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Shareholder Report Commentary–November 23, 2016

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 so far in 2016. The U.S. economic recovery has been affected by a number of secular factors that are continuing to alter the pace and composition of growth. The U.S. economy in 2016 has been affected by greater prudence and less speculation in lending, low inflation and a higher savings rate. Although the U.S. economy is growing, it is growing at a lower than ideal rate. Currently, unemployment is 4.9%. Unemployment is estimated to average 4.7% in 2017. For 2017, the outlook remains for slower than ideal growth, low inflation and low interest rates. However, all of these items are estimated to be at a higher level in 2017 than 2016. U.S. Gross Domestic Product (GDP) increased 2.6% in 2015, 2.4% in 2014, 1.5% in 2013 and 2.3% in 2012. GDP increased at a stronger than expected inflation-adjusted annual rate of 2.9% in the quarter ended September 30, 2016. GDP is estimated to increase at an inflation-adjusted annual rate of 1.9% in the quarter ended December 31, 2016. GDP is forecast to increase 1.5% for the year ended December 31, 2016. GDP is forecast to increase 2.3% for the year ended December 31, 2017.

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 0.1% in 2015, 1.6% in 2014, 1.5% in 2013 and 2.1% in 2012. U.S. inflation increased at a 1.1 % rate in the third quarter of 2016. U.S. inflation is estimated to increase at a 1.8 % rate in the quarter ending December 31, 2016 and increase 1.3% for the year ended December 31, 2016. U.S. inflation is forecast to increase 2.5% for the year ended December 31, 2017.

There are some current and potential economic and investment negatives at the present time: (1) worldwide economic growth continues at a slower than ideal rate; (2) growth in Brazil, Japan and Russia has been weak; (3) although continuing to improve, unemployment at 4.9% is higher than ideal; (4) mortgage rates are low, but mortgage credit is still somewhat tight; (5) capital spending has been lower than ideal; (6) whenever there is a change of administration there are uncertainties, this time more so; (7) the manufacturing sector remains mixed; (8) there is a widening disparity between higher and lower income levels; (9) productivity remains weaker than ideal; (10) Great Britain leaving the European Union (“Brexit”) is causing uncertainty; and (11) problems with the Middle East and other parts of the world.

Some current and potential economic and investment positives are: (1) monetary policy, financial conditions and future increased fiscal stimulus including increased infrastructure spending are supportive of growth; (2) the U.S. economy has grown in the last twentyeight quarters and growth should continue in 2016 and 2017; (3) the U.S. economy has recently strengthened including retail sales, housing starts and orders for business equipment; (4) the rise in residential property values has added to net worth and households have strengthened their balance sheets; (5) unemployment is currently at 4.9%, the lowest in more than seven years, the labor market continues to tighten and unemployment is forecast to be 4.7% in 2017; (6) although the Federal Reserve probably will be raising interest rates near term, interest rates will still be very low by historical standards; (7) gasoline prices remain low; (8) there has been an increase in the willingness of companies to commit capital as evidenced by the increase in merger and acquisition activity; (9) businesses have been able to use the credit markets to strengthen their balance sheets; (10) the regulatory environment for business should improve; (11) many companies are repurchasing their shares; (12) current valuations of many stocks are reasonable taking into consideration inflation and interest rates; (13) the U.S. economy currently has better fundamentals than the economies of most other industrialized countries; (14) Euro-zone economic growth recently picked up to a faster level; (15) many central banks worldwide continue with monetary stimulus to boost growth; and (16) worldwide economic growth does not appear to be strong enough to lead to a significant rise in global inflationary pressures.

The World Economy

The global economic recovery that started in mid-2009 is continuing in 2016, although at a lower than ideal rate. The world economy is forecast to increase 2.6% in 2016 and 2.8% in 2017 after increasing 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 1.6% in 2016 and 1.6 % in 2017, after increasing 1.5% in 2015, 0.9% in 2014, and decreasing -0.4% in 2013 and -0.5% in 2012. Brexit has not weakened the U.K. economy yet. The United Kingdom’s economy grew at a stronger than expected 2.0% rate in the third quarter. The United Kingdom’s GDP is forecast to increase 2.0% in 2016 and increase 1.0% in 2017 after increasing 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 1.1% in 2016 and to increase 1.6% in 2017 after increasing 1.9% in 2015, 2.5% in 2014, 2.0% in 2013 and 1.8% in 2012. Japan’s GDP is forecast to increase 0.5% in 2016 and increase 0.4% in 2017 after increasing 1.5 % in 2015, decreasing -0.1% in 2014, and increasing 1.5% in 2013 and 1.9% in 2012. Korea’s GDP is forecast to increase 2.9% in 2016 and to increase 3.0% in 2017 after increasing 2.6% in 2015, 3.3% in 2014, 3.0% in 2013 and 2.0% in 2012.

The biggest 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% of the world’s total population of approximately 7.4 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 6.6% in 2016 and to increase 6.0% in 2017 after increasing 6.9% in 2015, 7.4% in 2014, 7.1% in 2013 and 7.7% in 2012.

India’s population is approximately 17% 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 7.6% in 2016 and to increase 7.5% in 2017 after increasing 7.2 % in 2015, 6.9% in 2014, 4.6% in 2013 and 5.0% in 2012.

Brazil is Latin America’s biggest economy. GDP is forecast to decrease -3.9% in 2016 and to increase 0.6% in 2017, after decreasing -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 decrease -0.2% in 2016 and to increase 1.6% in 2017 after decreasing -3.7% in 2015, and increasing 0.7% in 2014, 1.0% in 2013 and 3.4% in 2012.

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