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July 25, 2014
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Cautiously optimistic
By: Clayton M. Albright, III, Senior Fixed Income Portfolio Manager
Member, Investment Strategy Team
Wilmington Trust Investment Advisors

Our current outlook
"Optimismůmakes people go out andůstart businesses and spend and do whatever is necessary to get the economy going." – Ben Bernanke

Optimism is a beautiful thing, as the former Federal Reserve chairman noted in a 2012 interview. And this is no less true today, when – in the wake of the very volatile showing we saw in the first half of 2014 – it's understandable that recent positive economic indicators might awaken a renewed sense of hopeful expectation.

The Investment Strategy Team (IST) had its monthly meeting last week to discuss its weightings and outlook.¹ We find that economic activity is pointing toward a more consistent performance in the second half of the year, where growth is likely to range between 2.5% and 3%. The strongest story supporting the economy may be coming from the employment front, where job growth last month reached 288,000 new nonfarm payroll jobs, the unemployment rate slipped to 6.1%, and job openings reached 4.6 million. In our view, all of these could support an economic growth picture that might see GDP growth exceed 3%.


Furthermore, we find that data supporting the economy have also come from a wide assortment of other sources, including:

Reasons for caution
Despite the positive signs, we have tempered our outlook due to the following mild headwinds that continue to blow:

Our investment positioning
From an overall perspective, our belief that the expansion still has time to run and that growth will be modest supports our continued positioning favoring equities and growth. However, against a background that includes the potential risks listed above, we have decided to take on a slightly more defensive position.

The prospect of rising short-term interest rates and a flattening yield curve should not bode well for short-term investment-grade bonds, so we have proactively begun reducing this position, putting money into cash which we feel could outperform bonds, provide safety, and provide us with a source of liquidity to respond to new opportunities. We have added to our non-fully diversified portfolios multi-strategy liquid alternatives, which will give us the ability to adjust exposures to fixed income and equity markets with respect to interest rate sensitivity, credit exposure, and downside protection. Given the use of liquid alternatives, the tactical allocations in this area can be easily changed as market conditions warrant. Our thoughts have not changed on inflation hedges and we remain underweight, since we see inflation as a relatively benign threat.

As we look at the performance gaps between value and growth, and between large cap and small cap, the markets are very near the biggest levels seen earlier this year and at levels that have historically been considered extremes. For that reason and as part of our more defensive posture, we have reduced our exposure to small-cap equities. That said, we maintain our small-cap overweight, since making major modifications now could result in locking in losses at peak levels. In our view, patience is the best course of action at this time.

1 The construction of our model asset allocation strategies generally reflects a combination of asset class valuation and momentum measures, overlaid by the judgment of our Investment Strategy Team. The extent to which—and speed with which—strategy-following client accounts reflect the Investment Strategy Team's models may vary, reflecting client-specific circumstances such as liquidity, tax sensitivity, and investment horizon.

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   Investments: • Are NOT FDIC-Insured. • Have NO Bank Guarantee. • May Lose Value. 

Wilmington Trust is a registered service mark. Wilmington Trust Corporation is a wholly owned subsidiary of M&T Bank Corporation. Investment management and fiduciary services are provided by Wilmington Trust Company, operated in Delaware only, and Wilmington Trust, N.A., a national bank. Loans, retail and business deposits, and other personal and business banking services and products are offered by Manufacturers and Traders Trust Company (M&T Bank), member FDIC. Wilmington Trust Investment Advisers, Inc., a subsidiary of M&T Bank, is a SEC-registered investment adviser providing investment management services to Wilmington Trust and M&T affiliates and clients.

These materials are based on public information. Facts and views presented in this report have not been reviewed by, and may not reflect information known to, professionals in other business areas of Wilmington Trust or M&T Bank who may provide or seek to provide financial services to entities referred to in this report. M&T Bank and Wilmington Trust have established information barriers between their various business groups. As a result, M&T Bank and Wilmington Trust do not disclose certain client relationships with, or compensation received from, such entities in their reports.

The information in Market Insights has been obtained from sources believed to be reliable, but its accuracy and completeness are not guaranteed. The opinions, estimates, and projections constitute the judgment of Wilmington Trust and are subject to change without notice. This commentary is for information purposes only and is not intended as an offer or solicitation for the sale of any financial product or service or a recommendation or determination that any investment strategy is suitable for a specific investor. Investors should seek financial advice regarding the suitability of any investment strategy based on the investor's objectives, financial situation, and particular needs. Diversification does not ensure a profit or guarantee against a loss. There is no assurance that any investment strategy will succeed.

Any investment products discussed in this commentary are not insured by the FDIC or any other governmental agency, are not deposits of or other obligations of or guaranteed by M&T Bank, Wilmington Trust, or any other bank or entity, and are subject to risks, including a possible loss of the principal amount invested. Some investment products may be available only to certain "qualified investors"—that is, investors who meet certain income and/or investable assets thresholds. Past performance is no guarantee of future results. Investing involves risk and you may incur a profit or a loss.

Any positioning information provided does not include all positions that were taken in client accounts and may not be representative of current positioning. It should not be assumed that the positions described are or will be profitable or that positions taken in the future will be profitable or will equal the performance of those described. Positions described are illustrative and not intended as a recommendation outside of a managed account.

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