Monday, April 26, 2010

MARKET UPDATE - April 25, 2010

The US markets were positive this past week even as political rumbling was emanating from Washington, DC, and the Euro Zone continued to be rocked daily by news from Greece.

For the week, the Dow Jones Industrial Average (DJIA) rose 186 points (1.7%) to close the week at 11,204 extending its winning streak to seven weeks. The broader-based S&P 500 moved up 25 points (2.1%) ending the week at 1217. For the year the DJIA is up 7.4% and the S&P 500 is up 9.2%.

European markets generally lost ground on news that Greece was in worst shape than had been reported. For the week, the MSCI (World) Index was down 32 points (2%) and for the year is just barely positive at 0.01%.

Mama Mia, Here We Go Again!

The news from Greece this past week worsened as each day passed.

First it was Moody’s Investors Services downgrading the country’s sovereign debt, then on Thursday the statistical arm of the European Union (EU) reported that Greece’s financial conditions were worst than previously thought. This sent the Greek bond market into a tailspin. Finally, on Friday, the Greek prime minister announced that he was formally requesting aid from the previously announced bailout fund from the International Monetary Fund and European Union for €45 billion ($60.2 billion). This last move helped stabilize Greek debt and the Euro—for now.

Greece simply cannot afford its lifestyle. Current year borrowing now represents 115% of the nation’s Gross Domestic Product. Interest rates on the debt exceed the anemic economic growth of the private sector; and as a nation, Greece does not have the tools available to independent countries to ease out of this economic mess. The traditional means used by countries in the past were to devalue its currency making repayment of debt cheaper and spurring economic activity through exports, or raising interest rates on debt to attract more lenders. Membership in the EU removes both of these options so the country is forced to cut spending—a politically unpopular move within Greece.

Ultimately the question that will have to be answered by the IMF and EU is whether or not a bailout package will solve the problem of governmental overspending or simply postpone the inevitable. Portugal, Ireland, Italy and Spain are all watching this Greek drama carefully as it will impact their destinies as well.

Looking to the future, the IMF Managing Director said the growing burden of sovereign debt in developed countries was one of the two (unemployment the other) major threats to global recovery. His comments were clearly directed at the US, UK, and Japan.

Goldman Sachs and Washington Politics

In watching the news stories this week following the Security and Exchange Commission’s (SEC) announcement on April 16th that it was seeking an indictment against Goldman Sachs for fraud relating to a Collateralized Debt Offering (CDO) in 2007, I am struck by the hyper-politicalization of this issue.

There was no new substantive information released by either Goldman or the government regarding the charges, but there were damning emails released by Senator Chuck Shumar’s (D-NY) office suggesting that Goldman Sachs cheered the collapse of the sub-prime mortgage sector. Then there was a news story published reporting that up to 33 individuals at the SEC had been surfing porn sites on the SEC-issued computers over the past 5 years—ala Rome burned while Nero fiddled. All of this as Congress begins debate on the Financial Reform legislation. It is time to get serious about addressing the regulatory and economic issues facing this country and not play tit-for-tat political games.

Other Stories of the Week

New housing starts for March showed a better-than-expected jump of 27%. This news helped the US equity markets and gold prices. Oil also increased about 1.5% in price to close the week over $87 per barrel. Investors see the housing numbers as another sign that the US economy is recovering and reason to be more bullish. Some economists fear, however, that the strong activity was driven by new home buyers pushing to get their contracts completed prior to the April 30th expiration of tax incentives at the expense of sales in the coming months. Regardless, this is the first good news for the new home market in a very long time.

US Treasuries fell slightly in price pushing the yield on 10-year notes to 3.817% up from last Friday’s close of 3.7703%. The housing numbers and expanded economic strength contributed to this rise in interest rates. The DJ Corporate Bond Index also closed the week higher 0.43 points at 109.44. This is a very bullish close for the corporate bond sector and this remains a favored bond sector.

International air travel is slowly returning to normal across Europe as the governments and airlines learn how to cope with the ash clouds coming from Iceland. I have been struck by how many people I personally know who have been impacted by this problem. Global travel has become so common place that we all take it for granted until it is taken away. The good news for the airlines is that they are able to reduce their losses stemming from the flight restrictions.

China continues to struggle with its growing economy. There was an announcement that the country is going to put strict trading limits on stock index futures contracts signifying concerns over getting too involved with more exotic derivative contracts found in the developed markets. Additionally, Brazil and India publically announced their support for an appreciation of the yuan against other currencies—something the US has been seeking for some time now. A stronger yuan would make foreign goods in China cheaper and therefore more competitive. The reverse would be true in the US and other countries. Chinese goods would be more expensive giving non-Chinese manufacturers a better opportunity to compete. This is a very important issue that I will be watching closely over the weeks and months ahead.

Looking Ahead

The ongoing tug-of-war between risky and less-risky assets is underway. You know that riskier assets are winning when you see the Euro rise, the S&P 500 outperform the DJIA, when gold, oil and other commodities rise, when small and mid cap stocks outperform, and when interest rates rise. Last week, riskier assets took control again and investors were rewarded by having riskier assets in their portfolios. This trend appears to be holding for now.

I continue to favor the Real Estate, Information Technology, Consumer Discretionary, and Financial Sectors. Small and mid cap stocks also continue to outperform. International stocks continue to be favored; however, I have not changed my position that the Euro Zone is to be avoided for now. The countries I like are Turkey, South Korea, China, Thailand, and Brazil.

Corporate and international bonds remain favored over other fixed-income sectors.

Tuesday, April 20, 2010

MARKET UPDATE April 18, 2010

Markets around the world retreated on Friday following the announcement by the Securities and Exchange Commission (SEC) that Goldman Sachs had committed fraud in the issuance of a Collateralized Debt Obligation (CDO) during the credit bubble several years ago.

Additionally, markets were also troubled by the belief that Greece is closer to a bailout from the International Monetary Fund (IMF) and European Union (EU) as interest by the private sector for Greek bonds waned.

The Dow Jones Industrial Average (DJIA) lost 125 points (1.13%) on Friday but still managed to extend its string of seven consecutive weeks of posting a weekly gain. The DJIA closed the week at 11,018.66 up 21.31 points (0.19%). The S&P 500 lost just over 19 points (-1.61%) on Friday closing the week down 2.24 points (-0.19%) and ending its consecutive weeks of posting a gain at six. For the year the DJIA is up 5.66% and the S&P 500 is up 6.91%. The MSCI EAFE (World) closed up 0.18% for the week (its fourth consecutive week of gains), and for the year this broad international index is up 2.01%.

Goldman Greece, Greece Goldman

The news on Friday that the SEC was charging Goldman Sachs with fraud regarding a CDO issuance in 2007 sent the markets into an immediate pullback.

Goldman Sachs (GS) stock dropped $23.57 (12.7%) following the announcement. The markets’ reaction was much more focused on the word “fraud” rather than any potential economic harm to Goldman. The SEC did not rule out other firms being charged stating they would look closely at “similar deals” by other Wall Street firms that sold CDO’s.

The background behind the complaint is that Goldman Sachs was approached by hedge-fund manager John Paulson (no relation to Hank Paulson, President Bush’s Secretary of the Treasury) to construct a CDO comprising of sub-prime mortgages only. CDO’s are essentially a large collection of mortgages that are combined into one package that are supposed to act much like a bond. Paulson’s belief was that the sub-prime market was going to fail and he wanted to have Goldman create a financial product that he could then short (bet against). Paulson would make money if the sub-prime CDO lost money. Goldman brought in a third-party bond firm, ACA Management, and (according to the SEC complaint) worked with Paulson to design the CDO which Goldman then went out and sold to investors. The central core of the complaint is not that Goldman improperly worked with Paulson and ACA (neither firm has been charged), but rather Goldman failed to notify buyers of the CDO that another investor (Paulson) had an active hand in designing the CDO in which that investor had a contrary position. The SEC is also alleging that Goldman did not make clear to ACA that Paulson was going to be short (bet against) the CDO.

As a precursor of things to come, Germany is apparently weighing its own investigation after that country was forced to bail out banks because of significant losses in US CDO investments including the CDO cited in the complaint.

Goldman Sachs strongly denies any wrongdoing in the case saying that “we did not structure a portfolio that was designed to lose money.” Goldman also contends that any sophisticated investor could have looked at the underlying mortgages within the CDO and conducted their own analysis and not rely only on the opinions offered by ACA. Additionally, Goldman contends that it actually took a long position (a bet that the CDO would rise in value) in the CDO and ultimately lost $90 million on their own money. Back in 2007, investors were buying billions of dollars of CDO’s and Paulson’s position had no assurance of success. It will now be up to the courts to decide the merits of the case, but the stock markets have reacted immediately by shunning all risky or riskier assets. As this story unfolds, do not be surprised if the facts of this case change.

Greece’s situation this past week was just more of the same. The private markets are showing no interest in buying Greece’s debt, the EU and IMF are pledging support for a bailout without offering any details, and the Greek’s continue to complain about the austerity measures taken by the government. With private investors moving away from supporting Greece, it is virtually certain that Greece will have to receive a bailout from the IMF and the EU. This should help stabilize the situation for now, however, it does not address the basic issue that Greece is spending more than it can afford and the EU will be challenged by this imbalance. The long-term impact on the EU is very uncertain at this time. The Euro lost $0.0015 on Friday closing the week at $1.3495. For the week the Euro lost $0.011 marking its second consecutive week of negative returns against the US Dollar.

The Rest of the Market

With all the fears of fraud and failure circulating through the markets on Friday, Treasuries and bonds appreciated in value as investors sought the safety of these traditional investments.

The yield on the 10-year Treasury dropped 0.11% for the week closing at 3.7703%. Just two weeks ago the yield briefly pushed above 4%. The Dow Jones Corporate Bond Index also gained and closed the week at 109.01 (+0.71). This is the first time since March 19th that the index closed above 109. While bonds have moved up over the past week, a break above 109.38 will overcome resistance in place since late last year and be a bullish signal for the bond market.

Commodities across the board fell on the Goldman news including gold. The most actively traded June delivery contract priced gold at $1136.30 down $23.40 (-2%). The general consensus among traders was that short-term gold contracts are considered volatile and therefore a more risky asset. Possibly adding a bit of nervousness to gold traders is the knowledge that at the end of 2009, John Paulson’s hedge-fund was the largest institutional holder of the gold SPDR (GLD) with 31.5 million shares.

Oil fell about 2% in value with Brent crude closing at $85.93 a barrel. There is some speculation that Goldman may be forced to liquidate some of its bets on rising oil prices to raise financial reserves stemming from the SEC investigation.

China reported on Friday that their 1st Quarter, 2010, Gross Domestic Product increased at a strong 11.9% raising concerns about the negative effects of an overheated economy. The Chinese did announce they were increasing down payment requirements on real estate, however, the real issue remains on hold and that is whether or not the Chinese will allow the yuan to appreciate against global currencies. The current valuation of the yuan is pegged against the US Dollar and is believed to be undervalued by currency experts. A cheap yuan makes Chinese goods less expensive to the US and the rest of the world while making foreign products sold in China more expensive.

Looking Ahead

The markets made a decisive turn away from all assets perceived as risky on Friday as investors worried about Goldman Sachs.

I believe that this was unwarranted because the real economic impact of the credit crisis has already been realized by the markets. One bank analyst from Barclays even speculated that the announcement of the Goldman law suit was timed to help propel the Financial Reform Bill through Congress. I do not know if this is true, but this is not the time to overreact to Friday’s news. If the trends turn defensive, then so will I. I will tell you if and when that happens and adjust portfolios as appropriate.

There has been no change in my favored sectors and they are Real Estate, Consumer Discretionary, Information Technology, Financials and Materials. Small and Mid Cap stocks continue to be favored over Large Cap stocks—a relationship that has been in place since the markets began their turnaround a year ago. The New York Stock Exchange Bullish Percent (NYSEBP) fell 0.15 on Friday to close the week at 79.55. For the week the NYSEBP was up 1.83.

While International Equities have returned to a favored status, emphasis is on the non-developed parts of the world. The top four countries on a relative strength basis are Turkey, Thailand, South Korea and Brazil. Thailand had a tough week with the political turmoil taking place in that country, but remains ranked fourth of the 33 countries and indexes in my iShare International Relative Strength matrix. I am watching developments in Thailand closely.

I still prefer US Corporate Intermediate-term Bonds and International bonds in the fixed-income area.

As always, if you have any specific questions on your portfolio or wish to talk to me, please do not hesitate to call.

Paul L. Merritt, MBA, CRPC® Principal NTrust Wealth Management

P.S. If you think this type of analysis would be of benefit to anyone you know, please share this communication with them.

Past performance is not indicative of future results and there is no assurance that any forecasts mentioned in this report will be obtained. Technical analysis is just one form of analysis. You may also want to consider quantitative and fundamental analysis before making any investment decisions. Information in this update has been obtained from and is based upon sources that NTrust Wealth Management (NTWM) believes to be reliable; however NTWM does not guarantee its accuracy. All opinions and estimates constitute NTWM's judgment as of the date the update was created and are subject to change without notice. This update is for informational purposes only and is not intended as an offer or solicitation for the purchase or sale of a security. Any decision to purchase securities must take into account existing public information on such security or any registered prospectus. The bullish percent indicator (BPI) is a market breath indicator. The indicator is calculated by taking the total number of issues in an index or industry that are generating point and figure buy signals and dividing it by the total number of stocks in that group. The basic rule for using the bullish percent index is that when the BPI is above 70%, the market is overbought, and conversely when the indicator is below 30%, the market is oversold. The most popular BPI is the NYSE Bullish Percent Index, which is the tool of choice for famed point and figure analyst, Thomas Dorsey. All indices are unmanaged and are not available for direct investment by the public. Past performance is not indicative of future results. The S&P 500 is based on the average performance of the 500 industrial stocks monitored by Standard & Poors. The Dow Jones Industrial Average is based on the average performance of 30 large U.S. companies monitored by Dow Jones & Company. The Dow Jones Corporate Bond Index is comprised of 96 investment grade issues that are divided into the industrial, financial, and utility/telecom sectors. They are further divided by maturity with each of the sectors represented by 2, 5, 10 and 30-year maturities. The Morgan Stanley Capital International (MSCI) Europe, Australia and Far East (EAFE) Index is a broad-based index composed of non U.S. stocks traded on the major exchanges around the globe. Securities and Advisory Services offered through Commonwealth Financial Network(R), Member FINRA/SIPC, a Registered Investment Adviser.

Monday, April 12, 2010

MARKET UPDATE April 11, 2010

Markets, both domestic and global, posted weekly gains amid crosscurrents of news and data. Greece, gold and oil all had an impact during the week. Bernanke spoke on Wednesday warning of rising deficits, and Treasury yields rose slightly after a solid auction.

The Dow Jones Industrial Average (DJIA) and S&P 500 closed the second week of April up 0.64% and 1.38% respectively. The DJIA briefly broke through 11,000 but closed the week at 10,997.35. This marks the sixth straight week of gains for both major US indexes. For the year the DJIA is up 5.46% and the S&P 500 is up 7.11%. The MSCI EAFE (World) closed up 0.33% for the week (its third consecutive week of gains), and for the year this broad international index is up 1.83%.

International Equities Return to Favored Status

As most of you know, I follow the technical analysis provided by Dorsey, Wright & Associates (DWA). One of the primary indicators I watch is the Dynamic Asset Level Investing (DALI) report (please click on the About Us tab to the left for a more detailed discussion) which evaluates five broad investment categories. On February 4, 2010, International Equities was removed following a 297 day run. This past Monday, International Equities returned to join US Equities.

It is easy to look back at such changes in hindsight and see that this time around we would have actually been better off staying invested in the International Equity market; unfortunately we never know how things are going to unfold when the change actually occurs. If we think back to back to early February there was a tremendous amount of concern and angst with respect to the credit worthiness of countries like Greece, Portugal, Spain and Ireland. The International Equity area was not the most stable asset class at the time, and with the strength of the US Dollar, International Equities were adversely affected.

There was no telling if this move out of International Equities was going to play out like 2008 when International Equities was removed in January and stayed out of DALI for an entire year. During this time the MSCI EAFE (World) Index was down just over 45% and 3 of the 4 countries that make up the BRIC countries were off more than 50%. The key to investing is to avoid big losses and DALI is a tool to help us do just that. This time, we lost a little on the trades, but next time it may prevent larger losses stemming from a major sell-off.

Greece, Gold, Oil and Treasuries

Concerns about Greece’s ability to meet its financial obligations without a bailout from the International Monetary Fund sent that country’s 10-year bond yield to 7.1%--a rate now 2.2 times greater than an equivalent bond in Germany. Adding to investor worries, the rating service, Fitch, announced on Friday that they were reducing Greece’s bond rating to BBB-minus its lowest investment-grade rating with a negative outlook. Reassurances by European Union leaders kept the problem from getting worse. Even with outside aid, many investors are beginning to believe this problem will not be resolved for a very long time. The Euro managed a slight gain of $0.0005 but was clearly held back by the news from Greece. The problems affecting Greece are dragging the entire region down and I am avoiding the European Zone with international investments.

Gold rallied despite a strong US Dollar primarily in response from European investors who are looking to hedge the Euro. As pressure in Greece lessened somewhat on Friday, so did the upward pressure on gold. If Greece continues to flounder, expect gold to resume its upward movement.

Oil prices also rose early in the week only to see a pull back on news of sizeable supply inventories. May futures closed Friday in New York at $84.92 per barrel after reaching nearly $87 early in the week. Many oil company stocks have rallied recently and I will be looking to add exposure to this sector if the price of oil holds.

US Treasuries rallied at the end of the week with a strong 10-year auction. Earlier in the week, the yield on the 10-year Treasury briefly exceeded 4% only to pull back and close the week at 3.8825% down from last week’s close at 3.9426%. The Dow Jones Corporate Bond Index was nearly unchanged and continues to move sideways in a very narrow band. Fed Chairman Bernanke spoke last Wednesday to the Dallas Chamber of Commerce and said that “unless we as a nation demonstrate a strong commitment to fiscal responsibility, in the longer run we will have neither financial stability nor a healthy economic growth.” I share this concern; however, I do not believe the markets are looking that far into the future. Eventually the US must face the same decisions as Greece is today: cut spending, raise taxes, or both.

Looking Ahead

As I noted earlier, the major US markets are on a six week positive run and the technical indicators are all positive. There has been no change in my favored sectors and they are Real Estate, Consumer Discretionary, Information Technology, Financials and Materials. Small and Mid Cap stocks continue to be favored over Large Cap stocks—a relationship that has been in place since the markets began their turnaround a year ago. The New York Stock Exchange Bullish Percent (NYSEBP) is at a yearly high of 77.24 and at a level not seen since last September. The NYSEBP is not predictive, but it signals that there is greater risk in the market today. Easy gains are likely to be harder to come by and particular focus must be given to individual stocks and sectors.

While International Equities have returned to a favored status, emphasis is on the non-developed parts of the world. The top four countries on a relative strength basis are Turkey, Thailand, South Korea and Brazil. I continue to avoid the European developed markets which represent the bottom 13 countries and indexes of the 33 found in my iShare International Relative Strength matrix.

I still prefer US Corporate Intermediate-term Bonds and International bonds in the fixed-income area.

As always, if you have any specific questions on your portfolio or wish to talk to me, please do not hesitate to call.

Paul L. Merritt, MBA, CRPC® Principal NTrust Wealth Management

P.S. If you think this type of analysis would be of benefit to anyone you know, please share this communication with them.

Past performance is not indicative of future results and there is no assurance that any forecasts mentioned in this report will be obtained. Technical analysis is just one form of analysis. You may also want to consider quantitative and fundamental analysis before making any investment decisions.

Information in this update has been obtained from and is based upon sources that NTrust Wealth Management (NTWM) believes to be reliable, however NTWM does not guarantee its accuracy. All opinions and estimates constitute NTWM's judgment as of the date the update was created and are subject to change without notice. This update is for informational purposes only and is not intended as an offer or solicitation for the purchase or sale of a security. Any decision to purchase securities must take into account existing public information on such security or any registered prospectus.

The bullish percent indicator (BPI) is a market breath indicator. The indicator is calculated by taking the total number of issues in an index or industry that are generating point and figure buy signals and dividing it by the total number of stocks in that group. The basic rule for using the bullish percent index is that when the BPI is above 70%, the market is overbought, and conversely when the indicator is below 30%, the market is oversold. The most popular BPI is the NYSE Bullish Percent Index, which is the tool of choice for famed point and figure analyst, Thomas Dorsey.

All indices are unmanaged and are not available for direct investment by the public. Past performance is not indicative of future results. The S&P 500 is based on the average performance of the 500 industrial stocks monitored by Standard & Poors. The Dow Jones Industrial Average is based on the average performance of 30 large U.S. companies monitored by Dow Jones & Company. The Dow Jones Corporate Bond Index is comprised of 96 investment grade issues that are divided into the industrial, financial, and utility/telecom sectors. They are further divided by maturity with each of the sectors represented by 2, 5, 10 and 30-year maturities. The Morgan Stanley Capital International (MSCI) Europe, Australia and Far East (EAFE) Index is a broad-based index composed of non U.S. stocks traded on the major exchanges around the globe.

Securities and Advisory Services offered through Commonwealth Financial Network(R), Member FINRA/SIPC, a Registered Investment Adviser.

Thursday, April 8, 2010

Market Update - April 4, 2010

The big economic news of last week was the release of the March employment numbers which showed an increase of 162,000 jobs.

Jobs Growth

The employment numbers reflected the first increase since March 2007 and the report is being touted as the final signal in the turn around of the economy following the “Great Recession.”

I for one am thrilled to see a positive number. However, my thrill is tempered by the fact that since the recession began, 8.5 million Americans have lost their jobs. At the current growth rate it will take until 2022 before those lost jobs are gained back. I am not suggesting that this will be the case, but I am saying that we need substantially greater job growth, especially in the private sector, before we start popping corks. As I have been saying in previous updates, we need to see this trend sustain itself. The overall unemployment rate remains at 9.7% and the number of long-term unemployed (greater than six months) has grown to just over 40%. The Fed is projecting overall unemployment to drop to just 8.3% by the end of 2011. Additionally, 48,000 jobs came from temporary census employment and another 40,000 were categorized as temporary. One important point is that historically, temporary jobs begin to expand ahead of permanent employment as companies cautiously expand their payrolls.

The stock market’s reaction can be expected to be positive for all the right reasons and will likely continue the on-going steady increase in all the major market indexes. For the week, the Dow Jones Industrial Average closed up 77 points (0.71%) to 10,927.07. Investors are watching closely as the market approaches the 11,000 level. There is nothing technically significant in the 11,000 number, but there is always a psychological boost when a big number is exceeded. The S&P 500 did slightly better last week gaining a little more than 11 points to close at 1178.1 (0.99%).

For bond investors the jobs report is likely to put pressure on bonds. US treasuries weakened on the news as the 10-year treasury yield closed at a 17-month high at 3.9426% from last week’s close of 3.8545%.

Oil Price Climbs

Somewhat quietly, oil futures pushed up nearly $5 per barrel to close the week at just under $85.

Oil buyers are suggesting that improving global economic data, especially in China and the Far East, will drive greater demand. However, there are conflicting opinions about whether or not the price of oil will continue to rise. For starters, the U.S. Energy Information Administration reported last week that gasoline inventories reached a 17-year high in late March, while oil stockpiles continued to rise as well. OPEC is sitting on 6 million barrels of excess spare capacity which they are likely to tap if oil prices rise too much. The Saudis have said that from their perspective they see the ideal price to be between $70 and $80 per barrel. So I will continue to watch this tug-of-war between supply and demand as the summer approaches. The Oil Sector is currently unfavored by my technical analysis; however, if prices continue to rise, I expect to see opportunity here.

Greece

I continue to watch Greece’s struggle with interest because of its potential impact on the international markets and as an illustrative example of a country’s battle with mounting debt and internal political conflicts.

Greece must issue more than €20 billion ($27 billion) of new debt in April and May to replace maturing bonds. Additionally, there is the possibility of another €10 billion ($13.5 billion) debt offering in the near term to meet on-going needs. The global credit markets will likely require even higher interest rates to take on this debt adding additional budgetary stress as they replace older and cheaper debt. The Euro closed Friday at $1.3483 which was a slight increase of $0.0021 from the previous Friday’s close. Analysts reported that the Euro would have been stronger had it not been for concerns over Greece’s on-going debt worries.

In general, international equities had a good week. The MSCI EAFE (World) index closed up 32 points (2%). For the year the index is up just 1.5% compared to the S&P 500 which is up 5.6% for the year. International stocks remain unfavored, but if last week’s gains continue, that may change.

Looking Ahead

The markets continue to show strength both domestically and globally. I remain cautiously optimistic that these gains will continue for now. Small and Mid Cap stocks continue to be favored over Large Cap stocks—a relationship that has been in place since the markets began their turnaround a year ago. I am adding Financials into my favored sectors along with Real Estate, Consumer Discretionary, Information Technology, and Materials.

Bonds have also rallied dramatically over the last year; however, their momentum has clearly waned. The Dow Jones Corporate Bond Index closed the week at 108.41 up 0.44 (0.41%). The index has failed three times since last September to break through 109.38 and continues to trade in a narrow band. US treasuries have shown the greatest weakness especially in the longer maturities. Barring a major international incident, I believe this trend will continue. Bond futures market have priced in an 84% likelihood that the Fed will increase the Fed Funds rate to 0.5% (up from 0% to 0.25%) when they meet in November. I do not believe this will have a negative impact on the equity markets, but I do think long-term treasuries will continue to weaken. Currently Corporate Bonds and International Bonds remain favored.

Paul L. Merritt, MBA, CRPC® Principal

P.S. If you think this type of analysis would be of benefit to anyone you know, please share this communication with them.

March 28, 2010 Weekly update

The US stock markets were up for the fourth week in a row and six of the past eight weeks. The Dow Jones Industrial Average closed up 1.01% last week, is up 5.09% for the month and 4.05% for the year. The S&P 500 was up 0.58% for the week and is now up 5.62% for the month and 4.62% for the year. US Treasuries had a lackluster issuance and the Euro closed lower for the second consecutive week falling just over a penny to $1.3421. The Euro did rally Thursday and Friday following an announcement that a general agreement of a Greek bailout had been reached by the European Union.

March Madness

Those of us who consider the NCAA Men’s Basketball Tournament, affectionately referred to as “March Madness,” the greatest sporting event annually in the United States have been reminded again of the difficulty in making predictions. ESPN reported March 20th that 98% of the approximately 4.8 million bracket predictions made by fans had Kansas reaching the Sweet Sixteen, 59% had the team reaching the Final Four, and 42% had them winning the championship. Only problem, Kansas lost to Northern Iowa in the second round shocking most serious and casual fans and wrecking their chances of winning the $10,000 first prize at ESPN.

What if all of those fans who picked Kansas had a chance to adjust their bracket selections after the Kansas loss or after each round, do you think their chances of picking the ultimate winner would be improved? Of course it would.

This is a timely example of the concept of relative strength analysis and trend-following that I use in building portfolios. Systematic trend-following analysis eliminates our dependency on the need to predict what is going to happen in the future. Relative strength identifies the strongest assets (just as the head-to-head competition in March Madness identifies the strongest teams currently playing) and allows me to stay with the asset/trend as long as long as it stays strong. When an asset weakens, it is kicked out of the portfolio and replaced with something stronger. This kind of casting-out methodology allows the portfolio to adapt to the market environment and is constantly being refreshed with new, strong assets. We all like to know what the future may bring, however, we rarely get it right. So do not base your asset selection on predicitions.

Mixed Signals

The GDP was revised downward slightly last week from 5.9% to 5.6% and the markets took little notice. Fed Chairman Bernanke continued to show support of an accommodative money policy, but has made it clear that he intends to stop purchasing mortgages as the previously stated $1.25 trillion ceiling is reached. Terminating this program will reduce money supply as banks and other institutions retain the loans they have issued making less money available for other lending. Mortgage rates have ticked up slightly in anticipation of this move. In another moved designed to pull money out of the economy, the Fed is considering selling some of its stake in high profile companies like Citigroup. All of this is healthy for the markets in the long term by reducing the risk of inflation in the future.

Jobs will continue to draw the attention of economists and investors. The general consensus for the March job numbers (released this Friday, April 2nd) is for nonfarm jobs to increase by 200,000. The headline will be good, but like so much of economics, the real story will be in the fine print. Much of the gains are expected to be attributed to hiring by the government for temporary census jobs, and for delayed hiring in March due to the terrible February weather in much of the country. I believe it will be important to see private sector job growth expand at 50,000 to 100,000 per month for a period of months before you can assume a real jobs recovery is under way.

Additionally, the US Treasury saw lackluster demand for the $118 billion in various notes issued last week. Interest rates were up slightly with the all important 10-year treasury yield closing the week at 3.8545% compared to 3.6930% the week before. Supply is clearly a factor, but the late week success in achieving an apparent deal for a Greek bailout has made investors a little more risk tolerant and also plays a role in the weakening demand.

The passage of health care reform did not have a negative impact on the markets early in the week. I believe that the jury is still out as companies assess the impact on their bottom lines. AT&T announced that they would have to take a $1 billion charge for the loss of tax breaks related to drug prescription plans for retirees. John Deere also announced restatement of $150 million and Caterpillar will restate $100 billion. These actions are being taken in accordance with tax rules requiring corporations to state changes to retiree liabilities when they are learned, not when they actually occur.

Greek Bailout

Germany, France and the other members of the EU reached agreement on the basic outline of a bailout plan for Greece. Germany had been the holding out for a demand that the International Monetary Fund be part of the bailout, lessening the potential liability of German taxpayers who have been opposed to any aid to Greece. The Euro rallied Thursday and Friday on the news. The next test will be Greece’s planned bond offering this week or next. The Greek government must replace about €11 billion ($14.7 billion) in April and another €11.6 billion ($15.6 billion) in May. Credit markets will be watching how much more Greece will pay compared to equivalent German bonds as a gauge of risk. Skeptics abound but the fact that agreements have been reached and credit markets are functioning can be seen as good news. International stocks remain unfavored in my analysis.

Looking Ahead

If the Euro begins to strengthen, you can anticipate a rise in general commodity prices due to exchange rate factors and also a return for greater risk taking in general. Oil is especially sensitive to these fluctuations, and look for gold to rally if interest rates continue to creep upward.

US equities remain favored. Small and Mid Cap stocks continue to show greater relative strength than the larger cap stocks and Growth favors Value. There has been no change in my favored sectors and they include Real Estate, Consumer Discretionary, Information Technology, and Materials. US Corporate and International bonds are favored. I am less optimistic about US treasuries. If the trend continues upward for interest rates, valuations will begin to slide.