Market Sector Update

• Negatives continued to stack up during the quarter, combining to push risk assets lower. It is difficult to point to a single catalyst, although fear of a hawkish U.S. Federal Reserve (Fed), lack of real progress in U.S.-China trade talks, uncertainty about a Brexit agreement and civil discontent in France all are likely to have weighed on global economies.
• Economic data weakened across Europe and China in particular while finally cracking in the U.S., where December manufacturing data fell substantially and especially in forward-looking new orders.
• The U.S. was among the weakest equity markets globally, with broad European and China/Hong Kong markets outperforming the S&P 500 Index in the U.S. as well as Japan’s market.
• Given the fear of weakening global economies, other markets behaved roughly as one would have predicted. The 10-year U.S. Treasury yield fell, causing further flattening in the yield curve, while credit spreads widened considerably. Gold rose 7.5% in the quarter, the Japanese yen (which tends to rise during periods of stress) gained 3.5% vs the U.S. dollar, and Brent crude oil dropped a whopping 35% as demand fears began to exacerbate continued supply concerns.
• Fixed income markets acted in typical risk-off fashion, with “safe haven” yield curves – such as in the U.S., Germany and Japan – rallying while credit markets behaved poorly with limited liquidity.
• Defensive sectors prevailed within equities, with health care, consumer staples and utilities outperforming other sectors in the U.S. By contrast, energy was the worst-performing sector in the quarter. Value outperformed growth and large-cap stocks outperformed small caps.

Portfolio Strategy

• The Portfolio had a negative return in the quarter that was slightly better than the negative return of its benchmark index, and performed roughly in-line with our defined risk position.
• The equity sleeve underperformed the benchmark index during the quarter, with oil services and exploration & production industry segments within the energy sector performing the worst. These segments wholly offset the positive impact of an overweight position and stock selection within consumer staples, which helped on a relative basis. The equity sleeve also was affected by:
  • Apple, Inc., the weakest holding within technology, although the Portfolio is underweight versus the index. We think it is a little late to sell, given the weakness already in iPhone units as foretold by the company’s decision to stop disclosing the sales data.
  • Communication services had a negative effect on performance, largely because of the Portfolio's exposure to internet and media stocks versus traditional telecommunications, which behaved more defensively.
  • Utilities had a positive return in the index, but the Portfolio's very limited exposure led to a negative effect because of the lack of allocation.
  • Some of the moves in the Portfolio in the third quarter and early fourth quarter helped, including trimming some technology winners, adding to consumer staples and trimming overall equity exposure.
• The credit portfolio performed poorly during the quarter. Positions in telecommunications and emerging markets came under pressure during the volatility in credit markets late in the quarter.
• U.S. Treasury position did help offset some of the price volatility in the equity sleeve. We used the duration rally to trim exposure to longer maturities during the quarter.
• Gold finally helped again this quarter, as we expect it to during similar periods, with a positive return of over 7%.

Outlook

• Given the fourth-quarter correction in equity and credit markets combined with weakening economic data, the path for returns from here is difficult to call. Thus, we won’t make a large commitment one way or the other.
• It is difficult to separate the effects of the fading U.S. fiscal stimulus, rising short-term interest rates (along with higher long-term rates until recently) and the impact of the trade dispute on China and other emerging market economies. We believe they all conspire to slow the global economy, but the magnitude is the key question.
• s we move into 2019, consensus expectations are muted, given price action and the disconnect between Fed expectations and fixed income markets – which predict the next move for U.S. short-term interest rates is likely to be down, not up.
• We are focused on new developments in trade negotiations, the progression of Chinese fiscal and monetary stimulus, U.S. housing and the impact of myriad uncertainties on U.S. and global capital expenditures.

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 Dec. 31, 2018, 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 12/31/2018: Microsoft Corp., 3.07%; Pfizer, Inc., 2.79%; Visa Inc., Class A, 1.85%; Coca-Cola Co., 1.84%; Amazon.com, Inc., 1.82; AIA Group Ltd., 1.73%; Wal-Mart Stores, Inc., 1.61%; Qualcomm, Inc., 1.58%; Airbus SE, 1.56%; Nestle S.A, 1.55%.

W. Jeffery Surles, CFA, became a co-portfolio manager on Feb. 5, 2018. Co-Portfolio Manager Cynthia Prince-Fox retired from the firm on April 30, 2018.

The S&P 500 Index is a float-adjusted market capitalization weighted index that measures the large-capitalization U.S. equity market. It is not possible to invest directly in an index.

Risk factors: The value of the Portfolio’s shares will change, and you could lose money on your investment. An investment in the Portfolio is not a bank deposit and is not insured or guaranteed by the Federal Deposit Insurance Corporation or any other government agency. The Portfolio may allocate its assets among different asset classes of varying correlation around the globe. The Portfolio’s Equity Sleeve typically holds a limited number of stocks (generally 50 to 70). As a result, the appreciation or depreciation of any one security held by the Portfolio may have a greater impact on the Portfolio’s NAV than it would if it invested in a larger number of securities. International investing involves additional risks, including currency fluctuations, political or economic conditions affecting the foreign country, and differences in accounting standards and foreign regulations. These risks are magnified in emerging markets. The Portfolio’s Diversifying Sleeve includes fixed-income securities, that are subject to interest-rate risk and, as such, the net asset value of the Portfolio may fall as interest rates rise. Investing in high-income securities may carry a greater risk of nonpayment of interest or principal than higher-rated bonds. Loans (including loan assignments, loan participations and other loan instruments) carry other risks, including the risk of insolvency of the lending bank or other intermediary. Loans may be unsecured or not fully collateralized may be subject to restrictions on resale and sometimes trade infrequently on the secondary market. The Portfolio may seek to hedge market risk via the use of derivative instruments. Such investments involve additional risks. Investing in commodities is generally considered speculative because of the significant potential for investment loss due to cyclical economic conditions, sudden political events, and adverse international monetary policies. Markets for commodities are likely to be volatile and the Portfolio may pay more to store and accurately value its commodity holdings than it does with the Portfolio’s other holdings. These and other risks are more fully described in the Portfolio's prospectus.

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