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Your FP/CM Q2 2016 . Table of Contents Key Investment Takeaways............................................................................................................................. 2 Short-Term Headwinds & Tailwinds ......................................................................................................... 2 Markets in Graphs… ................................................................................................................................................. 3 Decisions, Decisions…............................................................................................................................................ 4 Maximize the Tax Benefits of Your Charitable Giving .................................................................. 4 Celgene’s Opportunity......................................................................................................................................... 5 So, You Are Thinking of Moving to the U.S… ........................................................................................ 6 Why Own Them? ..................................................................................................................................................... 7 Real Estate in Graphs: We favor homebuilding over Apartments REITS at this time. ...........8 Our Investment “Balance Sheet” .................................................................................................................. 9 /1 Your FP/CM Q2 2016 Key Investment Takeaways Brexit has created additional uncertainty and should result in a higher risk premium. As usual, it will take some time for the market to sort out the current situation. Rallies are likely to be short lived for a while. We are planning to be opportunistic and patient, as always, keeping an eye on your long-term objectives. The probability of a recession has increased, especially in the UK and Europe, but it is still relatively low for the U.S. Beware of interest rate risk. Global bond markets are overbought, “Bullish” sentiment is extreme, and the term premium (the price of “time”& “inflation”) is low. We are past the trough in credit spreads for the cycle. Credit risk has increased over the past few months because of lower oil & commodity prices, lower economic growth and rising pressure on emerging market currencies. The bear market in commodities and energy is in a late-stage. We believe oil prices below $50-60 are unsustainable in the long-term. Political and geo-political risks are high and could have meaningful impact on markets. We favor high quality companies with durable business models, high free cash flow yields, high net cash and/or low debt levels, positive earnings revisions, and some degree of relative price momentum. In fixed income we favor inflation-indexed Treasuries (TIPS), intermediate corporates rated BBB- to A, and special opportunities. We expect volatility to remain high, so we are holding a large percentage of cash to be deployed opportunistically over time. We believe investment returns will be mediocre over the next few years. Record low rates and relatively low spread leave little room for adequate returns in bonds. Expectations for equity returns are also discouraging. The U.S. trades at a relatively high multiple and near-record corporate margins, so further gains will be mostly dependent on economic growth. Europe and Japan suffer from lackluster growth and the lack of a short-term catalyst for improving margin. Emerging markets are highly dependent on a troubled China and commodity prices. Short-Term Headwinds & Tailwinds AARON COHEN, Ph.D. Partner, President, Portfolio Manager, Tailwinds + Monetary policy & interest rates. + EQUITIES are attractive relative to interest rates. + Supportive Fiscal policy over the next few years. Neutral o Not much room for positive impact from monetary policy. o Sentiment: significant skepticism in the short term, but not enough bearishness in the long-term. Savings rate is low and leverage is still high. Headwinds - Economic & financial impact from BREXIT. - Slow global economic growth - Credit is likely to deteriorate going forward (spreads & availability). - Risky assets’ absolute valuation level leaves limited room for error. + Higher wages in the U.S. should give additional support to consumer spending. o Higher wages in the U.S. are a “tailwind” for consumer spending - Increasing wages in the U.S. should put additional pressure on corporate margins. + Overly “bearish” investor sentiment in the short-term is a positive ‘contrarian” indicator. o No major economic excesses or “bubbles” (except probably for interest rates and monetary policy). - The total debt level in the global economy is still very high. + High free cash flow generation, dividend yields and stock repurchases. o Corporate earnings in the U.S. are likely to rebound in 2016-17 after a down year for the first time since the recession. - Chinese economy is unlikely to add meaningfully to global growth, and poses a significant credit risk due to high debt and lack of transparency. - Political and geo-political risks are very high, and unlikely to diminish over the next few years. - Record high corporate margins leave little room for potential improvements. /2 Financial Partners Capital Management fpcm.net Your FP/CM Q2 2016 Markets in Graphs… VOLATILY is back to the higher-end of the range …. and CURRENCIES have been a focal point The ECONOMIC conditions were improving before BREXIT And CREDIT SPREADS didn’t widen significantly …. but the FLATTENING yield curve indicates some stress /3 Financial Partners Capital Management fpcm.net Your FP/CM Q2 2016 Decisions, Decisions… CHRISTOPHER CONWAY Portfolio Manager company, its competitive environment, and related industry trends. We do this so that we can continuously assess the risk/reward profile of the investment. We will sell or reduce a position when an investment no longer meets our criteria, due to specific aspects of the company itself, industrywide challenges, macro issues (economic, technological, social, etc.) that impact competitiveness, or changes that result in a valuation that no longer compensates for the risk. Our investment decisions are based on our probabilistic assessments of numerous potential scenarios. In this regard, our decisions to buy or sell are not perfectly correlated with the movements in specific stocks, i.e. in the short-term we can make the right investment decision yet lose money, or vice versa. However, we believe that, over time, following a disciplined process will yield better decisions and above average returns. After we purchase a stock, we view ourselves as “owners” of the business, and actively follow the Why We Sold Alibaba (BABA)? • Increasing concerns about the company’s accounting practices; while the stock was trading at a reasonable multiple to earnings, the accounting issues made us question the “attractiveness” of the company’s valuation. • Company became more acquisitive, and we did not agree with the pricing and strategic rationale. • Deterioration and increasing risk within the Chinese economy. • Weak track record in corporate governance and shareholder rights. Why We Purchased Alibaba in the First Place • Strong competitive position with significant market share. • Asset-light business model, good returns on capital, high margins & low debt level. • Potential for significant growth due to further penetration of E-Commerce within China. • Valuation: stock was trading at a reasonable multiple of earnings and cash flow. Maximize the Tax Benefits of Your Charitable Giving VINCENT MARSDEN Partner, Senior Vice President of Financial Planning However, charitable trusts, private foundations and donor-advised funds do not qualify. Qualified Charitable Distributions (QCD) from IRAs were permanently added to our federal tax code in December 2015. They are a tax-efficient way to satisfy in whole, or in part, your IRA’s annual Required Minimum Distribution (RMD). In addition to the QCDs being non-taxable, they also reduce the taxpayer’s Adjusted Gross Income for the year, which may permit higher itemized deductions and further income tax savings. Using the QCD approach may also be preferable to donating highly appreciated securities. Taxpayers can choose to retain the securities instead, ultimately passing them on to beneficiaries through their estate with a step-up in cost basis. Beneficiaries who sell the inherited securities can then do so with little or no realized capital gains. Under the QCD provisions, taxpayers who are 70 ½ or older may make donations of up to $100,000 from their IRA, directly to one or more qualified charitable organizations. These distributions are not reported as income to the taxpayer, and their total amount reduces the Required Minimum Distribution (RMD) for that year. If the annual RMD exceeds the total QCDs made, the taxpayer takes the remaining RMD as a taxable IRA distribution for the year. Generally, any qualified charity may receive the QDC donations. If you would like to consider QCD giving for 2016, give us a call to review your personal situation. /4 Financial Partners Capital Management fpcm.net Your FP/CM Q2 2016 Celgene’s Opportunity AMIT FRIEDLANDER Research Analyst Imagine you could own, for a reasonable price, a rapidly growing business that makes the bulk of its money selling a life saving drug that will most likely face minimal competition for the next ten years. Is that an opportunity you might be interested in? Celgene Corporation (ticker: CELG) is the embodiment of exactly such an opportunity. What does Celgene do, and how do they do it so well? Sales of REVLIMID and POMALYST, another multiple myeloma drug, together accounted for 75% of Celgene’s 2015 revenues. Thanks to patent protection and favorable legal settlements, it is unlikely that REVLIMID will face meaningful competition before 2026. Celgene makes REVLIMID, the standard of care drug for treating multiple myeloma. Multiple myeloma is the third most common blood cancer, with a median age of diagnosis of 70. REVLIMID has become the standard of care because of its high level of efficacy combined with lower toxicity and negative side effects relative to Johnson & Johnson’s VELCADE, the other main drug used to treat multiple myeloma. Why do we own the stock? In terms of valuation, we believe Celgene stock is attractive at 15x 2017 EPS because it has the potential to double revenues over the next five years (15% average annual growth), with the possibility of additional earnings growth from margin improvement. In addition, under a discounted free cash flow analysis that explicitly assumes new products will only make up for part of the revenue lost when REVLIMID’s patent protection goes away in 2026, Celgene stock at our average purchase price still looks attractive relative to our normalized case fair value estimate of $110-$120, optimistic case value of $130, and pessimistic case value of $80. Note: Our optimistic case assumes key pipeline drugs generate higher sales than expected, and our pessimistic case assumes newer and pipeline drugs generate sales roughly 50% lower than expected. Strategically, we like Celgene because the company has a strong competitive position, and high and predictable levels of growth and profitability. In addition to REVLIMID’s patent protection, new multiple myeloma drugs must generally be taken in combination with REVLIMID, and due to the clinical trial process, it would take ten years for a drug to win approval for use as a monotherapy, without REVLIMID. We also like the fact that most of Celgene’s sales growth comes from demand for larger quantities of its drugs, and not from price increases, which are increasingly at risk, especially given the current political climate. Finally, results from eighteen late stage, Phase III trials for Celgene drugs are due by the end of 2018. Each one of these trials represents the potential for a new growth opportunity, and could result in further share price appreciation. What are the risks? Celgene’s high degree of revenue concentration is a double edged sword. On one hand, REVLIMID revenues have a high degree of predictability, which is wonderful. On the other, Celgene is extremely focused on proving it isn’t just a one-hit wonder, and plugging in the revenue hole that will come in 2026 once generic competition fully enters the multiple myeloma marketplace. As a result, Celgene’s key risks are (1) Overspending on acquisitions, and (2) Poor drug trial outcomes. /5 Financial Partners Capital Management fpcm.net Your FP/CM Q2 2016 So, You Are Thinking of Moving to the U.S… ROBERTO VAINRUB, Ph.D. Managing Director, Portfolio Manager Pre-planning is particularly valuable from a financial perspective because many key steps can only be taken before you become a U.S. Permanent Resident or Citizen. There are a number of important decisions that can either make your financial transition a successful one, or conversely, potentially hurt your financial health for years to come. Above all else, immigrating is a personal family decision and a life decision. It is also a significant financial decision. As part of your decision-making process, do not underestimate the importance of developing a carefully crafted transition plan. Many of your most important decisions will be more easily implemented if you make them before you immigrate. Basic Considerations Each family’s pre-immigration checklist will look different, but there are some basic considerations everyone should evaluate ahead of time. Among them: If you will continue to work, does your occupation require any licenses or certifications, and what is the process for obtaining them? Should you rent or buy a home? How do you find good healthcare providers, and what are your options for obtaining health insurance? What are your options for life, home, auto and liability protection? Are your current financial resources easily accessible to you from the U.S.? What steps should you take to move funds in advance of your immigration? How much money will you need to provide for your basic living expenses, and how much is the gap between your basic living expenses and the cost of the lifestyle you would like to maintain? Do you have enough liquidity to cover a short-term emergency or any unexpected transition costs? Some Complex Financial Issues Understand the impact U.S. tax laws will have on you and your family. The U.S. taxes its citizens and its permanent residents on worldwide income. Understand U.S. gift taxes. U.S. gift-tax laws limit the amount of money you can gift to others on an annual basis without incurring additional tax liabilities. And, while gifts to a spouse (regardless of amount) are normally exempt from taxation, gifts to a spouse who is not a U.S. citizen are taxed if they exceed certain thresholds. Understand U.S. inheritance and estate taxes. As of 2016, a married couple can avoid estate taxes on up to $10.8 million of their assets. However, absent proper planning, half that exemption can easily be lost, and limitations can dramatically constrain the ability to bequeath assets tax-free to your spouse if he/she has remained a non-resident alien. If you are a director, owner, trustee or administrator of a foreign company or entity, your immigration could unintentionally cause it to convert to a U.S. entity and become subject to new reporting obligations. Engage Qualified Professionals Of course, the task of finding the right advisors is not a simple one. We often find them through referrals from family, friends or trusted work colleagues. Don’t make a hasty choice. Consider such things as the advisor’s proven professional knowledge, discretion, language skills, physical location and availability, network of complementary advisors, and reputation for efficiency and follow-up. Lastly, do not underestimate the importance of personal chemistry and trust! The soundest advice of all is to work with competent and experienced advisors before you immigrate. Your Immigration Attorney, Tax Accountant and Estate Attorney should be regarded as essential partners in this process. You may also consider working with a Financial Planner who will assist you with formulating a comprehensive financial plan and coordinate your team of advisors, making sure your financial and transition strategies are consistent, integrated and suitable for your needs, and to ensure their proper execution. /6 Financial Partners Capital Management fpcm.net Your FP/CM Q2 2016 Why Own Them? CHRISTOPHER CONWAY Portfolio Manager in the U.S. to enjoy healthy growth over the next few years due to the low number of new homes built over the past 7 years, projected growth in the number of households in the U.S., low vacancy rates, and stabilization in the home ownership rate. Both PHM and TOL will benefit from this industry growth due to their good balance sheets, commitment to generating good returns on capital, and geographic diversification. The stocks trade for approximately 1.25x book value, and if the companies can consistently generate low-to-midteens returns on equity, the stocks have significant upside potential. (See the Real Estate graphs on page 8) Alphabet (aka Google, ticker is GOOG): Google is the leading global search and online advertising company. The company has a dominant competitive position due to its scale, network effects and brand, all of which will help the company take further market share in the global advertising industry. We believe the stock is attractive at approximately 20x EPS because the company has the potential to grow revenue at approximately 15% per year going forward, can improve operating margins through more expense discipline, and has a large cash balance on the balance sheet. JPMorgan Chase (JPM): Led by CEO Jamie Dimon, JPM has a superior and deep management team, leading franchises, and strong synergies among its various divisions. The company has a solid balance sheet, its capital metrics remain strong, and credit conditions for the company and the industry are still positive. Similar to other banks, the company has been negatively impacted by increasing regulatory pressure, low interest rates, and limited revenue growth. Despite these challenges, we believe management can improve earnings through better expense reduction and generate returns on tangible equity in the low-tomid-teens. With the stock trading at a Price-toTangible-Book ratio of approximately 1.2x, we believe the stock represents a favorable risk/reward investment. Pfizer (PFE): Pfizer is a global pharmaceutical company that has a stable, non-cyclical business model and enjoys significant advantages from patents and scale. The company is diverse both geographically and by product, has a good balance sheet, and generates good returns on capital. Revenue growth will be healthy due to a number of new drugs coming online that should offset the impact of the loss of exclusivity of some of their current drugs. The stock trades at a lowteens multiple to earnings, which makes it attractive given their stable business model and potential to grow revenue in the low single digits. Finally, the company expects to reach a decision within the next 6 months as to whether it will split itself into two separate companies. We believe the split could serve as a catalyst for the stock because it would result in more focused management teams, better capital allocation decisions, and enhanced capital structures. Pulte Group & Toll Brothers (tickers: PHM & TOL): PHM and TOL are two of the largest homebuilders in the U.S. We expect the homebuilding industry . /7 Financial Partners Capital Management fpcm.net Your FP/CM Q2 2016 Real Estate in Graphs: We favor homebuilding over Apartments REITS at this time. RENTING has been very popular since the recession and MULTIFAMILY properties have increased in price Rental rates have increased. BUYING is now cheaper than RENTING and AFFORDABILITY has remained HIGH We are not building enough houses to meet LONG-TERM DEMAND /8 Financial Partners Capital Management fpcm.net Your FP/CM Q2 2016 Our Investment “Balance Sheet” AARON COHEN, Ph.D. Partner, President, Portfolio Manager, POSITIVES + + + + CONCERNS Except for the risk of serious external shocks, it is difficult to foresee another deep recession at this time because the typical down-levers (capital expenditure, auto production, housing, excess leverage) are not extended. - The risk of recession has increased over the past few months. - BREXIT, although potentially positive for the UK in the long-term, is likely to generate serious economic & financial disruptions in the short & medium term. Central banks are unlikely to tighten monetary policy aggressively over the next 2 years. - The global economy, and in particular manufacturing, has slowed down over the past 18 months. - Earnings & earnings estimates have been negative since mid 2014. An upturn in earnings is necessary for U.S. equities to move higher. - The Federal Reserve reversed policy with last December’s hike, with the expectation of further increases over the course of the next couple of years, albeit at a moderate pace. - The Chinese economy has slowed down considerably over the past 3-4 years, exacerbating the decline in commodity markets, and slowing down emerging economies. - The U.S. Dollar strength has put pressure on the U.S. industrial sector, and emerging market currencies. - Higher leverage and the drop in oil and commodity prices are putting some emerging economies in a difficult position. - Inflationary expectations are extremely low. Even a random increase in headline inflation figures could scare the markets and put significant pressure on monetary authorities. - Lower productivity, the aging of the population in the developed economies, and low labor participation are important long-term headwinds for global economic growth. - Geo-political risks continue to increase across the globe. - Political “Populism”, on the rise across the world, could have major long-term economic consequences. - Valuation: Equity valuations are at best at fair levels. U.S. consumer spending should continue to grow thanks to increasing employment, higher wages, a recovery in U.S. household wealth, and the end of consumer deleveraging. Economic growth in Europe and in Japan, while still lackluster, has improved. + The rate of inflation is expected to remain low in the short- and medium-term. + U.S. Corporate balance sheets are in good shape. Free cash flow is plentiful, returnon-capital is high, and leverage is low. + Slow growth might be exactly what the developed economies can sustain and need at this time: lowers inflationary pressures, discourages re-leveraging, incentivizes savings, forces firms to remain efficient & keeps speculative tendencies in check. /9 Financial Partners Capital Management fpcm.net Your FP/CM Q2 2016 We hope you have enjoyed this publication. Please contact us with your questions, and with your thoughts and ideas to [email protected] We look forward to hearing from you! Thank you for your continued confidence and support. Your FP/CM Team Financial Partners Capital Management 150 East 52nd Street, New York, NY 10022 20900 N.E. 30th Avenue, Suite 517Aventura, FL 33180 t 646-277-7310 | t 305-921-4740 | f 646-277-7315 | fpcm.net | LinkedIn This newsletter might contain forward-looking statements, which involve risks and uncertainties. Actual results may differ significantly from the results described in the forward-looking statements. The information contained herein is for illustrative purposes only and should not be considered an offer to sell or a solicitation of any offer to buy interests in any particular investment. The inclusion of real estate properties discussed herein should not be perceived as investment recommendations and may no longer be held. Opinions and estimates expressed herein reflect the current judgment of Financial Partners Capital Management (FPCM), and are based on information obtained from sources, which are believed to be reliable, but FPCM does not offer any guarantees as to its accuracy or completeness. Nor are they intended as a forecast or guarantee of future results. The information is not necessarily updated on a regular basis; when it is, the date of the change(s) will be noted. In addition, opinions and estimates are subject to change without notice. FPCM, its officers, directors, employees, customers, or affiliates may have a position, long or short, in the securities mentioned herein and/or related securities, and from time to time may increase or decrease such position or take a contra position. FPCM may have other relationships with any company mentioned in this commentary. Past performance is not a guarantee of future results. No future or current client should assume that the future performance of any specific investment, strategy or product referred to directly or indirectly will be profitable or equal to any corresponding indicated performance levels. Reproduction without written permission is prohibited. /10 Financial Partners Capital Management fpcm.net