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December 20, 2013
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Steady as she goes into the homestretch
By: Clayton M. Albright, III, Director of Asset Allocation
Wilmington Trust Investment Advisors


Our Investment Strategy Team met this week and affirmed the weightings of our model asset allocation strategies.1 As depicted in Figure 1, we are overweighted, relative to our benchmarks, in equities. We are underweighted in fixed income securities—nominal bonds and cash equivalents combined. We are especially light on core bonds, such as U.S. Treasuries and investment-grade corporate and municipal debt. We continue to allocate to non-core bonds, such as speculative-grade floating-rate notes, and are overweighted in those assets by definition, because they are not included in our strategies' benchmarks. We retain our half-of-benchmark stakes—5% versus 10% in all strategies—in inflation hedges, which include inflation-linked bonds and commodity- and real estate-related securities.

So far 2013 has been a remarkable year for equity investors. Through November 30, 2013, the S&P 500 Index had outperformed the Barclays U.S. Aggregate Bond Index by 32.4%. Should the year end with this difference, it would mark the biggest historical differential going back to 1976. As we look to 2014, we expect that markets will continue to reward equity investors for a variety of reasons:
  1. We expect the global economic recovery to continue, despite the slowdown in emerging-market growth rates.
    1. Europe's economy, though still weak, appears to be stabilizing.
    2. The U.S. economy is likely to continue to grow more quickly, if slowly by historical norms, than most other developed economies.
    3. We have greater confidence in the U.S. recovery, in part because of the housing rebound.
    4. We expect U.S. GDP growth to accelerate to 2.5% or better in 2014, as the effects of U.S. fiscal drag decline while housing and business investment continue to increase.
    5. The Federal Reserve is likely to remain accommodative well into 2015 despite their decision this week to begin lowering their monthly bond purchases by $10 billion. We do not view "tapering" as equivalent to "tightening." Janet Yellen, current vice chairwoman of the Fed and presumptive successor to Ben Bernanke, has reinforced Bernanke's suggestions that the central bank's short-term interest rate target may remain near zero for some time after its bond-buying program has drawn to a close. This was reinforced by the Fed's decision to keep short rates low "well past reaching a 6.5% unemployment rate."
  2. We expect corporate earnings growth to continue to satisfy, though not overwhelm, investors.
    1. Our estimate of S&P 500 Index profits in 2014 is $116 per share, up from an estimated $109 per share this year. Our 2014 profit estimate is slightly conservative relative to the consensus forecasts of both top-down strategists and bottom-up company analysts ($118 and $122, respectively).
    2. We forecast that on September 30, 2014, the S&P 500 Index will be trading in a range of 1868–1988. The range reflects estimated price/expected earnings ratios of 15.5–16.5x and an earnings per share forecast of $120.50 for the 12 months ending September 30, 2015. Performance during 2013 has been largely driven by multiple expansion, but we expect next year's performance to be driven by earnings growth.
  3. As the Fed's tapering process evolves, we'd expect yields to rise further, thus hurting bond prices.
    1. The decision by the Federal Reserve to start decreasing their monthly bond purchases removes the uncertainty around the timing and magnitude of this expected policy change. Volatile markets may follow the decision but ultimately we expect investors to view the decision as positive for the economy and hence markets.
    2. We expect interest rates—specifically, the yield of the 10-year U.S. Treasury note—to climb into the 3.0% range or higher by the mid-2014, as the Fed begins to taper its asset purchases.
Looking ahead, our outlook for the first time in a long time is relatively clear of financial crisis, systemic risks, and government impasses. This supports our modestly optimistic view on economic growth, earnings increases, and market performance. However, we are also keeping a wary eye out for potential hazards that might not be part of our outlook now but should not be ignored:

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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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.

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