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Orlando's Outlook: Asset-allocation team adds to equities again

As of 06-18-2013

Bottom line For the second time this quarter, we opportunistically raised the equity position in our moderate growth asset-allocation model, this time from 57% to 59%, which is 70% of the maximum overweight (the minimum-to-maximum range is 52% to 62%). We made our tactical decision to potentially benefit from three expected developments. First, we are now forecasting stronger economic growth in this year’s second half, as we believe that a burgeoning “Wealth Effect” will offset a fading first-half fiscal drag, which could lead to better consumer-spending trends during the important Back-to-School and Christmas retail seasons. Next, stocks have corrected by 5% from mid-May’s new record highs—while benchmark 10-year Treasury yields have soared from 1.60% to 2.25% over the past six weeks—which we believe provides investors with an opportunity to average into stocks at more attractive prices. Finally, we believe that the consensus forecast among Fed Watchers—that the central bank will begin to taper its aggressive monthly bond-buying program at this week’s two-day Federal Open Market Committee (FOMC) meeting, which concludes tomorrow—is simply flat-out wrong. We believe, in sharp contrast, that this will be a data-dependent decision, and with the economy in the midst of a temporary slump, Fed policymakers are in no rush to begin pulling back on quantitative easing, which could spark a “sigh-of-relief’’ rally.

True, the S&P 500 rallied past our full-year target price of 1,660 to 1,687 in May, before correcting back to 1,598 earlier this month. We continue to believe that the equity market is undergoing an internal rotation at present, as investors take profits in expensive, yield-oriented defensive names and shift into cheaper, economically sensitive stocks. As such, we now believe that stronger economic growth will drive the S&P 500 to approach the 2,000 level within the next 18-24 months, which suggests to us that stocks could resume their grind higher to 1,750 or so before year end 2013.


Within equities, we added a tick each to domestic Mid Cap, taking it up to a neutral 6%, and domestic Small-Cap Growth, taking it up from a neutral 2% to 3%, which is half its maximum overweight.

Growth vs. value: We are at a 2% overweight in growth and a 1% overweight in value on economic fundamentals, valuations and sentiment.

Large vs. small: We are now at a 2% overweight in large-cap stocks, a 1% overweight in small-cap stocks and neutral on mid-cap stocks.

Domestic vs. international: At 39%, our domestic allocation is now at a 3% overweight, while our overall international exposure remains unchanged at 20% (a 4% overweight vs. a neutral 16%), with emerging markets at a maximum 5% weight. At 13%, developed international is still at a 1% underweight, while international small cap remains at a 2% over weight.

Fixed income

Investment-Grade Bonds: Our recommended allocation to investment-grade bonds remains at 11%, which is half the neutral weight of 22%. Recognizing that Treasury yields could rally after the conclusion of tomorrow’s FOMC meeting, we decided to hold duration constant at 95%, with a bias toward further lowering, given our view that any pullback in yields likely will prove temporary in a generally rising-rate environment.

High yield: High yield remains at an overweight 3% (versus a neutral 2%) on higher absolute yields and thus more income and spread opportunity, and on lower sensitivity to domestic interest rates and monetary policy.

International Fixed Income: We remain at a neutral 3%.


We lowered the allocation to Alternatives from 23% to 21% (vs. a neutral 16%), which is still half its maximum overweight, on 1-point reductions in each of Real Estate and Commodities, to fund the 2% increase in equities.

Treasury Inflation-Protected Securities (TIPS): TIPS were held at an overweight 9% (neutral is 8%), as the recent sell-off has improved their relative attraction.

Absolute Return: This stayed at an overweight 6% vs. a zero neutral allocation. Given very low yields on cash, we continue to place some of our normal cash allocation into this asset class. We expect that it should outperform cash and possibly bonds, with less downside, and serve as an effective hedge to declining stocks during pullbacks.

Net Short Equity: As we are only modestly overweight on the equity market currently, we have no allocation to this category.

Real Estate: We lowered our position from a neutral 4% to 3%, due to the potential negative impact that rising interest rates may have on REIT’s and other high-yield defensive stocks, such as utilities and telecoms.

Commodities: We lowered our position from a neutral 4% to 3% on slower-than-expected growth in the emerging markets, particularly China, which could hurt energy and metals.

Cash: Despite its 2% underweight position, easy-to-deploy cash remains at a sizable 3% allocation, freeing us to wait on the sidelines with some additional powder to burn, as we see where the economic, political and financial-market environment heads.

Views are as of the date above and are subject to change based on market conditions and other factors. These views should not be construed as a recommendation for any specific security or sector.
Bond prices are sensitive to changes in interest rates, and a rise in interest rates can cause a decline in their prices.
Diversification and asset allocation do not assure a profit nor protect against loss.
High-yield, lower-rated securities generally entail greater market, credit/default and liquidity risk and may be more volatile than investment-grade securities. For example, their prices are more volatile, economic downturns and financial setbacks may affect their prices more negatively, and their trading market may be more limited.
International investing involves special risks including currency risk, increased volatility, political risks, and differences in auditing and other financial standards. Prices of emerging-markets securities can be significantly more volatile than the prices of securities in developed countries, and currency risk and political risks are accentuated in emerging markets.
Investment in gold and precious metals, put options and commodities are subject to additional risks.
Investment in real estate involves special risks such as limited liquidity.
Mid-capitalization companies often have narrower markets and limited managerial and financial resources compared to larger and more established companies.
S&P 500 Index: An unmanaged capitalization-weighted index of 500 stocks designed to measure performance of the broad domestic economy through changes in the aggregate market value of 500 stocks representing all major industries. Indexes are unmanaged and investments cannot be made in an index.
Small-company stocks may be less liquid and subject to greater price volatility than large-capitalization stocks.
Value stocks tend to have higher dividends and thus have a higher income-related component in their total return than growth stocks. Value stocks also may lag growth stocks in performance at times, particularly in late stages of a market advance.
Federated Global Investment Management Corp.
Copyright © 2014 Federated Investors, Inc.

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