An analysis of the economy and
Our outlook for the economy remains largely unchanged over the past few months as a recession both in the U.S. and Europe appears possible according to leading indicators we follow, including the ECRI weekly leading index. Although The Conference Board’s Leading Economic Indicators remain positive, recent better-than-expected economic data are coincident or lagging indicators and not inconsistent with an impending recession. Seasonal and measurement factors are likely boosting the past several months’ economic indicators as well. In Europe, investor confidence has been bolstered by recent ECB bank liquidity measures, but fiscal austerity and structural issues continue to point to recessionary conditions for much of Europe. The U.S. remains vulnerable to further adverse shocks, such as a disorderly default of Greece or Portugal and especially Italian and Spanish fiscal and bank concerns. Balance sheets for corporate America are reasonably healthy, but there is little willingness to add new workers given the uncertain economy and policy climate in Washington. Real income growth is very weak and consumer savings rates are quite low. Meaningful economic improvement, however, hinges on global policy makers shifting to a pro-growth stance and the impending global economic downturn running its course.
Among the bright spots we see is a bottoming of the U.S. housing market, expectation of continued low inflation and historically low interest rates. Numbering among our concerns are weak income growth, continued high unemployment and fiscal drag looming for next year.
Recent U.S. economic data has been well below consensus after roughly a six-month period of beating expectations. As we have discussed, much of that perceived improvement was due to an unseasonably warm winter “pulling forward” demand as well as measurement issues related to using the very uncharacteristic years 2007 and 2008 as a base (normal or typical) with which to compare current economic activity. Recession is likely, and profit margins should weaken accordingly. The U.S. is very 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.
Spread products are attractive to Treasury and Agency debentures and based on our forecast of future inflation, Treasury securities now offer negative real yields at several tenors along the term structure. The sovereign debt crisis in Europe spurred a flight-to-quality that has significantly increased risk premiums, which in many instances do not reflect the fundamentals of the individual securities.
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. Our portfolio positions will be underweight Treasury exposure versus corporate bond and securitized products; underweight government-related securities in favor of municipal bonds; and overweight select commercial and residential mortgage-backed securities. We have reduced our overweight corporate bond exposure, reinvesting proceeds in 15-year mortgages and Treasuries.
We remain at our strategic weighting to equity for all models. At the subclass level, we remain underweight non-U.S. developed stocks within equity, and underweight international bonds within our fixed income allocation. In Europe, fiscal austerity and structural issues continue to point to recessionary conditions. Political uncertainty within the region is also a significant risk factor. We believe U.S. stocks are poised to outperform their international counterparts over the near to intermediate-term. We also remain at our strategic weighting to diversifying assets (alternative strategies, REITs, and commodities), as they can provide downside protection and risk reduction in periods of high volatility.
The opinions expressed herein are those of Jeffrey J. Schappe, Chief Investment Officer of Sterling Capital Management, and the Sterling Asset Allocation 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.