Market Monthly

An analysis of the economy and
the markets

November 2012

The Economy
As we have observed over several months, a continuing softening in the U.S. economy appears likely according to many leading, and coincident, indicators we follow that include industrial production, the Federal Reserve Board of Philadelphia’s Leading Index of the U.S. and ECRI Weekly Leading Index. We have observed many economic indicators come in below expectations with some negative revisions to prior periods. Business investment is decreasing and industrial production is generally slowing. Since the end of 2011, lagging indicators such as GDP have shown deterioration. Recent ECB measures in Europe to reduce peripheral countries’ interest costs are a significant step in the right direction; however, we believe the continent will remain mired in uncertainty for the foreseeable future as structural issues and austerity measures continue. On a bright note, 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 in this challenged environment. 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 generally 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 this has positive long-term implications for the U.S. economy.

Equity Market Strategies
U.S. economic data has generally been below consensus with negative revisions. Along with the likely continued economic contraction, profit margins and earnings could weaken accordingly. The U.S. is susceptible to shocks such as the European crisis or Mideast tensions. That said, we 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 yield curve. Therefore, in order to outperform inflation investors need an allocation to taxable bonds. Corporate balance sheets remain reasonably healthy despite growing revenue and earnings pressures, and property prices have stabilized, which is supportive for corporate bonds and securitized products.

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 favor of municipal bonds; and overweight select commercial and residential mortgage-backed securities. Our municipal portfolios will be managed long across all mandates as the municipal sector remains extremely attractive.

Strengths: 

  • Fed on hold until mid-2015
  • Corporate fundamentals remain satisfactory
  • Consumer and corporate deleveraging
  • 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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