Lower gasoline prices are a boost to auto owners (and boat owners). However, energy companies are not making enough profits to sustain business in the long-term. This is a classic case of increasing supply beyond the market’s needs. With technology, drilling for oil has gotten a lot more efficient. Many locations of the country are dependent upon the energy industry. The reduction in drilling will have a negative impact on those local economies. The slowing of manufacturing activity may be influenced by the reduction in oil drilling. The chart below presents business activities of all five Federal Reserve Bank regions. Similar to the ISM data, the index tanked in December.

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Longer term, there is a secular (very long-term) shift in the energy markets that may begin to appear soon. With the arrival of EV (electronic vehicles), the demand for energy will shift from the gas pump to the charging station. This bodes well for Florida Power and Light, but not so good for Exxon (Exxon is rumored to be evaluating the benefits of investing in charging stations). Oil will see moderate demand, while natural gas may switch from a bi-product to the targeted substance as it is the primary fuel used in power production. EV’s will finally displace the century-old combustion engine as the prices of batteries fall and consumers realize the lower cost of ownership of EV’s. EV’s have fewer parts to break and the fuel costs in the area of 95 to 130 miles to a gallon. Also, self-driving cars go from 0 to 60 miles per hour in 3 to 4 seconds which is also pretty cool. Tesla currently dominates the EV market while Jaguar recently introduced its EV400 model. In 2020 and 2021, look to see many new offerings including pick-up trucks from startup companies, Audi, Porsche and others. An interesting related trend is the fall in the investment for oil and gas exploration compared to the investment in renewable energy. Below is a chart from Bloomberg Intelligence showing this trend. This may partially explain why energy stocks have done poorly for years compared to the SP500.

Technology related spending continues to grow which will create opportunities across the employment spectrum. The 5G build out should gain momentum in 2019. This will provide employment opportunities for highly skilled individuals needed to write the software to protect the system from hackers, and strong individuals who will be needed to install the numerous small cell antennas.

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To summarize the numerous factors impacting the economy, growth around 2.5% seems reasonable for 2019 with the normal wide quarterly swings. Fed Chairman Jay Powell appears to be “way over his head”. His communication skills and decision-making suggest a lack of understanding of the psychology of markets. Powell’s resume includes government positions and roles in investment banking which is largely “deal making”, as opposed to buying stocks or bonds for clients who get mad if their portfolio drops in value.

5 Major Secular Trends Affecting Society

As new businesses are gaining millions of customers, such as Netflix; other businesses, such as Sears are near their final demise. There is little doubt that a business must be willing to recreate its product/services to avoid extinction. To survive, businesses need to adapt to changes. We have identified 5 major trends affecting the economy.

Technology Innovation

While the internet has impacted the last 30 years, 5G (5th Generation Cellular) may influence the economy over the next 30 years. 5G will offer massively faster speeds that will allow instantaneous data exchange.

Global Trade

Despite the Trump Administration’s attempts to restrict world-wide trade, the rest of the world is led by China who is building new trade alliances. While the US has passed on joining the TPP (Trans Pacific Partnership) the 11 countries listed below have agreed to lower tariffs and limited barriers to trade. An interesting future issue may be that the primary sources of lithium are located in Chile and Australia. Separately, China is focused on technology dominance and developing a trade geographic path across Asia to Russia.

Singapore

Brunei

New Zealand

Chile

Australia

Peru

Vietnam

Malaysia

Mexico

Canada

Japan

Changing Energy Sources

For the past 400 years, fossil fuels have been the primary source of powering our vehicles, power plants and motorized things. Recently, Electric Motors are approaching the rapid growth stage as products have been perfected and have completed the concept stage. Powering electric vehicles will be largely sourced from the exiting power grid. GM recently announced that the Cadillac would be the focus of their new EV products. The power grid is largely powered by the exiting utilities. So, the shift from crude gas to fuel transportation to utilities.

TPP Participating Countries

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Utilities are also changing as the technology of renewables continues to reduce the cost. Solar and wind power are cost competitive with natural gas and much less than coal and nuclear energy. Oil has never been a good source for power production. Expect to see oil demand wane over time, while natural gas and renewables will pick up a larger share of the new capital investment.

Aging of the Developed Nations

Due to various demographic factors, we are getting older. China, Japan and many other nations are experiencing similar trends. Population growth has slowed here in the United States. This creates many problems, including balancing our nation’s budget issues when we have fewer people working and more people receiving retirement benefits.

Environmental Decline

Southwest Florida has fallen victim to the environmental decline due to man-made decisions and weather events. The insurance industry was one of the first entities to signal the climate change alarm. In Florida, the failure of adopting appropriate environmental regulations on fertilizing, septic systems and other “man-made” water flows has created massive deaths of marine life and unknown consequences on human life. Further, the man-made issues have been exacerbated by Hurricane Irma and tropical storms.

UPDATE ON 5G TECHNOLOGY

There are numerous world drivers and mega-trends for utilizing 5G: the digital evolution, social and demographic shifts as cities become larger with increased population, new health and well-being demands, and industry/business trends towards hyper-competition and new disruptive technology.

As the fifth generation of cellular mobile communications, 5G will be the dominant technology among mobile/cellular subscriptions by 2026. Its key benefits are designed to increase productivity, save energy and reduce costs:

1. 100 times faster than 4G 2. Lower latency

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3. 10- year battery life 4. Capacity to network billions

In addition to its performance expectations, such as speed, coverage and better reliability, 5G will not just be another “G”. It will provide a whole new experience that enables new applications, new services, new devices and many other things that are impossible today. The mainstream expectations are that 5G will eventually provide self-driving vehicles, drone delivery, connected robots, tactile virtual shopping, live immersive gaming, 3D Hologram calling, and Virtual Reality cinemas, to name a few.

Several companies within the firm’s core holdings are well positioned to benefit from the attractive growth forecast of 5G.

-Amazon: Cloud computing, E-Commerce, Artificial Intelligence, Computer hardware

-Apple Release of 5G iPhone in 2020

-Blackberry: Securing data

-Ericsson: Leading telecom equipment vendor that has signed the first 5G commercial deals

-Palo Alto: Cybersecurity company transitioning from 4G to 5G

-Skyworks Solutions: Sky5 revolutionary platform

-Verizon: Launched “early” 5G network in the US in October 2018

With the rollout of 5G, this year consumers can expect to see a lot of marketing hype among the major carriers as they all compete for your business. The reality is 2020 is the year when the fifth generation of wireless connectivity will really take off. 5G will be a slow-moving progression with long-term benefits. Sources: PC Magazine, “What is 5G” buy Sascha Segan-December 14, 2018: Digital Trends, “5G Arrival is Transforming Tech”, by Steven Winkelman-December 18, 2018, “Industry Impact of 5G”, Webinar hosted by Ericsson on 10/08/2018; “5 G in 5 Minutes”, Video on www.skyworksinc.com/5G;

Capital Market Outlook

The major capital markets- Currencies, commodities, bonds and stocks are all interrelated in a similar nature to cousins. Sometimes cousins spend time together, sometimes they move in the opposite directions, and other times they show little concern for others.

Currencies The U.S. Dollar sets the tone for the other markets. Last year, the U.S. Dollar rose as higher interest rates and economic growth made the “buck” more attractive to foreign buyers. By the fourth quarter, the rise in the U.S. Dollar began to hurt foreign sales. More recently, it is expected that the Federal Reserve may slow the rate of further interest rate increases, which makes the U.S. Dollar less appealing to yield seeking global investors be stable or possibly decline relative to foreign currencies. Thus, we expect the dollar to be stable or possibly decline moderately.

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Commodities Should the U.S. Dollar be stable or decline, this would generally help the commodity markets. Gold is about 30% below its 2011 highs and may have appreciation potential, due to growing political concerns and central banks halting interest rate increases. Industrial commodities such as copper, may be more or less stable. Last year, copper lost about 20%, due to global economic concerns. If the economy performs not as bad or feared, copper may trend higher. With respect to the oil market, our long-term thoughts are included with our secular analysis. In the short-term, the price of oil will be largely influenced by the supply of oil. With stable demand, oil supply is the issue. With technology impacting the production of oil, it is far exceeding the needs. Further, the lack of pipelines is constraining supply. If the pipeline infrastructure was improved, oversupply of the oil markets would depress prices lower. For 2019, oil prices should stay within the range of $35 to $60 per barrel (West Texas crude). Unfortunately, for oil drillers once prices rise, producers flood the market and thus squeeze profits.

Interest Rates, the cost of borrowing money The outlook for interest rates is separated between short and long term interest rates. Short-term interest rates are heavily influenced by Federal Reserve policy. With short-term Federal funds at about 2.4%, the financial markets are projecting a 64% chance that rates stay the same and a 21% change of an interest rate increase hike and a 14% chance of an interest cut by year end 2019. Chair Powell appears motivated towards higher rates, possibly 3%, but this would dramatically hurt the economy and collapse the commodity and stock markets. Longer term interest rates may stay in the range of 2.6% to 3.3% over the course barring major changing factors that could reduce interest rates. This would be a significant economic slowdown, possibly resulting in the Federal Reserve increasing short-term interest rates too much. Interest rates could trend above 3.3% for two reasons. First, the economy continues to grow about 3% Gross Domestic Product (GDP) in 2019, which is not expected but would be a good thing. The second factor would be the ballooning Federal Deficit. Since the government payments exceed the revenues by about 20%, the Treasury has to sell Treasury bonds to fill the gap. As the supply of Treasury bonds increase, investors want higher and higher yields.

Stock Market Stocks are off to a good start in 2019, which holds historical significance. Since this Newsletter is a week behind schedule, we have the opportunity to include the early January trends. Our most likely stock

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market expectation is for gains of 10% to 15% this year which suggest the SP500 to finish in the range of 2700 to 2830. However, market expectations rarely pan out as expected. Just think of the recent college football championship which had Alabama heavily favored over Clemson, but the freshman quarterback for Clemson played the game of his life passing for three touchdowns and beating the Crimson Tide. Our negative case for stocks is a decline to about 2100, or a 16% decline. This could occur if the economy slowly trends towards a recession in 2020, possibly resulting from tariffs, interest rate spikes or profit margin pressure from increased costs. On the more optimistic view, should the economy hold up better than the expected slowdown and the Federal Reserve not raise interest rates, stocks could exceed the all-time highs set last year.

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The economic back drop will impact corporate earnings growth. Argus Research has lowered their SP500 composite earnings estimate from $185 to $175, or now 8% growth from 2018. We think that 5% growth would be more reasonable, or $172. As illustrated in the chart below, stocks have recovered a good portion of the losses in December.

Another factor supporting returns for stocks in 2019 is that they are cheap. With the 2018 Q4 debacle, stocks are on sale as the chart for JP Morgan Asset Management shows by just about every metric.

Investment Strategy -Where to Invest in 2019?

Bifurcating your portfolio between near- and long-term objectives. The first strategy investment consideration is the time horizon. For funds needed in the next 5 years, we usually allocate those to a “near term” portfolio to be apportioned to high grade bonds with credit ratings of A or better and money market funds that now yield about 2.3%. The objective of these funds is security, not yield.

Once funds are allocated to the near-term needs, the residual can be invested for the long term (generally over 5 years). Our objective is to outperform the SP500 by 1% to 2% over time. Most of the long-term strategies are focused on equities, but some sectors of the fixed income markets offer attractive returns especially after the Q4 2018 decline. Preferred stocks are the most enticing opportunity. With yields of around 6%, preferred stocks have return potential, close to stocks but with less risk. Shifting to our strategy for stocks to start the year. First, although the year has begun on a strong note which historically bodes well for the year, we are concerned with declining earnings in 2019. Given the moderating economy, we are bias to holdings that are less tied to the overall economy for sales growth. Technology will continue to be a big focus favoring opportunity associated with security, cloud and 5G.

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Our Top Holdings

Microsoft (MSFT $104) is the leader in office software with its long-time offerings in word processing, spreadsheets and PowerPoint. New features and the ability to collaborate with Cloud applications allow users to access via PC, phone or tablet. Unlike most companies, earning estimates have been rising lately.

Intuitive Surgical (ISRG $517) is the world leader in robotic surgery systems. Intuitive was one of the few companies to announce sales were better than expected recently. Few companies have larger barriers to entering this business.

Visa (V $138) is benefiting from the long-term trend to electronic payments. Visa is often the backbone to secure processing. Given the importance of securing money, Visa’s size and strong financials, provides a significant advantage over competitors.

Next Era Energy (NEE $172) a utility stock but has performed like a technology stock. By producing earnings growth greater than others utility companies, Next Era has been one of the best utility stocks for years. Next Era is in the process in building eight new solar/batter power plants in Florida. While Next Era is not perfect, it is more environmentally responsible than most utilities with less than 4% of power produced from coal.

Garmin (GRMN $66) the navigation is coming back to your car. Years ago, Garmin sold after-market navigation devices for cars. Recently, Garmin has signed agreements to provide their software for autonomous driving. Presently, Garmin is steadily growing sales in aviation, marine and outdoor products. Also, Garmin has zero debt and has a 3% dividend yield.

Deere (DE $154) is the world leader in agriculture equipment. Agriculture tends not to correlate to economic trends closely which makes Deere a good holding to diversify risk. Deere is exposed to trade disputes like a child whose parents are divorcing. U.S. farmers have lost sales of soybeans to China, but some have received government funds to compensate for their losses. Deere is considered one of the most ethical companies based on various peer reviews.

Natural Fuel Gas (NFG $53) is a producer of natural gas with a distribution business that provides funds to cover the 3.1% dividend yield. National Fuel needs to expand its pipeline infrastructure to markets in Canada. Demand for natural gas is growing as exports have begun and power plants are shifting from coal. National Fuel actively supports its community in Buffalo, NY.

Ericsson (ERIC $9) is one of the three largest providers of telecommunication equipment which is all focused on 5G. Ericsson is rebuilding itself after having success in the 1990’s. Ericsson may pick up business as Huawei, a leading Chinese telecommunications company receives greater scrutiny.

Xylem (XYL $67) is a leading provider of services and equipment for the management of drinking and waste water. A portion of their business is related to new construction, but the majority would be focus on municipalities. As a result of the contaminated water problem in Flint, Michigan, communities are concerned over the quality of drinking water. Xylem is at risk to higher steel & aluminum costs due to tariffs that may hurt profit margins.

Sun Communities (SUI $100) is one of the longest held positions in client accounts. Sun Communities is a Real Estate Investment Trust (REIT) focused on recreational vehicles and manufactured home communities. This unique market tends to be resistant against economic downturns. Also, while there tends to be a negative association of “trailer parks”, it is extremely difficult to obtain building approval, thus new competition is of limited concern.

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CVS Health (CVS $63) recently acquired Aetna, the health insurance company creating the first integrated insurance, pharmacy and care provider. Initially, investors have panned the deal which has left the stock very cheap and yielding over 3%. If CVS can accomplish their objective in providing better care at a lower cost, the stock could be a big winner in 2019.

Tesla (Tesla $341) a small position was added to some portfolios. Recently, Tesla improved its corporate governance to the point where investing in the shares is prudent. Tesla is the leader in EV, but other long-term potential is in their battery technology and potential reoccurring revenue streams from super-chargers.

TAXES: WHAT’S NEW IN 2019 FROM A FEDERAL STANDPOINT*

There are many tax changes that went into effect on January 1, 2019 and all taxpayers are affected one way or another. Basics:

- Regular Income Tax Rates: 10%, 12%, 22%, 24%, 32% 35%, 37% - Capital Gains Tax Rates: 0%, 15%, 20% - Personal exemptions are eliminated and replaced with credits - Standard deductions have increased: Married Filing Jointly: $24,000

Head of Household: $18,000 Single or Married Filing Separate: $12,000

Adjustments to Gross Income: - Alimony: If agreement signed on or after 1/1/2019: Expired - Principal Residence Cancellation of Debt Exclusion: Expired - Moving Expenses: Eliminated - Tuition and Fees Deduction: Expired - Health Savings Accounts: $6,900 Family/$3,450 Single - 529 Plans: Tax-free distributions can now be used for K-12 tuition up to $10,000 limit

Deductions:

- Itemized Deduction Phaseout: Repealed - Mortgage Interest: $750,000 limit on acquisition after 12/15/2017, and repeals home equity debt - Mortgage Insurance Premiums: Expired - State and Local Taxes: $10,000 limit to income and property taxes (still may deduct sales tax) - Charitable Contributions: Increase in limit to 60% (cash contributions: 50%) - Casualty and Theft Losses are now limited to Presidentially declared disaster areas only - 2% Miscellaneous Itemized Deductions: Repealed

Business Deductions:

- 100% Bonus Depreciation for new or used assets placed in service after 09/27/2017 and before 1/1/2023

- Section 179 deduction increases to $1M for assets placed in service for tax years after 12/31/2017 up to $2.5M threshold

- Meals: 50% deduction remains, however no deduction for entertainment expenses Credits:

- Child Tax Credit of $2,000 per child and $500 for qualified dependents who are not qualifying children

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Estate/Gifts:

- Unified exclusion amount now at $11.18M - $15,000 annual exclusion gifts - Up to $75,000 can be used to fund a College 529 Plan per year (or $150K if married)

Other:

- Repeals Affordable Healthcare Act individual mandate *Please note that the above notes are relative to Federal taxes only. State taxes may apply. Consult with your tax preparer, accountant or CPA with further respect to how the 2019 Tax Changes may or may not impact you and your household.

SPEAKING AND EDUCATIONAL EVENTS January 16, 2019 at 7:30 am: Institute of Management Accountants Regional Meeting The Northern Trust Building Andy Hill is the guest speaker who will discuss the financial market outlook for 2019 March 28, 2019 at 4:30 pm: Cybersecurity Program presented by Carrie Kerskie of Griffin Force The Naples Sailing & Yacht Club SAVE THE DATE October 17, 2019 at 5:00 pm: Annual Firm’s ESG Event honoring local charities The Naples Sailing & Yacht Club Disclosures: Information sources used to prepare this report include Argus Research, JP Morgan Asset Management, CFRA, Forbes, Zacks, Barron’s Kiplinger’s Fidelity and Decision Economics. Founded in 2010, Andrew Hill Investment Advisors, Inc. (AHIA) is registered as an investment advisor in the State of Florida and only transacts business in states where it is properly registered or is excluded or exempted from registration requirements. Andrew D.W. Hill and clients of AHIA hold positions in the investments listed in this report. Please contact AHIA if there are any changes in your financial situation or investment objectives, or if you wish to impose, add or modify any reasonable restrictions to the management of your account. Our current disclosure statement is set forth in Part 2 of Form ADV and is available for your review upon request. Tax and estate planning advise is general in nature and the firm does not practice law.