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When we wrote our last quarterly letter to you at the end of June, capital markets around the world were in panic mode due to the British voting to leave the European Union.  When was the last time you heard anything about the Brexit?  It is probably safe to say that once the U.S. stock market rebounded after a week, most people moved on and forgot this even happened.  With election dominated news, our normal financial reporting has been replaced with political propaganda.  Fortunately, by the time we write our next letter to you at the end of the year, the election will be behind us and we can (hopefully) get back to financial reports that are more meaningful.

Stocks and bonds both posted gains during the third quarter.  For stocks it was a relatively uneventful three months, which is not a bad thing.  The S&P 500 Index set a new record high in August before pulling back slightly to current levels.  Bond prices rose as interest rates dropped to record lows.  We expect to continue to see low interest rates as long as inflation remains tame.  For some perspective on this, for the five year period from 1977-1981, inflation averaged more than 10% per year.  Since then inflation has only reached 5% one time, and that was in 1990.  The inflation rate over the past twelve months is only 1%.  As we have said in the past, we think deflation is a bigger problem on a global scale than inflation is.

On the economic front, financial conditions in the U.S. remain accommodative and supporting of growth.  Job growth remains strong and the unemployment rate stands at 4.9%, which is usually considered to be full employment.  Over the past six years, the GDP of the U.S. has risen from $14 trillion to almost $18 trillion.  China’s GDP is $12 trillion, while Germany’s and Japan’s are less than $4 trillion.

Economic performance has improved markedly during the third quarter in China, which is great news for the smaller, emerging economies around the world.  Brazil and Russia, which together were in very deep recessions earlier this year are also in much better shape.  Why is this important?  Companies that make up the S&P 500 get 32% of their revenues from outside the U.S.  The world has become a global marketplace and problems, especially in the larger economies, are exported around the world.

By year end, some of our current problems will likely be forgotten, but they won’t be gone, just like the Brexit.  We continue to be somewhat cautious for the equity markets, but we would be surprised to see a major pull back during the remainder of this year.  We may even see a rally after the election as this uncertainty is removed.