Fed policymakers seem conflicted by the data.  For example, in early April, Federal Reserve Bank of St. Louis President James Bullard said he favored reducing monthly asset purchases by $10 to $15 billion increments.  However, just a few weeks later, Mr. Bullard spoke at a conference in New York and warned that inflation remained too low and suggested that the Fed could increase its rate of asset purchases.  Richmond Fed President Jeffrey Lacker, who was strongly opposed to additional QE last September, said at the end of April that he would give serious thought to increasing stimulus if disinflation persists.  Nevertheless, we believe current monetary policy is largely being steered by Fed Chairman Bernanke, Vice Chairman Yellen, and New York Fed President Dudley, who have all been supportive of QE. 

As long as unemployment remains unfavorably high and consumer prices remain under control, the Fed is likely to remain focused on growth.  The statement from last week’s Federal Open Market Committee meeting indicates that the Fed may increase or reduce the pace of its asset purchases, depending on the outlook for the labor market and inflation.  For now, the Fed will continue to purchase mortgage-backed securities at a pace of $40 billion per month and longer-term Treasury securities at a pace of $45 billion per month.  We believe this program is likely to remain on track through the end of this year, and that it is premature to speculate about a reduction in QE.

Why has investor rhetoric recently shifted toward increased QE?  We believe the data speaks for itself.  As reflected in the tables below, there was a rather dramatic reversal in economic data for March (which was released on a lagged basis throughout the month of April), after a string of positive data for February.  Though one month does not necessarily indicate a trend, we believe the impact of fiscal tightening at home and abroad is beginning to negatively impact economic growth.  Not only have we seen weaker economic data in the U.S., but fundamental concerns about the growth trajectory in Europe have increased with the ECB cutting policy rates last week and hinting at the possibility of providing additional credit measures to fuel growth.  This week, the European Union warned that a recession in the euro zone is likely to continue through the rest of this year.   In the U.S., we believe the impact of sequestration (which went into effect on March 1st) may have begun to ripple through the economy over the past two months.  We also suspect that rising healthcare costs and the recent increase in payroll taxes have put pressure on consumer spending.

In addition to the deceleration in economic growth during the first quarter, corporate earnings results for the period were also somewhat disappointing.  So far, more than 80% of companies in the S&P 500 Index have reported their first quarter 2013 earnings results.  According to data compiled by Bloomberg, of those companies that have reported, more than half have posted lower than expected sales for the period.  While first quarter earnings per share have been largely better than expected, we believe a lot of the upside has been driven by low-quality factors such as accounting adjustments and share repurchases.  In addition, year-over-year earnings growth was generally weak in the first quarter, up just 2.4% on average (compared to 9.2% in the fourth quarter).  Sales actually declined 1.4% year-over-year on average, according to Bloomberg data, compared to 3.6% growth in the fourth quarter.  Weak topline results are particularly worrisome, considering that revenues are much more difficult than earnings to manipulate with accounting treatments.  In addition, we believe management guidance has been more negative than prior quarters, and many companies continue to focus on cost-cutting rather than growth initiatives.  Overall, we would characterize first quarter corporate earnings season as being rather lackluster, adding fuel to the speculation that the Fed could step in to provide further stimulus.

The Fed’s most recent statement asserted that “fiscal policy is restraining economic growth.”  This language was more intense than the Fed’s previous comment in March that fiscal policy had become “somewhat more restrictive.”  If fiscal tightening is to blame for the deceleration in March economic data, we believe economic growth is poised to decelerate further, considering that cost-cutting from sequestration still unfolding.  However, there is also the possibility that the government will intervene and replace sequestration with a watered down package of spending cuts.  We believe last week’s better than expected jobs report for April (and the upward revision to payrolls for March and February) reduces the probability of the government making revisions to sequestration and reduces the probability of the Fed adding stimulus.  In fact, we believe the rhetoric could shift back toward tapering of asset purchases if the employment report for May is strong.

Our base case scenario assumes that domestic economic growth remains slow and the Fed remains highly accommodative for at least the next 6 months.  We also believe sequestration is likely to remain in place over the intermediate-term, and that restrictive fiscal policy will continue to be a drag on the economy.  However, we expect that an ongoing recovery in housing through the second half of this year will provide a modest tailwind to economic growth. 

 -          Shelly Henbest

                   VP, Credit Analyst

In March, overall CPI inflation declined to 1.5% on a year-over-year basis from 2.0% in February.  The year-over-year Core CPI (CPI less food and energy) edged down to 1.9% from 2.0%.  The core inflation rate is slightly below the Fed’s long-term goal of 2.0% and remains below the trigger rate for policy action of 2.5%.

Retail Sales

In March, Retail Sales rose 2.8% on a year-over-year basis.  However, on a month-over-month basis, Retail Sales declined 0.4% in March.  Overall, recent consumer spending trends have held up well in spite of headwinds from higher payroll taxes, rising gas prices, a delay in tax refunds, and ongoing uncertainty about the government’s fiscal policy.  However, trends may be decelerating. 

Labor Markets

The April employment report showed that payrolls increased by 165,000 (better than the 153,000 consensus estimate).  The unemployment rate fell to 7.5% from 7.6%.  Private payrolls increased 176,000 (slightly ahead of expectations), while government jobs fell 11,000 in April.  The net revisions in nonfarm payrolls for February and March were up 114,000.  Overall, improvement in the labor market remains moderate.

Housing Starts

Single-family housing starts declined 4.8% in March to 619,000 from 650,000 in February.  Multi-family starts rose 31.1% in March.  Housing permits dropped 3.9% in the month which was weaker than expected.  Recent housing data suggests that the housing market may have lost some momentum after a relatively strong start to the year. 

 Yields declined in April, reflecting weaker than expected economic data.  Yields also continue to be influenced by the Fed’s accommodative monetary policy.

 The Federal Open Market Committee left policy rates unchanged at its April 30-May 1 meeting, as expected.  The Fed noted that the economy continues to grow at a moderate pace, but cautioned that fiscal policy has been restraining growth.  The Fed also highlighted that the housing market has continued to strengthen, while the labor market has also shown some improvement, though unemployment remains unfavorably high.  The Fed will continue to purchase mortgage-backed securities at a pace of $40 billion per month and longer-term Treasury securities at a pace of $45 billion per month.  However, for the first time, the Fed officially stated that it may increase or reduce the pace of its asset purchases, depending on the outlook for the labor market and inflation.  With the core inflation rate at just 1.9% in March (well below the Fed’s trigger rate for policy action of 2.5%), we believe the Fed’s current focus is primarily on growth. 

A comprehensive “laundry list” of fiduciary duties isn’t available within the governing law, which is the Investment Advisers Act of 1940.  However, the Chartered Financial Analyst (CFA) Institute has created and approved The Code of Ethics and Standards of Professional Conduct that CFA® charterholders are required to uphold. The members of our firm who hold CFA charters are bound by The Code of Ethics and Standards of Professional Conduct, and everyone at Chandler believes in and upholds the principles of the Code.

The tenets of the Institute’s Code of Ethics include the following:

• Act with integrity, competence, diligence, respect and in an ethical manner with the public, clients and prospective clients.
• Place the integrity of the investment profession and the interest of clients above personal interests.
• Use reasonable care and exercise independent professional judgment when conducting investment analysis, making investment recommendations, taking investment actions and engaging in other professional activities.
• Practice and encourage others to practice in a professional and ethical manner.
• Promote the integrity of and uphold the rules governing capital markets.
•  Maintain and improve their professional competence and strive to maintain and improve the competence of other investment professionals.

The Institute’s Standards of Professional Conduct elaborate on the principles of the Code of Ethics.  The following are some of the requirements of the Standards with regard to section III: Duties to Clients:

A. Loyalty, Prudence and Care.  Members and Candidates have a duty of loyalty to their clients and must act with reasonable care and exercise prudent judgment. Members and Candidates must act for the benefit of their clients and place their clients’ interests before their employer’s or their own interests.

B. Fair Dealing. Members and Candidates must deal fairly and objectively with all clients when providing investment analysis, making investment recommendations, taking investment action, or engaging in other professional activities.

C. Suitability.

1. When Members and Candidates are in an advisory relationship  with a client, they must:

a. Make a reasonable inquiry into a client’s or prospective client’s investment experience, risk and return objectives, and financial constraints prior to making any investment recommendation or taking investment action and must reassess and update this information regularly.

b. Determine that an investment is suitable to the client’s financial situation and consistent with the client’s written objectives, mandates, and constraints before making an investment recommendation or taking investment action.

c. Judge the suitability of investments in the context of the client’s total portfolio.

2. When Members and Candidates are responsible for managing a portfolio to a specific mandate, strategy, or style, they must make only investment recommendations or take only investment actions that are consistent with the stated objectives and constraints of the portfolio.

D. Performance Presentation. When communicating investment performance information, Members and Candidates must make reasonable efforts to ensure that it is fair, accurate, and complete.

E. Preservation of Confidentiality. Members and Candidates must keep information about current, former, and prospective clients confidential unless:

1. The information concerns illegal activities on the part of the client or prospective client,

2. Disclosure is required by law, or

3. The client or prospective client permits disclosure of the information.

Clients Benefit from the Institute’s Code of Ethics and Standards of Professional Conduct

In order to obtain the CFA designation, a candidate must gain command of a large body of knowledge focused on investment analysis, portfolio management, practical knowledge and ethics.  The designation shows that its holder has completed a graduate degree level of study and has passed three sequential 6-hour examinations.

Due to its depth and comprehensiveness, the CFA program is recognized worldwide as a comprehensive foundation for investment analysis and portfolio management.  Most industry professionals and many members of the public recognize the value of the designation.  Equally important to the CFA Institute and to the public is the program’s primary focus on ethics and professional conduct.

When a client retains an investment adviser who holds a CFA charter, the client can reasonably expect that the adviser will approach the portfolio in a methodical way that includes:

• First, a Charterholder has the depth and breadth of knowledge to understand fully the client’s investment objectives, risk constraints and investment policy.
• Next, a Charterholder has specific training in structuring an investment plan designed to fulfill the client’s objectives.
• And a methodology for evaluating, researching and selecting securities for inclusion in the portfolio is an integral part of their training.

Key to the process is that CFA charterholders are bound to execute the investment program in an ethical way that places the client’s interests above their own while aligning with the client’s needs.  They will seek best execution on securities that are suitable for the individual client, and must treat all clients fairly in all of their dealings.

We believe the CFA program combines the critical elements of knowledge and ethics to improve the quality of investment decision-making and the integrity of the investment industry.  This is why we support our employees’ participation in the program, and require that portfolio managers hold the CFA designation at the time they take on portfolio management responsibilities.

- Kay Chandler, CFA

     President

In February, overall CPI inflation rose to 2.0% on a year-over-year basis, up from 1.6% in January.  The year-over-year Core CPI (CPI less food and energy) rose to 2.0% from 1.9%.  The core inflation rate is currently in line with the Fed’s long-term goal of 2.0% but remains below the trigger rate for policy action of 2.5%.

Retail Sales

In February, Retail Sales rose 4.6% on a year-over-year basis.  On a month-over-month basis, Retail Sales rose 1.1% in February, exceeding the 0.5% consensus estimate.  Overall, recent consumer spending trends have held up well in spite of headwinds from higher payroll taxes, rising gas prices, a delay in tax refunds, and ongoing uncertainty about the government’s fiscal policy.

Labor Markets

The March employment report showed that payrolls increased by just 88,000 (well below the 193,000 consensus estimate).  The unemployment rate fell to 7.6% from 7.7% in February driven by a steep decline in the labor force.  Private payrolls increased 95,000 (vs. expectations of 200,000), while government jobs fell 7,000 in March.  The net revisions in nonfarm payrolls for December and January were up 61,000.  Overall, improvement in the labor market continues to be modest.

Housing Starts

Single-family housing starts rose slightly in February to 618,000, up from 615,000 in January.  Multi-family starts rose 1.4% in February.  Housing permits rose 4.6% in the month which was better than expected.  In our view, recent data suggests that the housing market continues to improve.

 Yields remained within a relatively tight range at low levels in March.  Overall, yields continue to be influenced by the Fed’s accommodative monetary policy.

 The Federal Open Market Committee left policy rates unchanged at its March meeting.  Overall, the Fed provided a modestly better assessment of the economy and noted the labor market has improved in recent months.  The Fed also highlighted the housing market has continued to strengthen, but fiscal policy has become more restrictive.  In a press conference after the March FOMC meeting, Fed Chairman Bernanke indicated that at some point the central bank is likely to adjust the pace of its asset purchases.  For the time being, the Fed continues to purchase mortgage-backed securities at a pace of $40 billion per month and longer-term Treasury securities at a pace of $45 billion per month.  The Fed is forecasting GDP growth of 2.3% – 2.8% and sees the unemployment rate falling to between 7.3% – 7.5% this year.

The team at Chandler took a look back at three previous tightening cycles to gain a better perspective on what to expect in the next tightening cycle regarding the Fed Funds rate and the Treasury yield curve. Neither Chandler nor the Federal Reserve are forecasting monetary policy to tighten in the traditional sense during fiscal 2013 – the purpose of the article is to get investors thinking about potential implications for their portfolio when the tightening cycle does commence. It is also important to note that due to the extraordinary measures taken by the Federal Reserve away from traditional monetary policy in the current easing cycle, primarily the various forms of Quantitative Easing (QE) and the corresponding expansion of the Fed’s balance sheet, the Federal Reserve will have traditional and non-traditional tools at its disposal to serve as a countercyclical force to the expanding economy. If inflation does surprise to the upside, the Federal Reserve has the ability to sell assets from its balance sheet, in addition to raising interest rates, to aggressively counteract any surge in inflation. Clouding our ability to draw definitive conclusions based on the historical data set is the fact that the Fed Funds target has never been set this low (0.25%), for this long (four plus years), which has over time contributed to the very low current yields on Two-year, Five-year, and Ten-year Treasury notes (see the below table).

In each of these three historical tightening cycles, a positive spread differential existed between the Fed Funds target and the Two-year Treasury prior to the beginning of a tightening in policy. In the May 2004 – June 2006 period the Fed Funds rate started at 1.00% versus Two-year notes at 2.54%, in May 1999 – May 2000 Fed Funds started at 4.75% versus Two-year notes at 5.40%, and in January 1994 – February 1995 Fed Funds started at 3.00% versus Two-year notes at 4.11% (see chart and tables). Also of note, at the beginning of each of the respective tightening cycles the Treasury curve had a positive slope (i.e., longer maturity notes had higher yields than shorter maturity notes). In all three tightening periods, the shorter the maturity of the Treasury notes, the closer the correlation to the change in the Fed Funds rate at the conclusion of the tightening cycle. The orange bar in the graphs highlights the yield change over the period for each of the respective securities. In all cases the longer the maturity, the smaller the overall change in yield (in the first cycle Ten-year notes change by 0.49%, in the second cycle Ten-year notes change by 0.67%, and in the third cycle Ten-year notes change by 1.56%).

Currently, the spread between the Fed Funds rate and the Two-year Treasury note is close to zero (0.25% versus 0.24%), implying in the next tightening cycle the Two-year note may match the change in the Fed Funds rate based on current valuations in a best case scenario. In longer maturity points, we can conclude the move wider in yields versus the Fed Funds rate will be less than one times the Fed Funds rate change, but clearly the starting point in yields at the beginning of the tightening cycle is crucial. The current low level of yields on both Five- and Ten-year Treasury notes supports the earlier notion that a tightening of policy is not priced into the market for 2013. We would anticipate longer maturity yields moving higher before the Fed begins raising the Fed Funds rate, thus the Treasury curve is likely to become steeper (differential between Ten-year and Two-year Treasury notes expands) before the commencement of a change in the Fed Funds rate.

The Federal Reserve publishes forecasts for the targeted Fed Funds rate quarterly. The most recent iteration valued the ‘long run’ central tendency of the Fed Funds rate at 4.0% sometime in 2016 or later. A 4.0% forecast appears to be more consistent with a Federal Reserve that is concerned about inflation. We think the Fed’s fears of inflation are aggressive based on two primary factors: changing demographics (both in the US and globally) and the synchronization of developed economies on a global basis. The average age of the population in the United States and globally is rising thereby increasing the demand for assets that pay a predictable stream of income. Despite the move lower in yields in the fixed income market, demand has not waned. We partially attribute the inelasticity of demand for fixed income to the aging population in developed economies. We believe the strong demand for fixed income will cause the differential between short maturity Treasury notes and the Fed Funds rate to contract on a secular basis, which will also lead to lower rates than would otherwise be the case.

The economic slowdown since the financial crisis of 2008 has impacted the global economy, not just the United States. All of the major developed country central banks (Federal Reserve, European Central Bank, and the Bank of Japan) are easing monetary policy to try and stimulate aggregate demand and to grow their economies. The economies of Europe and Japan also face significant demographic hurdles due to aging populations and are arguably in a more precarious situation than the United States despite the upcoming retirement wave of the baby boom generation domestically. If the Federal Reserve were to prematurely and aggressively tighten domestic monetary policy before the global economy was strong enough to absorb the change, the dollar would strengthen relative to other global currencies, likely leading to a domestic economic slowdown. We believe the Federal Reserve has an incentive to keep rates low relative to other developed economies to keep dollar based manufacturers competitive.

So where do Treasury rates normalize after monetary policy is no longer accommodative? If we assume the Federal Reserve will be able to keep the inflation rate at their long-run target of 2.0%, it is difficult to envision the Fed Funds rate trading at much of a premium to inflation. The demographic shifts mean fixed income assets will not have to offer as competitive a yield versus inflation to attract assets. In a normal environment Treasury yield curves are upward sloping. Therefore, assuming a Fed Funds rate 50 basis points above inflation, Two-year Treasury notes trading at a slight yield pick-up to the Fed Funds rate (approximately 2.75%), and 150 basis points for the term premium for Ten-year yields, 4.25% appears to be a good estimate of Ten-year Treasury yields sometime after 2015.

– William Dennehy II, CFA
            Portfolio Manager

Retail Sales
In January, Retail Sales rose 4.4% on a year-over-year basis. On a month-over-month basis, Retail Sales rose 0.1% in January, in line with expectations. Overall, recent consumer spending trends have been modest.

Labor Markets
The February employment report showed that payrolls increased by 236,000 (exceeding the consensus estimate of 171,000). The unemployment rate fell to 7.7% from 7.9% in January. Private payrolls were up 246,000 (vs. expectations of 195,000), while government jobs fell 10,000 in February. The net revisions in nonfarm payrolls for December and January were down 15,000. Overall, improvement in the labor market continues to be modest.

Housing Starts
Single-family housing starts rose 0.8% in January to 613,000 from 608,000 in December. Multifamily starts fell 24.1% in January after spiking in December. Though housing starts were weaker than expected in January, there was an ongoing increase in housing permits. Housing permits rose 1.8% in the month which was slightly more than expected. In our view, recent data suggests that the housing market continues to improve.

Yields remained within a relatively tight range at low levels in February. The US Treasury yield curve flattened as short-term yields rose slightly while longer-term yields declined. Overall, yields continue to be influenced by the Fed’s accommodative monetary policy.

The minutes from the January FOMC meeting indicated that the debate among Fed officials on quantitative easing (QE) is growing. Some Fed members voiced concerns about ongoing bond purchases and their longer-term impact on the economy and the threat of inflation, while others worried about cutting back prematurely on accommodation and the risk of rising interest rates. The minutes raised anxiety that the Fed will begin unwinding its policies before there is a meaningful pickup in employment. However, in early March, Chairman Bernanke defended continuing the central bank’s bond buying programs and signaled that the Fed remains committed to providing stimulus to the economy. He cautioned that raising interest rates too soon would be harmful to the economy. The Fed is maintaining its highly accommodative stance for now, and will continue to debate the cost/benefit of QE. The next FOMC meeting is scheduled for March 19 and 20.

Fourth quarter earnings have been generally better than expected.  More than half of the companies in the S&P 500 Index have reported fourth quarter earnings thus far, and of those, nearly 75 percent have posted positive earnings surprises.  Sales have also been generally better than expected with roughly two-thirds of companies posting positive sales surprises thus far.  According to Bloomberg data, earnings growth has been nearly 9% in aggregate on a year-over-year basis.  Financials, Materials, and Utilities have posted the largest year-over-year earnings growth rates, while Health Care, Industrials, and Telecommunication Services have posted year-over-year earnings declines, on average.  In terms of earnings surprises, Financials have posted the biggest upside surprises, while Telecommunications Services have posted the most disappointing results.  Forward-looking guidance for 2013 has been mixed, but overall analysts’ earnings per share estimates for the year have declined slightly (-0.38%) since the unofficial start of earnings season on January 8^th. In our view, this signals that guidance has been less favorable than expected, on average.

Thematic highlights from 4Q earnings season:

• Recent trends suggest that banks’ overall credit quality continues to improve, although net interest margins remain pressured by the low interest rate environment.  Mortgage businesses continue to be a source of earnings strength, but refinancing activity may be slowing.  Multiple banks are reducing headcount and remain focused on cost-cutting, especially as costs associated with increased regulation are likely to rise this year.
• Sequestration is likely to provide a significant headwind to revenues this year for companies exposed to the defense industry, such as General Dynamics, Lockheed Martin and Raytheon. However, some companies in the defense industry expect that growth in other areas of their business and in foreign markets will help offset the impact of spending cuts in the US. 
• Some companies including Constellation Brands and Texas Instruments have indicated that their businesses have been negatively impacted by uncertainties about government spending and by consumer anxiety stemming from the fiscal cliff and debt ceiling.  Most retailers have yet to report their fourth quarter earnings, but some may report that such uncertainty and anxiety hindered results.  Looking ahead, ongoing uncertainty about fiscal policy and the potential for significant spending cuts could be a headwind to consumer-related businesses this year, particularly in the first half of the year.
• Sales trends in Europe remain weak for many companies, but trends in emerging markets appear to be strengthening.  In particular, Alcoa, DuPont, and 3M were among the companies that signaled improving trends in China. 
• Share repurchase activity is likely to be aggressive this year as many companies, such as United Technologies and BlackRock, have authorized substantial share repurchase programs.

 2013 Outlook

Over the next twelve months, we expect the economy will continue to grow at a slow pace.  Momentum heading into the year was weak, following a 0.1% decline in GDP during the fourth quarter of 2012 (according to the advance estimate).  Market participants are currently forecasting GDP growth of just 1.5% in the first quarter of 2013, though growth is expected to accelerate throughout the year for a full year average growth rate of 2.0%.  Slow, but positive, economic growth should provide support for corporate earnings and credit quality this year, particularly as many companies have spent the past few years focusing on efficiency and strengthening their balance sheet.

However, we see a number of headwinds to the economy and corporate earnings this year.  We anticipate headwinds to consumer spending from higher taxes (a 2% increase in payroll taxes due to the expiration of the payroll tax holiday), higher gas prices (average prices have risen more than 7% since the end of 2012), and weakening consumer confidence (which dropped to 58.6 in January from 66.7 in December).  Government spending cuts are also likely to put pressure on the overall economy.  Federal defense spending declined 22.2% during the fourth quarter of 2012.  Uncertainties about taxes and government spending remain, including whether or not across-the-board spending cuts, known as sequestration, will actually kick in on March 1^st.  The government is currently operating without a budget and without a ceiling on its debt.  On February 4^th, the President approved legislation suspending the debt ceiling through May 18^th.  The bill requires the Senate to pass a budget by mid-April and threatens to withhold lawmakers’ pay if it fails to do so.  These issues are likely to weigh on consumer confidence and economic growth for the next few months, but conditions should improve in the second half of the year with increased clarity from the government.

While we see potential challenges to the economy, there are several factors that should be positive for corporate earnings and the financial markets. The Federal Reserve’s ongoing accommodation and continued improvement in the housing market should be positive for the economy. Reacceleration of growth in China, more stabilization in Europe, and the potential for an uptick in business capital spending should also have a positive impact.  Corporate earnings comparisons should also get easier in the 4th quarter of the year, when companies cycle through disruptions from Hurricane Sandy and anxiety about the fiscal cliff.  We believe the Federal Reserve’s accommodative stance throughout the year will provide support for economic growth and financial market valuations.  Recent housing market data has also been favorable, with prices firming and demand outpacing supply.  In addition, recent data suggests that unemployment, manufacturing, and inflation may be stabilizing in the euro-zone.  Throughout February, several European banks are expected to begin repaying their loans under the ECB’s Longer Term Refinancing Operations program, which was implemented a year ago in order to avert a credit crunch. This is another indication that market conditions may be improving in the euro-zone.   Moreover, manufacturing data out of Asia at the end of January suggested the region is also improving.  The official purchasing managers’ index from the China Federation of Logistics was 50.4 in January (a reading over 50 indicates expansion), while HSBC’s China PMI reached a two-year high of 52.3 in January.  Furthermore, recent comments from a number of corporate management teams suggest that China’s growth is rebounding.

In terms of corporate credit, we believe quality remains robust, but fundamentals likely peaked in 2012.  The benefits from cost cutting to improve profitability are largely behind us and we believe stockholder friendly transactions will be on the upswing in 2013 at the expense of bondholders.  Debt financing is relatively inexpensive, and corporations are under pressure to support equity prices.  As such, many companies have recently announced higher dividends and aggressive share repurchase programs, often funded through new debt issuances.  M&A activity also poses a risk, especially as multinational corporations look to expand into emerging markets.  For other companies, assets sales, restructurings, break-ups and/or spin-offs could put pressure on credit quality.  We believe shareholder-friendly activity is the biggest threat to corporate credit quality this year, and thus, we will be looking to avoid names more exposed to event risk going forward.

 -  Shelly Henbest

     VP, Credit Analyst