Making The Most Out Of A Confounding Market

June 14, 2016 mcescher.com

Market Headwinds & Tailwinds

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Source: Citi Research (June 10, 2016)

A Long Path to Nowhere

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Source: Bloomberg, UBS

Short-Term Equity Returns Correlated with Oil

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Source: Bloomberg

Oil Supply/Demand Rebalancing is Positive for Equity Markets

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Source: Credit Suisse Research (June 2016), IEA, EIA, JODI, Petrologistics, Country Data

But Headwinds May Limit Oil Price Recovery

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Source: Credit Suisse Research (June 2016), IEA, EIA, JODI, Country Data

Inventories Remain Elevated Drilled but Uncompleted Well Backlog

Source: Rystad Energy (Jan. 2016)

A Stronger US Dollar Could Pressure Oil Prices

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Source: Bloomberg

3-Year Crude Oil Price (RHS) vs. Dollar Index Inverted (LHS)

Longer-Term, Technological Disruptions Could Pressure Oil Demand

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Source: Morgan Stanley Equity Research Energy Teach-In (May 2016) Source: Bloomberg New Energy Finance (April 2016)

Transport Sector Accounts for 64% of Oil Demand Electric Vehicle Development may Limit Demand Upside

Despite Accommodative Monetary Policy, Global Growth Remains Sluggish

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IMF GDP Growth Revisions (April 2016)

Source: The Economist (April 16, 2016)

Prospects for Global GDP Growth Have Shifted Down

Source: PIMCO (June 2016), IMF World Economic Outlook

Is the U.S. Entering a Soft Patch?

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Source: GavekalResearch (June 6, 2016)

Or Approaching Full Employment?

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Source: Lombard Street Research (June 13, 2016) Source: Deutsche Bank Research (June 13, 2016)

Jobless Claims vs. Job Openings Number of Unfilled Job Vacancies per Unemployed Worker

Are We Reaching the End of an Investment Era?

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“My take from these observations is that this 40-year period of time has been quite remarkable – a grey if not black swan event that cannot be repeated. With interest rates near zero and now

negative in many developed economies, near double digit annual returns for stocks and 7%+ for bonds approach a 5 or 6 Sigma

event, as nerdish market technocrats might describe it. You have a better chance of observing another era like the previous 40-

year one on the planet Mars than you do here on good old Earth.”

Source: Bill Gross Investment Outlook (June 2, 2016)

Lowest Interest Rates in 5,000 Years

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Source: BofA Merrill Lynch Global Investment Strategy (June 7, 2016), BoE, Global Financial Data, Homer and Sylla "A History of Interest Rates" Note: the intervals on the x-axis change through time up to 1700. From 1700 onwards they are annual intervals.

Persistently Low Inflation

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Source: BofA Merrill Lynch Global Investment Strategy (June 7, 2016)

Diminishing Yields on Fixed Income

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Source: “Most Expensive Bond Market in History Has Come Unhinged. Or Not.”, Bloomberg.com (June 12, 2016)

Over $6 Trillion in Negative Interest Rate Debt

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Source: JP Morgan (June 6, 2016)

Amount of global bonds outstanding with negative yield in JPM GBI broad index ($tn)

U.S. 10-Year Treasury Yield Lags S&P 500 Dividend Yield

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Source: “Most Expensive Bond Market in History Has Come Unhinged. Or Not.”, Bloomberg.com (June 12, 2016)

Search For Yield Leads To Stretched Valuations

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Source: UBS (June 3, 2016)

Forward PE Heat Map

What do the Following Stocks Have in Common?

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• Kraft Heinz • Clorox • Colgate-Palmolive • Fastenal • Coca Cola • Procter & Gamble • Hershey • Philip Morris Source: Bloomberg

Higher Forward PE Ratios than Google

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• Kraft Heinz (PE of 27.59) • Clorox (PE of 26.56) • Colgate-Palmolive (PE of 25.46) • Fastenal (PE of 24.18) • Coca Cola (PE of 23.23) • Procter & Gamble (PE of 22.66) • Hershey (PE of 22.55) • Philip Morris (PE of 22.54) • Google (PE of 21.93)

Source: Bloomberg

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Equity Valuations Elevated But Reasonable, Given Low Interest Rate Environment

Source: Bloomberg (as of June 13, 2016)

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Where Is The Opportunity?

1) Technology Sector: If comfortable with volatility, companies causing market disruption and on cutting edge of technological innovation have potential to create long-term value for patient shareholders.

2) Select Undervalued Stocks that have pulled back due to near-term headwinds, but have sustainable business franchises and competitive advantages.

3) High or Increasing Dividend Paying Companies with reasonable valuations, ample free cash flow, increasing and/or stable earnings, growing dividend payments and moderate dividend payout ratios.

4) Call writing on current positions that have elevated volatility and option premiums.

5) Select Emerging Markets where valuations are their lowest levels relative to U.S. equities

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Examples of Technology & Renewable Energy Companies with Long-Term Opportunities to

Grow Market Share & Earnings • Amazon • Google / Alphabet • Apple • Microsoft • Facebook • Visa • MasterCard • Tesla • Mobileye • First Solar • Hannon Armstrong

*See Technology Addendum for Charts on Structural Trends

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Examples Of Undervalued Stocks Where Consensus Is Too Pessimistic

• Apple (AAPL)

o Consensus: Company lacks innovation; iPhone in structural decline; China sales face existential political risk. o Anti-Consensus: Rising spending on research and development ($9b in last 12 months) suggests Apple is working on more than incremental iPhone updates

(such as vehicle technology); iPhone sales follow 2-year cycles and faced unrealistically high iPhone 6 comps; Apple assuring access to Chinese market by placating officials and investing in local businesses (such as $1b in DiDi); hardware/software focus creates moat around product ecosystem, warranting a higher multiple than generic hardware vendors; if earnings halved, company would still be most profitable in S&P 500.

• Gilead (GILD) o Consensus: Hepatitis-C revenues will soon crater; political pricing pressure to cut profitability; no growth prospects. o Anti-Consensus: Trading under 7x expected 2016 earnings, stock is already pricing in a substantial decline in Hep-C sales, which is unlikely to materialize in

medium-term; Sovaldi and Harvoni efficacy make Gilead’s Hep-C treatments substantially superior to those of competitors (Merck and AbbVie); Gilead has discounted its pricing – not in response to political pressure – but to grow market share and increase sales volumes; HIV segment, often overlooked, is roughly $10b and growing business, with ~75% US market share and expanding internationally; new CEO has committed to investing in continued scientific and product innovation and using Gilead’s $21b in cash to make accretive acquisitions.

• General Motors (GM) o Consensus: Auto sales at unsustainable peak levels; electric vehicles and automated driving pose long-term threat. o Anti-Consensus: Rarely do companies improve margins, beat earnings expectations and raise guidance, only to be punished with a compressing 5x multiple;

GM’s N. American car cycle (still underpenetrated in NY and CA), brand revitalization, growing aftermarkets business and leading presence in emerging markets is underappreciated; truck demand (most profitable segment and less prone to disruption) continues to grow; GM is committed to innovation and has invested in automated and electric vehicle development, as well as ride-sharing; if driving adapts to shared-mobility model, increased vehicle usage would lead to faster depreciation and shorter replacement cycle (a net positive for GM).

• Delta Airlines (DAL) o Consensus: Profits unsustainably high due to low fuel prices; airline industry lacks capacity and pricing discipline. o Anti-Consensus: Stock price nearly unchanged from 2014 when oil was ~$100/barrel; even at $70-$80 oil, profits would be outsized; Delta recently announced

plans to cut capacity growth in order to support revenue per airline seat mile metric; all airlines have likely learned excess capacity and pricing war lessons of prior cycles that ended in bankruptcy; plans to return excess free cash flow to shareholders in an amount equal to ~33% of market cap by 2018.

• JPMorgan (JPM) o Consensus: Interest rates in structurally low environment; legislative risks and regulatory burdens to increase. o Anti-Consensus: Fed is likely to raise rates over time, which would improve net interest margins; bank has proven it can operate profitably in a more stringent

regulatory environment and risk of congressional mandated break-up is remote given importance of institution to financial system; global reach of bank is impossible to recreate, providing moat around business; stock at current levels likely prices in mild recession; JPMorgan management is best of breed.

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Examples of Quality Dividend Paying Stock Opportunities

Select Real Estate Investment Trusts: • Hannon Armstrong (HASI) – Price to 2016 Est. Core Earnings: 17, Yield 5.71%, Payout to Core Earnings Ratio: ~ 100% • Pebblebrook Hotel Trust (PEB) – Price to 2016 Est. Funds From Operations (FFO): 9.06, Yield: 6.06%, FFO Payout Ratio:

51.33%

Stock Company Forward PE Dividend Yield Payout RatioFree Cash Flow to

Enterprise Value Yield13-5 Year Annual

EPS Growth Forecast 3-Year Annual

Dividend Growth ForecastGM General Motors Co 5.07 5.26% 22.44% 8.15% 9.58% 15.49%TUP Tupperware Brands Corp 12.61 4.86% 74.00% 4.86% 12.00% 5.46%T AT&T Inc 13.85 4.80% 80.51% 4.68% 3.92% 2.06%F Ford Motor Co 6.41 4.64% 32.28% 40.21% 6.67% 0.39%WDC Western Digital Corp 12.15 4.34% 28.51% 16.62% 4.63% 3.23%LYB LyondellBasell Industries NV 8.33 4.30% 31.60% 9.99% 5.67% 8.73%VZ Verizon Communications Inc 13.48 4.28% 47.54% 5.83% 3.95% 3.37%QCOM QUALCOMM Inc 11.95 4.01% 55.63% 10.95% 10.40% 8.12%MET MetLife Inc 7.48 3.77% 32.08% 22.02% 7.10% 9.46%IBM International Business Machines 11.08 3.71% 36.64% 8.75% 3.54% 9.72%INTC Intel Corp 13.13 3.24% 39.89% 7.76% 8.52% 5.67%WFC Wells Fargo & Co 11.60 3.19% 35.31% 0.00% 11.47% 6.83%JPM JPMorgan Chase & Co 10.57 3.06% 28.94% 0.00% 4.21% 10.89%MSFT Microsoft Corp 18.00 2.89% 82.53% 7.21% 8.99% 7.98%BLK BlackRock Inc 16.70 2.69% 44.13% 4.87% 13.54% 11.22%JCI Johnson Controls Inc 10.85 2.61% 47.46% 2.51% 9.20% 12.29%AAPL Apple Inc 11.57 2.33% 21.41% 14.66% 11.28% 7.42%HD The Home Depot Inc 19.45 2.20% 43.00% 4.65% 13.47% 11.83%CVS CVS Health Corp 15.91 1.78% 30.09% 4.91% 13.85% 16.01%DIS The Walt Disney Co 16.60 1.45% 36.58% 3.90% 10.08% 16.07%SBUX Starbucks Corp 26.81 1.45% 36.85% 3.11% 18.45% 18.82%NKE NIKE Inc 23.38 1.17% 28.43% 2.39% 13.91% 11.52%MA MasterCard Inc 25.62 0.81% 19.83% 3.95% 15.00% 13.37%V Visa Inc 26.53 0.72% 18.55% 3.46% 17.25% 14.94%

1. Free Cash Flow (FCF) is equal to operating cash flow less capital expenditures; Enterprise Value (EV) is equal to a company’s market capitalization plus outstanding debt less cash on balance sheet; FCF to EV Yield is a measure of FCF divided by EV.

Source: Bloomberg (June 14, 2016)

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Covered Call Strategy

• Opportunistically sell calls against positions in portfolio to generate extra income where either the position is fully valued, or call premiums are elevated.

• Selling 3-month or 6-month covered calls against current positions can enhance portfolio’s yield/income and protect against downside.

• Primary risks are: (1) holdings rally above option strike prices and are called away below market value and (2) holdings decline beyond strategy break-even levels.

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Twitter Call Overwrite Example

• Twitter has sold off 38% in 2016 (as of June 13th). • Stock has slumped as it is unable to broaden user base. • Speculation grows that it is a takeover candidate after

Microsoft’s purchase of LinkedIn Corp. • Buying TWTR stock ($14.55) and selling September $15 calls

(at $1.55) will generate an non-annualized return of 10.6% if the stock price is unchanged. The breakeven is below the 52-week low of $13.72. -25.00% -15.00% -10.00% -5.00% 0.00% 5.00% 10.00% 20.00% 25.00%

ExpDate Strike Price %Notl %OTM 10.92 12.37 13.10 13.83 14.55 15.28 16.01 17.47 18.1916Sep16 15.00 1.55 10.6% 3.1% -14.4% -4.4% 0.6% 5.6% 10.6% 13.7% 13.7% 13.7% 13.7%16Sep16 16.00 1.18 8.1% 9.9% -16.9% -6.9% -1.9% 3.1% 8.1% 13.1% 18.0% 18.0% 18.0%16Sep16 17.00 0.89 6.1% 16.8% -18.9% -8.9% -3.9% 1.1% 6.1% 11.1% 16.1% 22.9% 22.9%16Sep16 18.00 0.67 4.6% 23.7% -20.4% -10.4% -5.4% -0.4% 4.6% 9.6% 14.6% 24.6% 28.3%

Stock Price Change (% and $ terms)

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Select Emerging Markets

• Asian emerging market equities offer diversification. • The local markets benefit from falling interest rates. • Fiscal easing in countries benefits stock markets. • Attractive valuations (relative to U.S. equities).

Select Emerging Markets

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Technology Addendum

Falling Costs for Wind & Solar Energy

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“Learning rate” refers to the drop in costs for every doubling in industry scale. Source: Bloomberg New Energy Finance (April 2016)

Competing Views of Fossil Fuels vs. Renewables in Future Electricity Mix

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Source: US Energy Information Administration, International Energy Outlook 2016

EIA Projection of Electricity Generation through 2040

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Source: Bloomberg New Energy Finance (June 13, 2016)

Bloomberg New Energy Finance Electricity Generation through 2040

Competing Views of Fossil Fuels vs. Renewables in Future Electricity Mix

Development of Autonomous Vehicles & Shared Mobility

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Source: Morgan Stanley Research (April 19, 2016)

Exponential Improvements in Computing Power & Artificial Intelligence

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Source: “Artificial intelligence is changing SEO faster than you think,” TechCrunch.com (June 4, 2016)

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E-commerce vs. Traditional Retail

Source: Citi Research (May 25, 2016)

Long Runway For Cash To Card Payments Switch & Rise In Mobile Payments

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Source: Barclays Equity Research (June 1, 2016)

The Rise of Cloud Computing

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Source: JP Morgan (May 11, 2016)

Dislocation in Advertising Market

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Source: Mary Meeker, Internet Trends 2016 (June 1, 2016) Note: Data adjusted for inflation and shown in 2015 U.S. dollars. Television consists of cable and broadcast television advertising. Radio consists of network, national spot, local spot, and streaming audio advertising. Internet consists of mobile and desktop advertising.

Disclosure

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NOT AN OFFER TO BUY OR SELL – The information provided in this brochure is for informational purposes only and does not constitute an offer to sell nor a solicitation of an offer to buy any interest. Any offer can only be made by the relevant offering memorandum exclusively to eligible investors and only in jurisdictions in which such an offer would be lawful and exempt from registration. FACTS & OPINIONS – Although the statements of facts in this report have been obtained and are based upon sources believed to be reliable, their accuracy and any such information may be incomplete or condensed. All opinions and estimates included in this report constitute judgments as of the date of this brochure and are subject to change without notice. NO RECOMMENDATION – The mention of or reference to specific strategies or instruments in this brochure should not be interpreted as a recommendation or opinion that you should make any purchase or sale or participate in any transaction. NO TAX OR LEGAL ADVICE – Nothing in this brochure should be considered to be or construed as rendering tax or legal advice of any kind. CONFIDENTIALITY; NOT TO BE DISSEMINATED – The brochure contains proprietary information. The brochure has been provided to the recipient under the express agreement that the recipient will not reproduce, retransmit, distribute, disseminate, sell, publish, broadcast or circulate the report or any of its contents to anyone, without express prior written consent. SECURITIES OFFERED THROUGH WESTERN INTERNATIONAL SECURITIES, INC. Member FINRA and SIPC. Karmin Capital Management, LLC and Western International Securites, Inc. are separate and unaffiliated entities.