Wednesday, February 9, 2011

The world watched events unfolding in Egypt closely last week and also digested a series of relatively good US economic reports moving equity markets upward around the world.

The Dow Jones Industrial Average (DJIA) gained 268 points (+2.27%) to close at 12,092. The S&P 500 added 35 points (+2.71%) to close at 1311, and the Russell 2000 added 25 points (+3.19%). For the year is up DJIA 4.45%, the S&P 500 is up 4.23%, and the Russell 2000 is up 2.10%.

Investors absorbed a swirl of conflicting news last week as positive US economic data was reported as scenes of chaos and rioting in Egypt shown around the clock on every news channel. The US unemployment rate dropped unexpectedly in January from 9.4% to 9.0%on a gain of just 36,000 net new jobs. Economists had been predicting the joblessness rate to increase by 0.1%. The extreme weather conditions throughout much of the US raised questions about validity of the data and certainly hurt the construction and transportation sectors. Positives taken from the report were a growth in manufacturing and private sector jobs, while the negatives include less than robust growth and an overall worker participation rate of the US population 16 and older at its lowest level since 1984 at 64.2%. Another data point out last week came from the Institute for Supply Management which showed the US services industry (90% of the economy) grew at the greatest rate since 2005. So the consensus of opinions remain that the US economy is growing, and will continue to grow, even though that rate of growth is not as robust as many would like to see.

The top three broad economic sectors last week were Energy, Materials, and Information Technology while Utilities, Real Estate, and Consumer Staples were the bottom three performers. For the year, Energy, Information Technology, and Industrials are the best performing sectors and Consumer Staples, Telecom, and Consumer Discretionary are the bottom three.

The MSCI (EAFE) World Index gained 1.69% for the week and is now up 3.93% for the year. Developed markets outperformed emerging markets and continued to widen that gap for 2011. On a sharp reversal from the previous week, Egyptian stocks posted the largest single country gain (trading on international markets) as investors appear to be gaining optimism (or are simply placing speculative bets) that the transition from Mubarak to anyone else, will go smoothly. According to Bloomberg, the Egyptian stock exchange will remain closed until at least February 8th, although banks opened for abbreviated hours on Sunday, February 6th. Turkey and Australia were the other top performers last week. The bottom three performers of the countries I follow were India, Brazil, and China. For the year, Spain, Italy, and France are the top performers while India, Egypt and Chile are the worst. Investors are growing concerned about the onset of strong inflation in emerging markets which is a major factor contributing to under-performance. These concerns were articulated by the International Monetary Fund's First Deputy Managing Director who said in an interview Friday with the Dow Jones Newswires that countries are running out of excess capacity while holding in place "expansionary, accommodative monetary and budgetary policies."

The Euro fell slightly closing the week at $1.3576 from last week's close of $1.3609. This drop was attributed to a variety of factors including the European Central Bank (ECB) President's comments that inflation in Europe was not a major concern for now and that rising prices were mostly in the energy and commodity areas leaving investors to conclude that the ECB will not raise interest rates in the near future. Additionally, some rather public disagreements emerged over policies proposed by Germany (and supported by France) to force weaker European Union (EU) countries to tighten their fiscal and monetary policies. The Germans proposed raising retirement ages, abolishing wage-to-inflation indexing (automatic cost of living adjustments), setting more uniform corporate tax rates, and installing some kind of controls over how much new borrowing a country can undertake. In other words, the Germans want to strengthen the role of the EU at the expense of individual country rights. This debate is far from over in Europe.

Commodities were flat to mostly higher last week. Gold rebounded slightly adding $6.60 per ounce (0.49%) to close at $1348.30. Gold is being pushed and pulled by investor concerns over the turmoil in Egypt while eying positive economic news from the United States. Oil prices dropped $0.31 (-0.35%) and closed the week at $89.03. Like most other asset class movements last week, belief that Egypt was not perilously close to collapsing and the Suez Canal and pipeline were not immediately threatened, contributed to oil's pullback. Additionally, the strengthening US dollar also helped stem price increases.

Bonds had their worst week of 2011 with the Barclays Aggregate Bond Index falling 1.25% pushing the broad bond index down 0.95% for the year. The 10-year Treasury yield increased to 3.6397% from the previous Friday's close of 3.229% following a series of positive economic reports. As investors gain confidence in the equity markets, bond positions are trimmed to raise cash to buy stocks pushing prices down and yields up. The high yield and floating rate sectors of the bond market were the best performers while long-term government bonds were the worst.

FOLLOW-UP ON THE JANUARY EFFECT

A couple of weeks ago I discussed the "January Effect" and I wanted to follow that up with some more analysis now that January has concluded. I attribute this analysis to my friends at Dorsey Wright & Associates in Richmond, Virginia.

The old market adage warns, "as January goes, so goes the year;" the idea of course being that if the first month of the year records a gain, the year will follow suit on a positive note. This is exactly how we are moving forward into 2011 since last month we witnessed the S&P 500 gain 2.26%. Conversely, if January begins the year in the trenches, the adage implies the overall year will leave investors loss stricken. There is research to support this historical bias, and using data going back to 1950 (as published by Stock Trader's Almanac), this barometer has roughly a 74% accuracy rate, and a 90% success rate of simply avoiding significant mistakes (the market moving 5%, or more, in the wrong direction). Since 1950 there have only been 7 years where the S&P 500 moved more than 5% in the opposite direction than how the month of January closed. Interestingly, 4 of those 7 years where the barometer has been "broken," came within the past decade! In 2001 the market offered a quick rally of 3.5% in January before nose-diving to post the sixth worst year on record since 1950 -- down 13%. Contrasting that move was 2003, when the S&P 500 closed January in negative territory leading up to the beginning of the 2nd Gulf War, but as we know ended the year up 26.4%. In 2008 the Barometer was right on target, as January was a down month (-6.1% for SPX) and the rest of the year was abominable, posting a loss of -38.5% for 2008. In January 2009, we started the year much like 2008 ended, with a loss of -8.6%. But after a March bottom, the market got back on solid footing and ended the year with huge gains of +23.5%. Now, that is the kind of error you like to see! The most recent "error" in the Barometer was just last year in 2010 when we entered the year with a -3.70% loss in the S&P 500, yet the rest of the year was quite positive as the market scratched back from the Summer doldrums and ended 2010 up 12.78%.

A point that bears repeating (that was displayed in the last two years) is that the "January Barometer" is notably better at predicting strong years than it is at predicting losers. Of the 24 red Januaries since 1950 the market has followed up with down years 54% of the time (13 occurrences), with only 4 double-digit rallies following a bad month of January (2010 and 2009 being the most recent). These historical tendencies are just that, tendencies, and can obviously be wrong and shouldn't serve as a primary indicator for anyone looking to tactically manage market risk. For this we turn to our market barometers and tactical allocation tools, which currently present a bullish outlook or guidance with regard to the equity markets, yet with a higher risk backdrop. Equities are currently a favored asset class (along with International Equities), and the NYSE Bullish Percent (NYSEBP) is in offense (>70), albeit in overbought territory.

Looking Ahead

The markets have posted nice gains so far in 2011; however, I believe that risk levels remain elevated. The NYSEBP closed the week at 78.96 up from last week's close at 78.30 well above the overbought level of 70 held since October 2010. Events unfolding in the Middle East will likely to continue impacting stock markets next week-good or bad.

Small and mid-capitalization stocks rallied strongly last week and closed the gap on large cap stocks, and they remain favored on a relative strength basis. I like the technology, energy, and basic materials sectors. Basic materials include metals, timber, and chemical companies.

Emerging markets rallied as well; however, they continue to under-perform developed markets. The major emerging market countries including India, Brazil, and China are all under-performing so far in 2011 as inflation continues to weigh on markets and investors expect economic tightening measures to continue or be put in place. I believe close scrutiny of emerging market holdings is warranted, but not outright selling of all positions.

Bonds had a tough week and investors should remain vigilant. Long-term treasuries and corporate bonds are clearly under the greatest stress. There are many different flavors in bonds and you should understand what types of bonds you have and adjust accordingly. I am still comfortable with the intermediate corporate bond category, but I believe that high yield and floating rate bonds should be considered as part of an overall bond portfolio at this time.

I believe that commodities will remain volatile. Oil prices are clearly sensitive to the uncertainty in the Middle East, but also to the strengthening of the US dollar. Gold strengthened last week and I still like it as a hedge against the uncertainty in the world. I will watch the price closely to see how it reacts to this week's events. The agriculture commodities have continued to rally and move higher.

The less sensitive indicators found in the Dynamic Asset Level Indicators (DALI) still show US and International stocks to be favored, Emerging Markets favored over Developed, equal-weighted indexes favored over capitalization-weighted, mid and small cap over large cap, and growth over value. Because the DALI is less sensitive than the markets in general, changes, when they occur, are significant.

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.

Emerging market investments involve higher risks than investments from developed countries and also involve increased risks due to differences in accounting methods, foreign taxation, political instability, and currency fluctuation. The main risks of international investing are currency fluctuations, differences in accounting methods, foreign taxation, economic, political or financial instability, and lack of timely or reliable information or unfavorable political or legal developments.

The commodities industries can be significantly affected by commodity prices, world events, import controls, worldwide competition, government regulations, and economic conditions. Past performance is no guarantee of future results. These investments may not be suitable for all investors, and there is no guarantee that any investment will be able to sell for a profit in the future.

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. The Russell 2000 Index is comprised of the 2000 smallest companies within the Russell 3000 Index, which is made up of the 3000 biggest companies in the US.

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