Wednesday, June 2, 2010

Weekly Market Update - May 31, 2010

Volatility in May increased dramatically from April.

If you recall, April had 5 of 21 trading days where the Dow Jones Industrial Average (DJIA) gained or lost more than 100 points from the previous day's close. In May, that number jumped to 16 out of 20 days. The net result of all this volatility was a month where the DJIA lost 872 points (-7.92%) closing at 10,137 marking one of the worst May performances in 50 years. The S&P 500 fell 97 points (-8.20%) closing at 1089. For the year, the DJIA is now down 2.79% and the S&P 500 is off 2.30%. If there is any good news to take out of last week was that the two major US indexes rate of change dropped to under 1% (DJIA -0.56%, S&P 500 +0.16%) possibly signaling a pause while the markets digest all of the news.

The MSCI (EAFE) World Index fell 11.86% for the month and is down 13.52% for the year. Last week the MSCI (EAFE) managed a 0.90% gain.

The Euro closed the week down to $1.2274 from $1.2568. For the month of May, the Euro lost $0.10 (7.7%) continuing the long tumble from $1.4316 at the start of 2010. The Euro is likely to continue to show weakness given the challenges facing that part of the world.

Oil rebounded during the week gaining over $4 per barrel rising to just under $75 per barrel, and gold reversed its losing trend gaining some $24 per ounce to finish the month at $1215 per ounce. The long-term trend of gold has remained positive since 2008. What has not held up has been the more industrial metals such as copper, lead, and nickel. These metals have all seen significant pull-backs in recent months as demand from China has dropped.

Demand for US treasuries remains strong. For the week, the 10-year bond closed at 3.3033% a slight increase from last Friday's close of 3.261%. Rising interest rates signal less demand for US treasuries overall. However, rates did drop on Friday following the news that Fitch Ratings downgraded Spain's sovereign debt.

Fears in Europe Simply Will Not Go Away The news of Fitch's downgrade of Spain's sovereign debt from AAA one notch to AA+ worried investors and hurt US markets, the Euro, and helped US treasuries.

The downgrade reversed a couple of days of relative calm in Europe driving investors back into the worry and risk-avoidance column. I believe this is telling as to just how fragile the markets are. When the news is relatively benign, the markets show stability or even some growth; however, negative news really takes a toll on investors. Caution is still the order of the day.

The news from Israel following the storming of a Turkish flotilla of has suddenly jumped tensions in the Middle East adding to an already nervous world as North Korea and South Korea continue their sparring.

Volatility is Back

After a good start to the year in the equity markets, the turn of the calendar to May brought about unwelcomed volatility along with selling pressure in equity markets.

Volatility is always unpleasant and causes investors to worry and wonder about what the future holds. I suggest that if you look back over history, volatility typically marks a point of change within the markets. In the past ten years, the Dot-com bust ended NASDAQ's reign and signaled the emergence of the financial sector. The end of 2007 and all through 2008 saw the demise of the once great financial sector. Companies like Lehman Brothers and Merrill Lynch vanished or are now a subsidiary of some other conglomerate. In each of these cases, the market leaders going into a corrective, high-volatility phase were not the same ones that emerged later. This current period has much of the same feel to it.

So use volatility as a market indicator, a signal that change is underway. Be watchful for what new trends may emerge from the turmoil and be prepared to act.

Looking Ahead

The risk management indicators I track continue to shift to a defensive position. As a result, I have been recommending that certain client holdings be sold or reduced resulting in higher cash positions. This goes straight to the heart of my risk reduction philosophy as we are preserving wealth within a weakening market environment. While the volatility in the equity markets continues to rise, I will continue to seek out investments that I feel could help reduce overall portfolio volatility.

Over the coming weeks (or even months) we may have better opportunities to pick up solid values-so I believe it's wise to be patient. In recent Weekly Market Updates I have been stressing that I cannot predict how this market is going to go from here. Are we pausing before another bull run, or are the problems in Europe and elsewhere signaling the return of another bear market? If this is a market pause, how long could we be hobbling along (a sideways market)? I don't know and no one with a shred of integrity would tell you they do know. What we do know is that given the information we have at hand risk is elevated right now and reduced exposure to the equity markets is prudent. Put simply-the risk of owning a heavily weighted portfolio of stocks is too high for most investors.

If you continue to hold equities make sure you are holding the strongest companies or sectors on the basis of relative strength. If you are not sure how your stocks or mutual funds compare to their peers, please give me a call and I will review with you.

I continue to recommend investment in quality bonds, especially corporate intermediate-term. A portion of the investment can also include some quality international bonds.

Treasuries are very strong, however, I remain extremely concerned that treasuries are very expensive at this point in time and new positions should be entered into thoughtfully.

Oil is very much at the mercy of the global economy and strength of the dollar. I continue to believe both are working against oil for now.

Gold is much harder to predict because on one day it is a safe haven and on the next it is a risky asset class. I do know that the long-term trend of gold has been steadily going up for several years. If you want to own gold, my suggestion would be to do so in small quantities and not overweight your portfolio because of the schizophrenic nature of gold recently.

Finally, on a personal note, Virginia and I are going to Omaha this Thursday for a weekend visit to see my mother, my cousin and her family, and celebrate my brother's birthday. Therefore, my update will not be published until late Tuesday or early Wednesday. I will be available should the need arise.

Corporate bonds contain elements of both interest rate risk and credit risk. Treasury bills are guaranteed by the U.S. government as to the timely payment of principal and interest, and if held to maturity, offer a fixed rate of return and fixed principal value. U.S. Treasury bills do not eliminate market risk. The purchase of bonds is subject to availability and market conditions. There is an inverse relationship between the price of bonds and the yield: when price goes up, yield goes down, and vice versa. Market risk is a consideration if sold or redeemed prior to maturity. Some bonds have call features that may affect income.

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

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

Sincerely, Paul Merritt, MBA, AIF(R). CRPC(R) Principal NTrust Wealth Management 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.