Market Monthly December 2012

Market Monthly

An analysis of the economy and
the markets

December 2012

The Economy
As we have observed over several months, a continued softening in the U.S. appears likely according to many coincident indicators we follow, including industrial production, sales, real personal income, as well as the ECRI Weekly Leading Index. Indeed, much of the globe is either in or near recession. Many economic indicators are coming in below expectations with negative revisions to prior periods. Business investment is declining and industrial production is generally contracting. Recently reported 3rd quarter 2012 GDP was revised up from 2.0% to 2.7% due to a spike in defense spending and inventory build, which are unlikely to be sustained. Indeed, negative revisions are likely because many coincident economic indicators for the period have been revised sharply lower. While recent ECB measures in Europe to reduce peripheral countries’ interest costs are a significant step in the right direction, the continent will remain mired in recessionary territory for the foreseeable future as structural issues and austerity measures continue to bite. However, the worst of the liquidity crisis appears to be past.

The Fed hopes its new quantitative easing measures (QE3) will improve employment and boost core inflation expectations (from current deflation concerns), but the economic impact has largely already played out. Fiscal policy remains the primary concern. The U.S. continues to remain vulnerable to adverse shocks, whether from the fiscal cliff, Europe, the Middle East, or elsewhere. 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 remain weak and consumer savings are low. 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 remains a bright spot as it continues to show progress and should provide positive long-term implications for the U.S. economy.

Equity Market Strategies
U.S. economic data has generally been below consensus with negative revisions. Recession has likely begun and profit margins and earnings should continue to weaken accordingly. The U.S. is vulnerable to shocks such as the European crisis or Mideast tensions. 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 remain attractive on a long-term basis, stocks are vulnerable in the near-term due to economic weakness and external shocks. While Fed quantitative easing should help financial assets temporarily and weaken the dollar, the underlying economic and company fundamentals will remain challenged.

Strengths:

  • Higher quality companies reasonably valued on a long-term basis
  • Federal Reserve is accommodative; QE3 just announced
  • Housing improving

Concerns:

  • Contracting economy
  • Weak consumer income and savings bode ill for consumption
  • Declining exports
  • Cyclical companies at higher risk

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 support corporate America.

Our short-term portfolios will be managed long relative to benchmark duration, as we believe the front-end of the yield curve will be anchored by an accommodative monetary policy. However, intermediate- and long-term portfolios will be managed neutral to benchmark duration, due to the potential for headline risks in Europe, the fiscal cliff and political uncertainty. Our portfolio positions will be underweight Treasury exposure versus corporate bond and securitized products; underweight government-related securities in taxable municipal bonds; and overweight select commercial and non-agency mortgage-backed securities. Our municipal portfolios will be managed long across all mandates as the municipal sector remains attractive.

Strengths: 

  • Fed on hold until mid-2015
  • Corporate fundamentals remain satisfactory
  • Strong investor demand/bond fund inflows
  • Continued low inflationary pressures

Concerns:

  • European economic woes
  • Fiscal cliff
  • Large budget deficit
  • Low absolute yields

Our Investment Strategy
The Advisory Solutions Team has decided to maintain the strategic allocation to equities, fixed income, and diversifying assets. Within equity, we are at our strategic weighting to international developed equities versus U.S. equities, and we are maintaining an equal weight to both growth and value stocks. Emerging markets stocks remain at their strategic weighting. Within fixed income, we are maintaining our overweight to U.S. aggregate fixed income versus international bonds. The balanced allocation should perform well in a variety of situations, including if the U.S. economy enters recession 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.

For these reasons, we believe our models should perform well in a slow to no-growth environment and are well-positioned for current and future economic conditions.

The opinions expressed herein are those of 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.

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