Market Sector Update

• The U.S. Federal Reserve (Fed) raised interest rates in June, the second hike this year. As short rates rose, the yield curve flattened through most of the quarter as oil prices weakened and optimism waned for Trump Administration-led stimulus.
• Equity and fixed income markets generally moved higher around the globe. In U.S. equities, growth indexes again outperformed value.
• European markets took a turn for the better, in part following the market-friendly election of Emmanuel Macron as president in France and a potentially reform-minded legislature.
• The U.S. dollar continued to consolidate and weaken against the currencies of most trading partners, including the Mexican peso which is showing strength after a battering in 2016 following the U.S. presidential election.
• U.S. economic data showed improvement, Europe’s economy continued its positive trajectory and economic growth moderated in China.

Portfolio Strategy

• The Portfolio had a positive return for the quarter but trailed the return of its all-equities benchmark index.
• Several equity holdings contributed to performance for the quarter. Within the information technology sector, contributors included Alibaba Group Holding Ltd. and MercadoLibre, Inc., as the internet continues to alter the retail landscape globally.
• Holdings in the financials sector also contributed for the quarter – despite the flatter yield curve – driven primarily by positions in Asia and Europe. An underweight versus the benchmark in telecommunications also was a contributor, based on the Portfolio's sole position in the sector – Nippon Telegraph and Telephone Corp. in Japan.
• An overweight position in energy and an underweight in healthcare detracted from performance for the quarter. Oil prices have come under pressure, with inventories still elevated and a great deal of debate about the marginal costs to produce in U.S. shale areas. In healthcare, the Portfolio lacked exposure to the insurance and supply companies, which fared better than those in pharmaceuticals and biotechnology.
• Within the fixed income holdings in the Portfolio, emerging market bonds were a contributor for the quarter, especially a position in Mexican sovereign debt. The appreciating peso has compounded a stronger bond market in Mexico.
• However, detractors included Treasury Inflation Protected Securities (TIPS), which underperformed U.S. Treasuries. Shorter-term instruments also were a performance drag relative to equity returns in the Fund.

Outlook

• We continue to prefer the risk/reward of equities, which was about 72% of Portfolio assets at the quarter’s end. Within fixed income, we continue to prefer emerging market local debt along with some exposure to TIPS to protect against potentially higher inflation, given the market’s somewhat complacent views about inflation now.
• Gold makes up about 4.7% of the Portfolio. We use gold to cushion the volatility of the equity weighting and think it can be a potential beneficiary of inflation or the opposite – a global slowdown in a time of mounting global debt loads.
• We are less optimistic about the prospects for meaningful tax reform in the U.S. or a significant infrastructure investment plan. However, the U.S. economy continues to gain strength, as does most of Europe, with employment continuing to improve, small business confidence returning to 2004 levels and capital investment appearing to strengthen despite political uncertainty.
• We still believe that monetary policy is of utmost importance. In the U.S., we believe short-term interest rates will continue to rise, but there is uncertainty about how quickly the Fed will shrink its balance sheet and the effect on fixed income markets.
• Almost more importantly, we wonder when the European Central Bank (ECB) will begin to normalize rates, and to stabilize and then shrink its balance sheet. If this begins to occur faster than the market now expects, we think there’s the potential for a spike in some sovereign debt yields across Europe. In addition, we think there is the potential for the suppressive effect the ECB has had on the U.S. yield curve to disappear and perhaps cause it to steepen.
• We do know that European financials trade at similar price-to-earnings ratios as U.S. banks, but their price-to-book ratios are much lower. We think this makes the European financials potentially attractive in a world where all central banks may move toward a neutral policy stance.

The opinions expressed are those of the Portfolio’s managers and are not meant as investment advice or to predict or project the future performance of any investment product. The opinions are current through June 30, 2017, are subject to change at any time based on market and other current conditions, and no forecasts can be guaranteed. This commentary is being provided as a general source of information and is not intended as a recommendation to purchase, sell, or hold any specific security or to engage in any investment strategy. Investment decisions should always be made based on an investor’s specific objectives, financial needs, risk tolerance and time horizon. Past performance is not a guarantee of future results.

Top 10 Equity Holdings as a percent of net assets as of 06/30/2017: JPMorgan Chase & Co., 2.63%; Microsoft Corp., 2.24%; Philip Morris International, Inc., 2.14%; Adobe Systems, Inc., 1.99%; AIA Group Ltd., 1.95%; Pfizer, Inc., 1.72%; Lockheed Martin Corp., 1.68%; Alibaba Group Holding Ltd. ADR, 1.61%; Alphabet, Inc., Class A, 1.57%; Coca-Cola Co., 1.57%.

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