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MESSAGE FROM THE PRESIDENT TOM L. STRINGFELLOW, CFA®, CFP®, CPA, CIC

President and Chief Investment Officer

The following has been compiled from information and comments provided by the investment professionals of Frost Investment Advisors:

Investor Stress Test…

One more set of successive records were broken last week, heralding the first real global market setback in recent memory, while ending the most recent streak of no 10-percent corrections. Following Thursday’s selloff, the S&P 500 had fallen 10 percent below its earlier all-time high, its first serious drop in 578 days. Equity market volatility gained momentum during the week, with market swings becoming more exaggerated. At Friday’s close the domestic equity benchmarks were off at least 5 percent for the week with overseas markets moving in lockstep with the U.S. investor losses. To add some perspective from research firm Bespoke Investment Group, during this shortened month-to-date time frame, 69 out of 76 country-specific markets were in negative territory for the year, with all of the G-7 country benchmarks off more than 5 percent. To add a little more color for investors here at home, there were really no safe hiding places. Since the market’s retracement beginning on Jan. 26, the average stock in the S&P 500 is off 9.85 percent, with the top 10 percent of the stock index off 8.19 percent, and the worst 10 percent off by 11.83 percent. Indeed it was a stressful (and filled) week, with bullish sentiment readings reversing course over a matter of a few trading days, prompting a panicked reversal of earlier record investor global equity flows.

There was little in the way of negative news sparking last week’s selloff (despite the largest one-day increase in the VIX volatility measure in history). But unfortunately, if history repeats itself, volatility pendulum swings like this won’t fade away overnight. Market corrections tend to look for the equilibrium point where panicked investors calm. Fortunately, there is still quite a bit of positive economic news in the pipeline that may help to mute the market bashing while providing some relief for the market basing. While the selloff did catch the Fed’s attention, it was viewed as more of a distraction. One noted remark from NY Fed President William Dudley was that thus far, this correction had no economic complications and was “small potatoes.” That doesn’t mean that the central bank won’t deviate from what many expect to be three more interest rate hikes this year, nor does it eliminate the chance there are a few more investor-driven moves brought on by other global central bank tightening efforts as the year progresses. There may also be some boost in volatility from the last-minute budget deal out of Congress earlier in the week, given some expressed concerns raised over the potential for trillion-dollar budget deficits, etc.

As we move on from the last few days and look ahead, we remind ourselves of the inevitability of market corrections. We must always determine if these are merely “repricing” moments or “macro-market” trend changes. This analysis requires a deeper look at the data. Last week, for instance, saw a continuation of positive news on the global economy, trade, jobs, wages, housing, manufacturing, industry surveys and, at least here at home, the scorecard on corporate earnings. According to the latest FactSet earnings report, today’s blended growth rate for Q4 S&P 500 earnings per share now stands at 14 percent, up from 11 percent at the end of the quarter, with a blended revenue growth rate of 8 percent, up from 6.7 percent in early January. And for those companies deriving more than half of their revenue abroad, the blended sales growth rate is 10.5 percent. Regarding 2018 overall, earnings estimates today are projecting a full-year’s growth rate of 18.5 percent. Will the latest rounds of stimulus, corporate earnings upticks, improving trade and manufacturing reports be enough to sustain global growth? Probably. For a while anyway.

Next Monday the markets will be closed in observance of Presidents Day. In observance of the market holiday, the next edition of News & Views will be sent out on Feb. 26.

M A R K E T N E W S & V I E W S W E E K O F F E B R U A R Y 1 2 , 2 0 1 8

M A R K E T C O M M E N T A R Y

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Another interesting tidbit from the markets relates to passive investment vehicles (both equities and fixed income) and the impact increasing market volatility is having. With the increase in volatility, these ETFs have been selling their assets to meet redemptions. Goldman Sachs reports that option contracts on passive ETFs are currently almost matching, in dollar terms, the total dollar value of the underlying funds. In response to the selling pressure it appears that large institutional investors have been buying options contracts, rather than buying or selling the underlying funds. If volatility continues to be elevated, this condition will likely contribute to additional turmoil. Something to be aware of.

The Fed, Deficits, Trade and Outlook

The wild card for the markets is whether the current expansion is overly inflationary and outside the control of central bank policies. Thus far the Fed has dismissed the equity-market selloff, but it is aware of increasing growth strains on the markets and the potential impact of an accelerating interest rate environment. Interest rates are rising but that hasn’t yet taken a toll on consumer credit growth or on the demand for commercial and industrial loans, with demand particularly increasing for the smaller firms (the highest since Q3 2015).

Business surveys are off to a good start. The ISM Non-Manufacturing Index jumped to a cycle high in January. Its counterpart, the ISM Composite PMI, blending manufacturing and services, was at its highest level since 2005. That helps explain job openings at a seven-month low, the four-week moving average for unemployment claims at its lowest since March 1973, and new manufacturing orders at a seven-year high.

Deficits made the news last week following the recent tax and budget bills. According to a few scattered reports, the combined deficit from the combined tax overhaul and new budget deal might exceed $1 trillion over the next two years. In the near term, they’re certainly a boost to growth, consumption and wages. Longer term, they need to be sustainable.

Trade growth continues to be another bright spot, albeit not in the direction that had been targeted. On a year-over-year basis, exports rose 7.3 percent while imports were up 9.5 percent, all courtesy of a strong global economy. We shipped more capital goods, industrial supplies, materials and food. We bought autos, cell phones and other consumer goods.

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MARKET PERFORMANCE

Key Market Indices Last Chg % Chg 1 Week

Chg 1 Week % Chg

1 Mth % Chg

YTD % Chg

12 Mth % Chg

52 Wk High

52 Wk Low

S&P 500 2,619.55 38.55 1.49 -142.58 -5.16 -4.79 -2.02 13.51 2,872.87 2,311.10

Bloomberg Barclays US Agg 100.75 0.03 0.03 -0.15 -0.10 -1.31 -1.92 1.04 104.56 100.72

Bloomberg Barclays Glbl Agg x US 109.57 0.03 0.02 -0.11 -0.70 1.89 1.51 10.58 111.97 109.54

MSCI AC World Ex US 360.43 -4.94 -1.35 -21.32 -5.58 -6.97 -4.21 11.50 392.92 335.15

WHAT WE ARE WATCHING

Key Events: President Trump releases the 2019 budget; the president is also expected to release a plan to update and upgrade U.S. infrastructure by spending up to $1.5 trillion.

NATO defense ministers meeting in Brussels. Chinese New Year – Year of the Dog – means tens of millions of Chinese go home and factories shut down this week. 2018 Olympic Winter Games continue in South Korea. Important macro data out this week includes CPI, retail sales, industrial production, and housing starts.

US: CPI & core CPI (estimated around 1.7 percent year over year), with headline CPI month over month likely to rise due to higher gas prices, and around 2.0 percent year over year. Retail sales. Industrial production and housing starts. Empire manufacturing and Philadelphia Fed surveys. NFIB small business survey. Producer wholesale prices.

EUZ: Eurozone 4Q GDP growth second estimates; a risk that the GDP gets revised upward; Industrial production. German 4Q GDP is expected to expand 0.7 percent quarter over quarter. France unemployment rate.

JPN: 4Q GDP, machine orders.

Central Banks: Australian central bank Gov. Lowe presents to a parliamentary committee.

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This commentary is furnished for informational purposes only and is not investment advice, a solicitation, an offer to buy or sell, or a recommendation of any security to any person. Managers’ opinions, beliefs and/or thoughts are as of the date given and are subject to change without notice. The information presented in this commentary was obtained from sources and data considered to be reliable, but its accuracy and completeness is not guaranteed. It should not be used as a primary basis for making investment decisions. Consider your own financial circumstances and goals carefully before investing. Certain sections of this commentary contain forward-looking statements that are based on our reasonable expectations, estimates, projections, and assumptions. Forward-looking statements are not indicators or guarantees of future performance and involve certain risks and uncertainties, which are difficult to predict. Past performance is not indicative of future results. Diversification strategies do not ensure a profit and cannot protect against losses in a declining market. All indices are unmanaged and investors cannot invest directly into an index. You should not assume that an investment in the securities or investment strategies identified was or will be profitable.

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