An analysis of the economy and
We are witnessing continued economic weakening in the U.S. Year-over-year payroll growth, despite upward revisions after Hurricane Sandy, has dropped to a new one-year low. Most coincident economic indicators have weakened considerably, especially on a year-over-year basis. While recent ECB measures in Europe to reduce peripheral countries’ interest costs were a step in the right direction, the continent will remain in recessionary territory for the foreseeable future. The Cyprus situation highlights the risks of policy mistakes. The Fed hopes its quantitative easing measures will improve employment and boost core inflation expectations (from current deflation concerns), but the economic impact has largely already played out. Recent tax hikes and the potential spending sequester are a concern. The U.S. continues to remain vulnerable to adverse shocks. Corporate America has taken advantage of record low interest rates to lever up from a low base, leaving it more vulnerable as earnings (and revenue) pressures continue to mount. Companies remain largely unwilling to add workers given the uncertain economic and policy environment in Washington. Consumer real incomes and savings rates remain below historic levels. Meaningful economic improvement, however, hinges on global policy makers shifting to a pro-growth stance, staunching the European crisis, and the global economic downturn running its course. Housing, a recent bright spot, is showing signs of moderating.
Equity Market Strategies
The U.S. is vulnerable to shocks such as the European crisis or tensions in the Mideast and Asia. We therefore favor a more diversified portfolio that offers greater growth and defensive exposure, with strong financial strength and attractive valuations. We believe these companies should outperform in this environment. While equity valuations in general are fairly valued on a long-term basis, stocks are vulnerable in the near-term due to economic weakness and external shocks. While Fed quantitative easing has helped financial assets temporarily and weakened the dollar, the underlying economic and company fundamentals will remain challenged.
- Higher quality companies reasonably valued on a long-term basis
- Dividend yield for many equities relatively attractive in current low interest rate environment; prospective dividend growth increases return potential
- Federal Reserve is accommodative
- Earnings and revenue growth quickly weakening as slow growth in the U.S. and recession in most of the developed world begin to sting
- Weak consumer income and savings bode ill for consumption
- Exports/imports growth increasingly challenged
- Cyclical companies at higher risk
- Housing growth will moderate
Fixed Income Strategies
Treasury securities offer negative real yields at several tenors along the term structure. Therefore, in order to outperform inflation investors need an allocation to spread products. Corporate balance sheets remain generally healthy despite growing revenue and earnings pressures. The gradually improving real estate market should support our overweight position in CMBS and in addition help regional banks’ balance sheets.
We have recently increased duration in our longer term taxable accounts to take advantage of the 10-year Treasury yield increasing to 2%. We are now roughly a quarter year long across all our taxable and tax-exempt portfolios. Our taxable portfolio positions remain underweight Treasury securities; overweight corporate bond and securitized products; underweight agency bonds in favor of taxable municipal bonds and overweight select commercial and non-agency mortgage-backed securities.
- Fed on hold until unemployment is less than 6.5%
- Corporate fundamentals, although weakening from a stronger base, remain satisfactory
- Growing pressure to reduce government debt/spending
- Continued low inflationary pressures
- Strong investor demand/bond fund inflows
- Looming sequestration risk
- Most of developed world in recession
- Large budget deficit
- Low absolute yields
- Increased shareholder-friendly activity
Our Investment Strategy
- The balanced allocation should perform well in a variety of situations, including if the U.S. economy slows materially or if it merely maintains a stable lower growth pattern. It will tend to underperform if the economy (and company earnings) grows at a much stronger clip, an unlikely occurrence in our opinion.
- We are maintaining our strategic allocation to equities, fixed income, and diversifying assets.
- We continue to recommend a 60/40 mix between U.S. and international developed equities, and we are maintaining an equal weight to both growth and value stocks.
- The weighting to emerging markets is currently below the long-term target allocation.
The opinions expressed herein are those of Jeffrey J. Schappe, CFA, Chief Market Strategist of Sterling Capital Management, and the Sterling Advisory Solutions Team, and not those of BB&T Corporation or its executives. The stated opinions are for general information only and are not meant to be predictions or an offer of individual or personalized investment advice. They also are not intended as an offer or solicitation with respect to the purchase or sale of any security. This information and these opinions are subject to change without notice. Any type of investing involves risk and there are no guarantees. Sterling Capital Management LLC does not assume liability for any loss which may result from the reliance by any person upon any such information or opinions.
Investment advisory services are available through Sterling Capital Management LLC, a separate subsidiary of BB&T Corporation. Sterling Capital Management LLC manages customized investment portfolios provides asset allocation analysis and offers other investment-related services to affluent individuals and businesses. Securities and other investments held in investment management or investment advisory accounts at Sterling Capital Management LLC are not deposits or other obligations of BB&T Corporation, Branch Banking and Trust Company or any affiliate, are not guaranteed by Branch Banking and Trust Company or any other bank, are not insured by the FDIC or any other government agency, and are subject to investment risk, including possible loss of principal invested.