Economic and Market Update April 30, 2014 Fredric T. Walls, II Managing Director SunTrust Banks, Inc. Foundations and Endowments Specialty Practice (202)879-6689 [email protected] Taylor Howerton Director SunTrust Robinson Humphrey Financial Risk Management (404)926-5735 [email protected] Andy Richman, CTFA Director of Fixed Income SunTrust Banks, Inc. Private Wealth Management (561)972-9333 [email protected] Table of Contents I. Investment Overview II. Economic Overview III.Monetary Policy Overview IV.Investment Outlook V. Q&A Summary Global stocks were slightly higher in March, capping off a choppy first quarter – Equities proved resilient in March despite ongoing tensions in Ukraine and soft China economic data. A rebound in payrolls and manufacturing indicates the US is thawing from the winter chill, while Europe’s recovery continued at a gradual pace. – The MSCI ACWI, a proxy for global equities, rose 0.4% in March, finishing a choppy first quarter with a gain of 1.1%. The S&P 500 gained 0.8% in the month, bringing its year-to-date return to 1.8%; eight of the ten S&P 500 sectors were positive for the month, with Telecom, Utilities, and Financials gaining over 3%. – Emerging markets (EM) equity was the clear leader last month, gaining 3.1%. This rebound helped cut EM’s first quarter loss to just 0.4%. Conversely, Developed International markets declined 0.6% in March but closed the first quarter up 0.7%. Bonds were mixed in March, but outperformed stocks in the first quarter – Remarks from new Fed Chair Janet Yellen suggested short term interest rates could rise earlier in 2015 than market expectations led to a slight rise in yields; the benchmark 10-year US Treasury yield ended March at 2.72%, up from 2.65%. – The Barclays Aggregate Index declined 0.2% in March, but returned 1.8% in the first quarter. The Barclays High Yield Index extended its year-to-date outperformance by gaining 0.2% in March, while EM bonds snapped back with a return of 1.3%. Municipal bonds also continued its 2014 leadership, gaining 0.2% for the month and is now up 3.3% for the year. REITs and Commodities posted another positive month, as the FTSE NAREIT All Equity Index and DJ-UBS Commodity Index each gained 0.4%. Both asset classes are up strongly thus far in 2014. 2014 base case outlook remains intact – With economic series rebounding, we expect the US growth will rise near 3% over the course of the year. Our 2014 equity outlook remains unchanged; we anticipate positive but moderate returns with greater volatility. This view is predicated on an improving economic and earnings outlook as we progress through the year. Within fixed income markets, we continue to favor a slightly short maturity portfolio and taking credit risks over interest rate risks. 2 Economic Overview 3 Sluggish Recovery in World’s Largest Economies 2013 GDP GDP 2014E GDP 2015E Unemployment Rate 2014E United States 1.9% 2.7% 3.0% 6.4% China 7.7% 7.4% 7.2% 4.1% Japan 1.5% 1.4% 1.2% 3.8% Germany 0.4% 1.8% 2.0% 6.7% France 0.2% 0.9% 1.3% 10.8% UK 2.7% 2.7% 2.5% 6.8% Brazil 2.2% 1.9% 2.3% 5.7% (1.9%) 0.5% 1.0% 12.7% Russia 1.3% 1.1% 2.1% 5.7% India 4.5% 4.7% 5.3% 4.8% Canada 2.0% 2.3% 2.5% 2.8% World 2.1% 2.7% 3.0% 7.6% Country Italy The US holds 4.5% of the world’s population and produces 22% of global GDP 4 Source: Bloomberg, IMF, Consensus Estimates US Economic Indicators have Lagged by Most Measures… Industrial Production Total Workers Employed 109 106 Average Recovery 105 101 102 97 100 93 98 89 96 85 94 81 -18 -9 0 9 18 27 36 Average Recovery 104 45 92 54 9M jobs lost 651K to go -18 -9 Retail Sales 127 122 117 112 107 102 97 92 87 -9 0 9 18 27 9 18 27 36 45 54 45 54 Real Personal Income 109 107 105 103 101 99 97 95 93 91 Average Recovery -18 0 36 45 54 Average Recovery -18 -9 0 9 18 27 36 Source: Strategas Research Partners. Data through February 2014. Charts begin at cycle peak of Dec 2007 where indexed to 100. Average recovery ends after approx. 20 mos. 5 US Economic Indicators by Comparable Recessions US GDP Growth Three Years Into Recovery 30% Since the Great Depression, ten recessions have been followed by a recovery that lasted at least three years 25% 20% The recovery that started June 2009 was the weakest coming out of a recession as shown in the graphs to the left: 15% (1) GDP growth never been weaker 10% 6.8% (2) Unemployment rate never remained so high 5% 0% 1948-49 1953-54 1960-61 1969-70 1973-75 1981-82 1990-91 2001 2007-09 Recession Cycles US Unemployment Rate Three Years Into Recovery 10.0% 8.2% 8.0% 6.0% 4.0% 2.0% 0.0% 1948-49 1953-54 1960-61 1969-70 1973-75 1981-82 1990-91 2001 2007-09 Recession Cycles 6 Source: Bloomberg, US Department of Labor History suggests recessions caused by financial crisis lead to much slower recoveries But We Expect Growth to Pick Up in 2014 US Annual Real Economic Growth (%) >3% 2.8% 2.8% 2.5% 1.9% 2.5% 2.1% 2.0% 2011 2012 STI EST -0.2% -2.8% 2005 2006 2007 2008 2009 2010 Source: STI Econ 7 2013 2014 Recently Improved US Macro Backdrop Metric Description Case-Shiller Home Price Index 2.0% MoM% Change 1.5% 1.0% 0.5% 0.0% -0.5% Home prices up 8% YOY Housing starts up 11% YOY Residential investment growing > 20% and contributing -1.0% ~0.5% to GDP -1.5% Housing -2.0% Jan-09 Jan-10 Jan-11 Jan-12 Jan-13 Jan-14 Consumer Sentiment Consumer Consumer Sentiment 90 85 80 75 70 US consumer ~70% of GDP Consumer sentiment recently reached a five year high Profound impact on sentiment due to rising equity prices US manufacturing growth has outpaced other advanced 65 60 55 50 Mar-09 Mar-10 Mar-11 Mar-12 Mar-13 Mar-14 US Manufacturing Jobs Manufacturing US Manufacturing Jobs 50% economies, adding over 500,000 jobs in the past three years 0% -50% -100% a repatriation of jobs as technological innovation and -150% -200% Mar-09 Rising costs of labor abroad and shipping to the US has led to specialized skills lead to efficiencies in production Mar-10 Mar-11 Mar-12 Mar-13 Mar-14 Natural Gas Production The EIA estimates the US will become a net exporter of natural U.S. Natural Gas Production (Trillions of cubic feet per year) 30 gas by 2016 EIA Forecast 25 20 Shale Gas petroleum gases (LPG) for the first time 15 Other 10 Energy Recently, the United States became a net exporter of liquefied US carbon emission hit a 20 year low as producers converted 5 0 1990 from coal to less expensive natural gas 1995 2000 2005 2010 2015 2020 8 Source: Bloomberg, Haver Analytics, US Census Bureau, PIMCO, National Association of Realtors, EIA Economic Overview Some, but not all, economic data no longer impacted by the winter weather distortions rebounded for February, as new durable goods orders surged 2.2% and industrial production increased 0.6%. The trend of housing data, however, remains somewhat unknown as the most recent housing data still included the impacted weather timeframe and showed monthly declines. US Auto Sales (SAAR) Though March 2014 18.00 16.00 Units in millions Depending on the industry, most US economic data is beginning to reverse the larger-than-normal impact from the harsh winter season. Auto sales jumped to 16.3 million units (SAAR), up 6.9% in March, after weaker results during December and January. Retail and food sales rose 0.3% in February, snapping a two-month slump. Manufacturing gauges also 14.00 12.00 10.00 8.00 6.00 2008 2009 2010 Data source: Bloomberg 9 2011 2012 2013 2014 Economic Overview, continued Recent jobs data appears back on prior trend, helping US private payrolls finally exceed pre-recession high As expected, job growth Total US Private Payrolls Through March 2014 accelerated once the wicked winter weather passed. 120 along with revisions of 37,000 more than previously 115 reported for January and February. That took the sixmonth average to 188,000, roughly in-line with the prior trend. The composition of the March gains illustrate that the industries that suffered the worst weatherrelated declines, such as construction and retail, accelerated in March (or in February and March). This has helped US private payrolls finally exceed prerecession high. In millions Nonfarm payrolls increased by 192,000 jobs in March, 110 105 100 95 90 1994 1998 2002 Data source: FactSet 10 2006 2010 2014 Monetary Policy Overview 11 12 The Fed’s Dual Mandate Core Inflation Metrics Unemployment (U-3) & Underemployed (U-6): Since 1994 4% 18% 14% Annual % Rate Annual % Rate 16% 12% 10% 8% 6% 3% 2% 1% 4% 2% Apr-96 Apr-02 Unemployment Rate Apr-08 0% Feb-96 Apr-14 Feb-02 Core CPI Underemployment Rate Feb-08 Feb-14 Core PCE Labor Force Participation Rate The unemployment rate has fallen to 6.7% from a peak of 10%. 68% Large part of the drop is due to falling participation rate 67% Annual % Rate Core inflation metrics, the second part of the Fed’s dual mandate, remain dormant Yet, given the expansion of the Fed’s balance sheet, price 66% 65% 64% 63% stability may become a greater challenge in the future 62% Mar-96 Mar-02 Participation Rate Source: Bloomberg 13 Mar-08 Average: 66.0% Mar-14 Economists’ Interest Rate Outlook (Bloomberg Survey – March 2014) 3M LIBOR – Past & Projected The charts on the right show the Bloomberg consensus forecast for 3Month LIBOR (48 economists) and the 10-Year Treasury (76 economists) 1.00% 5.00% 0.90% 0.80% 4.00% 0.70% through the fourth quarter of 2014 With a few exceptions, there is a general sense within the economic community that short-term rates will remain low for an 0.60% 3.00% 0.50% extended period. This view is consistent with recent comments by 0.40% 2.00% the Fed 0.30% 0.20% 1.00% 0.10% 0.00% 0.00% Q412 12 Q4 Q213 13 Q413 13 Q214 14 Q414 14 Q2 Q4 Q2 Q4 Economist Averages Economist Predictions Economist Averages 10Y Treasury – Past & Projected Economic Expectations Current Q1 14 Q2 14 Q3 14 Q4 14 Q1 15 Q2 15 10Y UST 2.78% 2.84% 3.00% 3.16% 3.34% 3.46% 3.59% 2Y UST 0.43% 0.39% 0.49% 0.63% 0.80% 0.94% 1.13% 3M LIBOR 0.24% 0.27% 0.31% 0.35% 0.41% 0.47% 0.63% Fed Funds 0.25% 0.25% 0.25% 0.25% 0.25% 0.25% 0.38% Real GDP 2.40% 1.90% 2.80% 3.00% 3.05% 3.00% CPI 1.60% 1.40% 1.70% 1.80% 1.90% 1.95% Unem ploym ent Rate 6.70% 6.60% 6.50% 6.40% 6.20% 6.10% 5.00% 4.00% 3.00% 2.00% 1.00% 0.00% Q4 12 Based on Bloomberg Economist Survey (3/13/2014) 14 Source: Bloomberg, Indicative only – Not a recommendation or offer to deal Q2 13 Q4 13 Economist Averages Q2 14 Q4 14 Economist Predictions Market Response to QE GDP is expanding (slowly), yet US treasury rates are still near record lows 10-yr Treasury Yield vs. GDP (annualized) QE1 Op. Twist & QE 3/4 QE2 6.0% 10.0% 8.0% 5.0% 6.0% 4.0% 4.0% 2.0% 3.0% 2.0% Even in the depth of the recession, the 10-year Treasury yield was above 2%. Over the past 12 months, the 10-year 0.0% yield reached new record lows following -2.0% QE despite an expanding economy -4.0% -6.0% 1.0% -8.0% 0.0% Apr-04 Apr-06 Apr-08 US GDP (rt. Axis) Apr-10 Apr-12 -10.0% Apr-14 10-yr UST Treasury rates are lower now than at any point during the great recession Source: Bloomberg 15 Market Response to QE 10-Year Treasury Yield vs. S&P 500 QE1 Op. Twist & QE 3/4 QE2 6.0% 1900 Since the announcement on March 5.5% 18, 2009 of the first round of Quantitative Easing (ending March 2010), the S&P has gained over 1700 5.0% 1500 4.5% 4.0% 100% 1300 3.5% The announcement came in 3.0% December that the Fed would begin 2.5% reducing their quantitative easing program by $10bln per month 1100 900 2.0% 700 1.5% 1.0% Apr-04 Apr-06 Apr-08 10-yr UST Apr-10 Apr-12 S&P 500 (rt. Axis) The typical relationship between treasuries and stocks has decoupled since the Fed began QE programs Source: Bloomberg 16 500 Apr-14 Interest Rate Volatility – 10 Year Treasury Yield Interest rate markets dominated by the Euro-zone, FOMC, and negotiations in Washington Yield reaches 3% for first time since July 2011 Yellen more hawkish than expected at press conference 2.90% Fed begins QE taper Possible QE slowdown 2.70% Fed refrains from QE taper 2.50% Positive April employment report 2.30% 2.10% Russia/Ukraine situation escalates Congress passes bill to avoid many of the “Fiscal Cliff” tax increases 1.90% 1.70% Fed announces QE4: $45BN of Treasury purchases monthly 1.50% 1.30% Oct-12 Nov-12 Dec-12 Jan-13 Source: Bloomberg Better than expected February payrolls Feb-13 Mar-13 Apr-13 May-13 Jun-13 Jul-13 17 Aug-13 Sep-13 Oct-13 Nov-13 Dec-13 Jan-14 Feb-14 Mar-14 Apr-14 Historical 10 Year Treasury – Last 30 Years Despite recent move higher, interest rates are still near historic lows 18.00% 16.00% 14.00% 12.00% 10.00% 8.00% 6.00% 4.00% 2.00% 0.00% 1964 1969 1974 1979 10 Year Treasury 1984 1989 Avg (6.66%) 1994 1999 2004 2009 2014 Avg Since '90 4.98% History suggests long-term rates may increase rapidly once the Fed begins signaling an increase in short-term rates, and/or if the market begins to price in the risks associated with current monetary policy and the unprecedented US debt burden Source: Bloomberg 18 Investment Outlook 19 March 2014 Market Returns Total Return* Periods ending March 31, 2014 1 Month YTD 0.4% -0.1% 1.1% 2.5% 16.6% 2.4% US Equities Large-Cap US Stocks (S&P 500) Small-Cap US Stocks (Russell 2000) 0.8% -0.7% 1.8% 1.1% 21.9% 24.9% International Equities Developed Countries (MSCI EAFE) (net) Emerging Markets (MSCI EM) (net) -0.6% 3.1% 0.7% -0.4% 17.6% -1.4% US Fixed Income US Treasury Bonds (Benchmark 10 Yr.) Barclays Aggregate Bond Index BofAML High Yield Master Barclays Municipal Bond Index -0.3% -0.2% 0.2% 0.2% 3.4% 1.8% 3.0% 3.3% -4.4% -0.1% 7.5% 0.4% 0.0% 1.3% 3.0% 3.5% 4.5% -1.1% Non-Traditional REITs (FTSE NAREIT Equity Index) Commodities (Dow Jones UBS) The MSCI ACWI, a proxy for global equities, rose 0.4% in March, finishing a choppy first quarter with a gain of 1.1%. Emerging markets equity was the clear leader last month, gaining 3.1%, while Developed international was down 0.6% Remarks from new Fed Chair Janet Yellen suggested short term interest rates could rise earlier in 2015 than market expectations led to a slight rise in yields; the benchmark 10-year US Treasury yield ended March at 2.72%, up from 2.65% the previous month. The Barclays Aggregate Index declined 0.2% in March, but returned 1.8% in the first quarter. The 12 Months Global Markets (in US $) MSCI AC World Equity Index (net) Citi World BIG USD un-hedged International Bonds Citi World BIG non-USD un-hedged JPM Emerging Mkts Bond Index Barclays High Yield Index and the Barclays Municipal Bond Index each rose 0.2% last month, extending their year-to-date outperformance. EM bonds also snapped back with a monthly return of 1.3%. 0.4% 0.4% 8.5% 7.0% 3.3% -2.1% * All returns in US dollars Data Source: Factset 20 REITs and Commodities had another positive month and are up strongly thus far in 2014. Market Overview Global stocks rose modestly in March, capping off an uneven first quarter in which bonds outperformed MTD YTD 8% 7.0% 6% 4% 3.1% 3.3% 3.0% 2.5% 1.8% 2% 0.8% 1.8% 1.1% 0.7% 0.2% -0.7% -0.6% 0.4% 0.2% 0% -0.1% -0.4% -0.2% Commodity World Bond Muni Bonds HY Bond Agg Bond Emerging Mkts -2% Developed Int'l 0.8% in March, bringing its year-to-date gain to 1.8%. The MSCI Emerging Markets Index raced up 3.1% for the month, but remained the biggest laggard for the year. Through March 2014 Small Cap and across markets. The MSCI ACWI gained 0.4% for the month and 1.1% for the quarter. The S&P 500 rose Major Market Returns S&P 500 After the best year for global equities since 2003 and the worst annual performance for the Barclays US Aggregate Bond Index since 1994, a reversion in trends took hold as bonds outperformed stocks in the first quarter. World equities generally rallied during March and in the first quarter, but returns were uneven. There was a great deal of rotation within Returns are represented by the follow indices: Barclays Municipal Bond Index, Citi World BIG Index, Barclays Aggregate Bond Index, Barclays US Corporate High Yield Index, Barclays Bellwether 10 and 30 year US Treasury Index, Barclays Financial Institutions Bond Index, Barclays MBS Fixed Rate Bond Index and Barclays US Investment Grade Corporate Index. Data source: Morningstar and Barclays Live 21 Equity Market Overview Global stocks were slightly higher in March, capping off a choppy first quarter The MSCI ACWI, a proxy for global equities, rose 0.4% in March, finishing a choppy first quarter with a gain of 1.1%. The S&P 500 gained 0.8% in the month, bringing its year-todate return to 1.8%; eight of the ten S&P 500 sectors were positive for the month, with Telecom, Utilities, and Financials gaining over 3%. US & International Equity Market Returns Through March 2014 1.1% 0.8% US (S&P 500) 1.8% -0.6% Developed Int'l USD (EAFE) 0.7% -0.5% -0.3% Developed Int'l Local (EAFE) Emerging markets (EM) was the clear leader last month, Emrg Int'l USD (MSCI EM) gaining 3.1%. This rebound helped cut EM’s first quarter loss to just 0.4%. Conversely, Developed international was Emrg Int'l Local (MSCI EM) down 0.6% in March but closed the first quarter up 0.7%. 0.4% Global (MSCI ACWI) 3.1% -0.4% 1.9% -0.5% MTD YTD Returns are represented by the following indices: S&P 500 Stock Index, MSCI Emerging Market Index in US dollars and local currencies, MSCI EAFE developed country index in US dollars and local currencies. Data source: Morningstar 22 Equity Market Overview, continued Modest headline index gains masked significant rotation below the surface Despite relatively flat headline index performance, a tremendous amount of rotation within and across markets occurred in the quarter. Many of the more expensive, high growth areas, such as internet and biotechnology stocks, sold off late in the March, as investors re-priced the amount they were willing to pay for future growth expectations. Japan, 2013’s star performer, has struggled this year, while peripheral European markets Italy and Ireland jumped 14.6% and 14.0%, respectively. Select First Quarter Country Stock Market Performance Italy 14.6% Ireland 14.0% India 8.2% USA 1.7% Germany -0.3% Japan -5.6% China -5.9% Russia -24.0% -14.5% -14.0% -4.0% 6.0% Data source: Factset, country returns based on MSCI indices; data shown in USD on a net basis 23 16.0% Taxable Bond Market Overview Fixed Income Market Sector Returns Through March 2014 MTD YTD 10% 8.1% 8% 6% 2.5% 2% -0.2% Agg Bond -0.1% Mortg Backed Muni Bonds Corporate High Yield -0.3% -2% 0.9% 0.2% 0.1% World Bond 0% 1.8% 1.6% 0.2% month. As a result, the yield curve flattened during the first quarter. The Barclays Aggregate Index declined 0.2% in March, but returned 1.8% in the first quarter. Meanwhile, the Barclays High Yield Index rose 0.2%, extending its year-todate outperformance. EM bonds also snapped back with a monthly return of 1.3%. 3.4% 3.3% 2.9% -0.3% US Tsy 30 Yr 3.0% US Tsy 10 Yr 4% Returns are represented by the following indices: Barclays Municipal Bond Index, Citi World BIG Index, Barclays Aggregate Bond Index, Barclays US Corporate High Yield Index, Barclays Bellwether 10 and 30 year US Treasury Index, Barclays Financial Institutions Bond Index, Barclays MBS Fixed Rate Bond Index and Barclays US Investment Grade Corporate Index. 3/31/2014 Spurred by low rates and strong investor demand, companies continued to borrow in record amounts during the first quarter. With rising demand, spreads on corporate Treasury Yield Curve Comparison 5.00% Remarks from Fed Chair Yellen suggested short term interest rates could rise earlier than market expectations led to a slight rise in yields; the benchmark 10-year US Treasury yield ended March at 2.72%, up from 2.65% last bonds closed the quarter at their lowest levels since July 2007. The average spread on investment grade bonds was 106 basis points at the end of March. Still, we find value in corporate bonds from the incremental yield they offer over 12/31/2013 4.00% 3.00% Treasuries and recommend overweight position. 2.00% 1.00% 0.00% 123 5 7 10 15 20 Maturity (years) 25 30 investors maintain an With spreads are at seven-year lows and some of the recent issuance driven by equity-friendly motives on the part of corporations, we believe security selection and active management of positions is critical. Data source: Bloomberg 24 Commodity Market Overview Surge in agriculture help commodities notch fourth straight monthly gain Gains in agricultural commodities offset a selloff in precious and industrial metals as the DJ-UBS Commodity Index gained 0.4% in March, bringing its year-to-date gain to 7.0%. Wheat prices surged over 15% while corn and grains jumped over 8% in March, aided by extreme weather conditions. Metals prices were generally lower. Copper fell over 5% on China growth concerns. The DJ-UBS Gold Index fell 2.9% in March and Silver declined 7.0%. Energy markets were mixed; natural gas gave back some of its previous gains. Commodity Index and Sector Returns Through March 2014 MTD YTD 20% 16.5% 15% 10% 7.0% 5.4% 5% 4.2% 5.0% 0.4% 0% -1.8% -1.6% -5% -4.6% -4.0% -10% Industrial Metals Precious Metals Energy Agriculture DJ-UBS Commodity Index Returns are represented by the follow indices: DJ-UBS Commodity Index and the following Sector Sub-Indexes of the DJ UBS Commodity Index: Industrial Metals, Precious Metals, Energy and Agriculture. Data source: Morningstar. 25 Alternatives Investment Overview Hedge funds stumble in March, but post solid first quarter results Choppy equity markets hampered hedge fund returns during March as the HFRI Fund Weighted Composite Index slipped 0.3%. Similarly, most of the major equityrelated strategies were negative for the month. Conversely, fixed incomebased approaches outperformed as the HFRI Relative Value Index rose 0.6% in March and were the best performing strategy during the first quarter, up 2.4%. Other narrowly-focus fixed income approaches also did well in March. Hedge funds, however, largely kept pace for the first quarter as the HFRI Fund Weighted Composite Index gained 1.1% compared to 1.8% for the S&P 500 Index. Comparative HFRI Hedge Fund Returns Through March 2014 MTD YTD -0.3% Fund Weighted Composite 1.1% -0.2% Equity Hedge Macro: Systematic Diversified 1.4% -1.9% -1.8% 0.6% Relative Value 2.4% -0.9% Fund of Funds Diversified 0.1% -0.2% Barclays Aggregate Bond 1.8% 0.8% S&P 500 1.8% -2.0% 0.0% 2.0% 4.0% Data Source: Hedge Fund Research, Factset Hedge fund investing involves substantial risks and may not be suitable for all clients. Hedge funds are intended for sophisticated investors who can bear the economic risks involved. Hedge funds may engage in leveraging and speculative investment practices that may increase the risk of investment loss, can be illiquid, and are not required to provide periodic pricing or valuation information to investors. Hedge funds may involve complex tax structures, have delays in distributing tax information, are not subject to the same regulatory requirements as mutual funds and often charge higher fees. 26 Strategy Summary April 2014 These positions represent SunTrust’s outlook regarding the attractiveness of asset classes and strategies versus our benchmark over a tactical time horizon in a balanced portfolio. Our opinions are informed by the assessment of global economic variables, financial stress indicators, valuation metrics and technical analysis under a broad range of potential risk and return scenarios. Category Underweight Neutral Overweight PORTFOLIO RISK EQUITY Valuations at rich levels and expectations for rising rates to increase borrowing costs. Improving economies, but these markets remain vulnerable and structural issues remain. Improving growth and credit environment is especially positive for smaller-cap companies. Non-US Dev. Mkts. Small Cap Emerging Markets While economically important and favorably priced, these markets still face headwinds. Should be a near-term beneficiary of a moderately improving economy and labor market. Real Estate Securities Though valuations are fair, commodity supply dynamics are not favorable. US Government Particularly vulnerable to a rise in rates; TIPS continue to provide some relative value. US Mortgage-Backed Securities Tend to outperform government bonds when rates rise and have a slightly higher yield. US Investment Grade Corporate US Preferred Securities US Convertible Within credit, investment-grade bonds have lower yields and a longer duration profile. High risk profile and sensitivity to interest rates increase chance for negative returns. Opportunity relative to US equity and credit is not compelling. Municipal Attractive on an after-tax basis, but underweight due to potential for rising rates. Better yield, lower duration and current environment supports low default expectations. US High Yield Provides duration management and return opportunity should rates rise. US Leveraged Loans Yields likely to remain lower than US as economic trends/monetary policy lag. Attractive yields and diversification opportunity, but volatility may persist near term. Emerging Markets NON-TRADITIONAL Alternative Strategies Real Assets With a better economy and a transition in Fed policy, rates should move higher; we continue to underweight the more interest-rate sensitive bond market sectors. FIXED INCOME Non-US Developed Markets Earnings growth potential, improved lending conditions and increased M&A activity. Non-US Developed Markets Natural Resources US leads recovery; reasonable valuations, strong balance sheets, and diverse revenue. US Small & Mid Cap Master Limited Partnerships Stocks are reasonably valued and offer dividend yields competitive with bond yields. US Large Cap Investment Rationale Improving economy and record corporate profitability vs. a maturing economic cycle, fair equity valuations, still fragile European recovery and emerging market risks. Allocations to hedge funds should smooth returns and expand the opportunity set as stock market returns moderate and a move up in interest rates pressures fixed income. Offers differentiated sources of return and lower risk profile vs. equity. Hedged equity should benefit from falling intra-stock correlations. Current data do not support adding inflation protection to portfolios. Commodities expected to be pressured by a stronger dollar, slower growth in China and improving supply. Allocations based on a balanced portfolio. Neutral = within 10% of benchmark weight; Over/Underweight = over 11% deviation from benchmark weight. Opportunistic allocations are out-of-benchmark and are made within a range of 0-20%. Benchmark = 50% MSCI All Country World Index, 50% Barclays Aggregate Bond Index. = No Allocation; = Current Allocation; = Opportunistic Allocation 27 What Next? Reasons for Concern Reasons for Optimism Improving economic backdrop Structural employment problems Housing market recovery Global monetary policy can distort markets and create unintended Wealth impact from increasing home consequences and equity prices Aging demographic trends Rapid technological innovation Large fiscal deficit Stabilizing European debt crisis 28 Q&A 29 Important Disclosures The information and material presented in this commentary are for general information only and do not specifically address individual investment objectives, financial situations or the particular needs of any specific person who may receive this commentary. Investing in any security or investment strategies discussed herein may not be suitable for you, and you may want to consult a financial advisor. Nothing in this material constitutes individual investment, legal or tax advice. Investments involve risk and an investor may incur either profits or losses. Past performance should not be taken as an indication or guarantee of future performance. Services provided by the following affiliates of SunTrust Banks, Inc. : Banking and trust products and services, including investment advisory products and services, are provided by SunTrust Bank. Securities, insurance (including annuities) and other investment products and services are offered by SunTrust Investment Services, Inc., an SEC registered brokerdealer and a member of the FINRA and SIPC, and a licensed insurance agency. 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The information contained in this material is produced and copyrighted by SunTrust Banks, Inc. and any unauthorized use, duplication, redistribution or disclosure is prohibited by law. STIS’s officers, employees, agents and/or affiliates may have positions in securities, options, rights, or warrants mentioned or discussed in this material. 30 Important Disclosures Asset Allocation does not assure a profit or protect against loss in declining financial markets. Emerging Markets: Investing in the securities of such companies and countries involves certain considerations not usually associated with investing in developed countries, including unstable political and economic conditions, adverse geopolitical developments, price volatility, lack of liquidity, and fluctuations in currency exchange rates. Fixed Income Securities are subject to interest rate risk, credit risk, prepayment risk, market risk, and reinvestment risk. Fixed Income Securities, if held to maturity, may provide a fixed rate of return and a fixed principal value. Fixed Income Securities prices fluctuate and when redeemed, may be worth more or less than their original cost. Hedge funds may involve a high degree of risk, often engage in leveraging and other speculative investment practices that may increase the risk of investment loss, can be highly illiquid, are not required to provide periodic pricing or valuation information to investors, may involve complex tax structures and delays in distributing important tax information, are not subject to the same regulatory requirements as mutual funds often charge high fees which may offset any trading profits, and in many cases the underlying investments are not transparent and are known only to the investment manager. International investing entails greater risk, as well as greater potential rewards compared to U.S. investing. These risks include potential economic uncertainties of foreign countries as well as the risk of currency fluctuations. These risks are magnified in emerging market countries, since these countries may have relatively unstable governments and less established markets and economies. Investing in smaller companies involves greater risks not associated with investing in more established companies, such as business risk, significant stock price fluctuations, and illiquidity. uncomfortable with this level of risk should not trade managed futures or commodities. Real Estate Investments are subject to special risks, including interest rate and property value fluctuations, as well as risks related to general economic conditions. Because of their narrow focus, sector investments tend to be more volatile than investments that diversify across many sectors and companies. High Yield Fixed Income Investments, also known as junk bonds, are considered speculative, involve greater risk of default and tend to be more volatile than investment grade fixed income securities. 31 Index Definitions It is not possible to invest directly in an index Barclays Aggregate Bond Index: The broadest measure of the taxable U.S. bond market, including most Treasury, agency, corporate, mortgage-backed, asset-backed, and international dollar-denominated issues, all with investment-grade ratings (rated Baa3 or above by Moody’s) and maturities of one year or more. Barclays US Corporate High Yield includes USD-denominated, non-investment grade, fixedrate, taxable corporate bond market. Securities are classified as high-yield if the middle rating of Moody’s, Fitch, and S&P is Ba1/BB+/BB+ or below. Barclays Corporate Bond Index includes fixed rate corporate bonds with a maturity of at least one year rated investment-grade (Baa3/BBB-/BBB-) or higher using the middle rating of Moody’s, S&P, Fitch after dropping the highest and lowest available ratings. Barclays US Government Index is representative of fixed income obligations issued by the U.S. Treasury, government agencies, and quasi-federal corporations Barclays 10-Year U.S. Treasury Bellwethers Index is a universe of Treasury bonds, and used as a benchmark against the market for long-term maturity fixed-income securities. The index assumes reinvestment of all distributions and interest payments. Barclays 1-15 Year Municipal Index is an unmanaged index of investment grade tax-exempt municipal bonds with maturities of one - 15 years The J.P Morgan Emerging Markets Bond Index Plus (EMBI+) tracks total returns for traded external debt instruments (external meaning foreign currency denominated fixed income) in the emerging markets. The regular EMBI index covers U.S.dollar-denominated Brady bonds, loans and Eurobonds. The EMBI+ expands upon J.P.Morgan's original Emerging Markets Bond Index (EMBI), which was introduced in 1992 and covered only Brady bonds. An external debt version, the EMBI+ is the JPMorgan EMBI Global. JPMorgan EMBI Global Index is an unmanaged index that tracks debt securities of emerging markets FTSE NAREIT Equity REIT Index is an unmanaged index reflecting performance of the U.S. real estate investment trust market BofAML US Treasury 3-Month Bill is represented by the a subset of The Bank of America Merrill Lynch 0-1 Year US Treasury Index including all securities with a remaining term to final maturity less than 3 months. US intermediate term government bonds index is derived from Morningstar’s database and tends to have a similar duration of three to five year treasuries 32 Credit Suisse Leverage Loans is a representative index of tradable, senior secured, U.S. dollar denominated non-investment-grade loans DJ Dividend Select Index is an index that selects stocks by dividend yield, dividend per share growth, dividend payout ratio, and average trading volume and weighted by indicated annual dividend. The S&P GSCI® Gold Index provides investors with a reliable and publicly available benchmark tracking the COMEX gold future S&P 500 Index is comprised of 500 widely-held securities considered to be representative of the stock market in general. MSCI EAFE Index comprises 21 MSCI developed country indices outside of North America: Europe, Australasia and the Far East. MSCI Emerging Markets Index is a free float-adjusted market capitalization index that is designed to measure equity market performance of emerging markets. As of May 27, 2010 the index consisted of the following 21 emerging market country indices: Brazil, Chile, China, Colombia, Czech Republic, Egypt, Hungary, India, Indonesia, Korea, Malaysia, Mexico, Morocco, Peru, Philippines, Poland, Russia, South Africa, Taiwan, Thailand, and Turkey. Source: MSCI. The MSCI information may only be used for your internal use, may not be reproduced or redisseminated in any form and may not be used as a basis for or a component of any financial instruments or products or indices. None of the MSCI information is intended to constitute investment advice or a recommendation to make (or refrain from making) any kind of investment decision and may not be relied on as such. Historical data and analysis should not be taken as an indication or guarantee of any future performance analysis, forecast or prediction. The MSCI information is provided on an “as is” basis and the user of this information assumes the entire risk of any use made of this information. MSCI, each of its affiliates and each other person involved in or related to compiling, computing or creating any MSCI information (collectively, the “MSCI Parties”) expressly disclaims all warranties (including, without limitation, any warranties of originality, accuracy, completeness, timeliness, noninfringement, merchantability and fitness for a particular purpose) with respect to this information. Without limiting any of the foregoing, in no event shall any MSCI Party have any liability for any direct, indirect, special, incidental, punitive, consequential (including, without limitation, lost profits) or any other damages. MSCI All-Country World ex-US Index: is a free float-adjusted market capitalization weighted index that is designed to measure the equity market performance of developed and emerging markets, ex-US equities.