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The S&P 500 suffered a miserable 4Q dropping -13.5% to erase all earlier gains and leave the index down -4.4% for the year.  Why?  We are in a rising interest rate environment which is bearish for equities (and fixed income securities).  Not only did the Fed raise short term rates four times in 2018, but it has also reversed Quantitative Easing (QE) and is now into Quantitative Tightening (QT).  The net effect of the Fed’s actions is to sop up some of that easy liquidity which had inflated the markets in previous years.  Secondly, the market correctly perceived slowing global growth.  Chinese exports are contracting due to tariffs, and Chinese consumers are retrenching (think iPhones).  U.S. earnings growth in 2019 will still be positive but markedly slower having lapsed the one-time tax cuts of 2018.  There was no Santa rally – only coal for Christmas.

The slowdown narrative is confirmed by sector performance analysis which shows the energy, industrial, and material sectors were all down -15.0% or more.  Only the safe haven of utilities posted a gain; that was a very modest +0.5%.

For the year, our best performing stock was BioSpecifics, up +39.9%.  The company owns the patents and receives royalties on both therapeutic and cosmetic injectable collagenase.  Our utilities, particularly First Energy (up +22.6%) added to performance.  Where we suffered was in the biotech arena – specifically with two companies that struggled to transition from development to commercial production.  Momenta, a maker of biosimilars, has fought tooth and nail in the courts against the generic companies whose drugs Momenta would supplant.  Synergy Pharma’s Trulance (irritable bowel syndrome) is a better drug than the established Linzess, but the company was unable to overcome first mover advantage and sales lagged.  We are completely out of both stocks.

Our single purchase in the 4Q was more Portola, inventor of the blood thinner reversal agent, Andexxa.  The stock was down on news that the European Union will delay approval of this 2nd Generation agent.  We used this weakness as a time to add to positions.  Since then, the 2nd Gen drug has been approved in the U.S. and is being rolled out to the top tier hospitals.

January 1, 2019                                                                           Paul F. Rodgers, CFA

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