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Shareholder Report Commentary–November 21, 2017

Annual Report

Investment Strategy

We believe that many stocks are currently selling at attractive valuations based on historical valuation measures. One of these valuation measures is a company’s price earnings ratio (the “PE ratio”) relative to inflation, interest rates and the economic outlook. Another valuation measure is a company’s PE ratio relative to its forecasted earnings growth rate (the “PEG ratio”). Many stocks of high quality companies are currently selling at PE ratios and PEG ratios below their average historical ranges relative to inflation, interest rates and the economic outlook..

Economic Discussion: The U.S. Economy

The U.S. economic recovery that started in mid-2009 has continued in 2017. The economic recovery has been affected by a number of factors that are continuing to alter the pace and composition of growth. The U.S. economy in 2017 has been affected by low inflation, stronger business and consumer confidence and spending, low unemployment, low interest rates and stronger worldwide economic growth. The U.S. economy is growing at a slightly lower than ideal rate. Unemployment was 4.9% in 2016, 5.3% in 2015, and 6.2% in 2014. Currently, unemployment is 4.1%, a 17-year low. Unemployment is estimated to average 4.4% in 2017 and to average 4.0% for 2018. U.S. Gross Domestic Product (GDP) increased 1.5% in 2016, 2.9% in 2015, 2.4% in 2014, 1.5% in 2013 and 2.3% in 2012. GDP increased at an inflation-adjusted annual rate of 3.0% in the quarter ended September 30, 2017. GDP is estimated to increase at an inflation-adjusted annual rate of 2.5% in the quarter ended December 31, 2017. GDP is forecasted to increase 2.2% for the year ended December 31, 2017 and to increase 2.6% in 2018.

U.S. inflation numbers have been helped in the last few years by global competition and technology innovations that are helping to lower production and distribution costs. Inflation, as measured by the Consumer Price Index, increased 1.3% in 2016, 0.1% in 2015, 1.6% in 2014, 1.5% in 2013 and 2.7% in 2012. U.S. inflation increased 2.0% in the quarter ended September 30, 2017. Inflation is estimated to increase 1.9% in the quarter ended December 31, 2017. Inflation is forecast to increase 2.1% for the year ended December 31, 2017 and to increase 2.2% in 2018.

We believe there are some current and potential economic and investment negatives at the present time: (1) although worldwide economic growth has strengthened, it continues at a slower than ideal rate; (2) growth in Brazil, Japan, Mexico and Russia has been weak; (3) some central banks may begin reducing some of their accommodative policies; (4) there is a widening disparity between higher and lower income levels; (5) productivity growth remains weaker than ideal; (6) Great Britain leaving the European Union (“Brexit”) continues to cause uncertainty; and (7) problems with the Middle East and North Korea.

We believe some current and potential economic and investment positives are: (1) small business confidence and spending is strong; (2) monetary policy, financial conditions and increased fiscal stimulus including increased infrastructure spending are supportive of growth; (3) the U.S. economy has grown in the last thirty two quarters and growth should continue in 2018; (4) manufacturing and services orders are strong; (5) the rise in residential property values has added to net worth and households have strengthened their balance sheets; (6) the labor market continues to tighten and unemployment is forecast to be 4.4% in 2017 and 4.0% in 2018; (7) consumer confidence and spending is strong; (8) although the Federal Reserve will probably be raising interest rates near term, interest rates will still be very low by historical standards; (9) gasoline prices remain low; (10) there has been an increase in the willingness of companies to commit capital as evidenced by the increase in capital spending and in merger and acquisition activity; (11) businesses have been able to use the credit markets to strengthen their balance sheets; (12) the regulatory environment for business has been improving; (13) many companies are repurchasing their shares; (14) lower taxes are likely; (15) current valuations of many stocks are reasonable taking into consideration inflation and interest rates; (16) the U.S. economy currently has better fundamentals than the economies of most other industrialized countries; (17) many central banks worldwide continue with monetary stimulus to boost growth; (18) worldwide economic growth has been strengthening and (19) there has not been a significant rise in global inflationary pressures.

The World Economy

The global economic recovery that started in mid-2009 has been strengthening in 2017. The world economy is forecast to increase 3.3% in 2017 and to increase 3.3% in 2018 after increasing 2.7% in 2016, 2.8% in 2015, 2.7% in 2014, 3.0% in 2013 and 2.7% in 2012.

The Eurozone’s GDP is forecast to increase 2.3% in 2017 and to increase 2.1% in 2018, after increasing 1.7% in 2016, 1.5% in 2015, 0.9% in 2014, and decreasing -0.4% in 2013 and -0.5% in 2012. The United Kingdom’s GDP is forecast to increase 1.5% in 2017 and to increase 1.7% in 2018 after increasing 1.8% in 2016, 2.3% in 2015, 2.8% in 2014, 1.7% in 2013 and 0.3% in 2012.

Among larger industrialized economies, Canada’s GDP is forecast to increase 3.0% in 2017 and to increase 2.1% in 2018 after increasing 1.4% in 2016, 1.9% in 2015, 2.5% in 2014, 2.0% in 2013 and 1.8% in 2012. Japan’s GDP is forecast to increase 1.6% in 2017 and to increase 1.0% in 2018 after increasing 1.0% in 2016, 1.5% in 2015, decreasing -0.1% in 2014, and increasing 1.5% in 2013 and 1.9% in 2012. Korea’s GDP is forecasted to increase 3.4% in 2017 and to increase 4.0% in 2018 after increasing 2.8% in 2016, 2.6% in 2015, 3.3% in 2014, 3.0% in 2013 and 2.0% in 2012.

The largest developing economies are many times referred to as the “BRIC” economy, which is short for Brazil, Russia, India, and China. China currently has the second strongest growth among “developing economies.” It is also currently the world’s second fastest growing major economy. China’s population is approximately 18.5% of the world’s total population of approximately 7.5 billion. In the second quarter of 2010, China overtook Japan and became the world’s second largest economy after the U.S. Many economists believe that China has a particularly good long-term outlook. Near term, however, there have been cross currents in China’s economic outlook and growth has been slowing, although economic growth is at a high rate. China’s GDP is forecast to increase 6.8% in 2017 and to increase 6.4% in 2018, after increasing 6.7% in 2016, 6.9% in 2015, 7.4% in 2014, 7.1% in 2013 and 7.7% in 2012.

India’s population is approximately 17.9% of the world’s population. India currently has the fastest growth among “developing economies” and it currently is the world’s fastest growing major economy. India’s GDP is forecast to increase 7.1% in 2017 and to increase 6.6% in 2018 after increasing 7.9% in 2016, 7.2% in 2015, 6.9% in 2014, 4.6% in 2013 and 5.0% in 2012.

Brazil is Latin America’s largest economy. GDP is forecast to increase 0.6% in 2017 and to increase 2.0% in 2018, after decreasing—3.6% in 2016, -3.9% in 2015, and increasing 0.1% in 2014, 2.3% in 2013 and 0.9% in 2012. Russia’s GDP is forecast to increase 1.9% in 2017 and to increase 2.0% in 2018, after decreasing -0.2% in 2016, decreasing -3.7% in 2015, and increasing 0.7% in 2014, 1.0% in 2013 and 3.4% in 2012.

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