Wednesday, December 14, 2011

The first three days of December saw the Dow Jones Industrial Average (DJIA) rally 814 points (7.25%) following a coordinated announcement by western central banks that they were increasing liquidity for financial institutions around the world. This important step immediately calmed nervous investors who saw Europe rapidly approaching a Lehman Brothers moment as banks severely curtailed inter-bank lending. Interest rates fell sharply in Italy and Spain and equity markets rallied everywhere. Since then, equity markets have calmed considerably as investors digest the latest agreements emerging from the European Union (EU).

For the week, the DJIA gained 165 points (1.37%) and the S&P 500 added 0.88%, and the Russell 2000 led all major indexes with a 1.41% increase. For the year, the DJIA is now up 5.24%, the S&P 500 is still in negative territory down 0.19%, and the Russell 2000 remains off 4.88%.

Sector returns were mixed last week. Real Estate, Financials, and Information Technology were the leaders while Telecom, Materials, and Energy were the worst performing sectors. The difference between the best and worst performing sectors was just over 1.75% reflecting a lack of investor certainty about the markets. For the year, Utilities, Consumer Staples, and Health Care are all positive and exceeding the DJIA, while Financials, Materials, and Telecom are the worst performing sectors. Financials remain down over 15% so far in 2011.

European markets were flat last week. The MSCI EAFE index lost 0.89% and is up a marginal 0.06% so far in December. For the year, the European-heavy MSCI EAFE index is down nearly 14%. Globally, the Pacific Region leads with Thailand the best performing country in December. For the year, the US is significantly outperforming all major global regions. The Americas is down 3.40%, Europe is down just over 14%, Africa/Middle East is down nearly 20%, and the Pacific Region is down about 17%.

The Euro was virtually unchanged against the US dollar last week giving back a mere $0.001, and for the year is up just $0.001. The Euro has been under pressure since closing above $1.40 in late October as the Euro crisis depended, and even though the Euro off its lows in late November, the latest efforts by the EU has failed to create another strong Euro rally.

Commodities were generally negative last week. The Dow Jones UBS Commodity Index was down 2.26% as gold fell 1.73% and WTI oil gave back 1.70%. Natural gas and cocoa were the biggest losers last week while base metals (tin and lead) managed good returns. For the year, gold and precious metals have outdistanced all other commodity returns while natural gas, cocoa, and base metals have all significantly underperformed the broader commodity and equity markets. Commodities, other than precious metals, reflect global growth expectations and as economic growth remains subdued, commodity prices remain subdued as well.

Bond markets have seen several weeks of modest gains. The US 10-year Treasury yield rose slightly last week from the previous week's close of 2.042% to Friday's close of 2.065%. However, the bond markets are also reflecting investor uncertainty as the Euro debt crisis plays itself out in Brussels. Like US sector performance, there was a fairly tight dispersion of returns between the various bond sectors with preferreds, intermediate-term municipals, and high yield leading the way while long-duration Treasuries and Inflation Protection were the worst performing sectors. For the year, long-duration Treasuries lead all bond sectors while preferreds and high yield are the worst. All of the major big four European countries: Germany, France, Italy, and Spain saw interest rates fall even though Italy and Spain have rates considerably higher than Germany and France. Standard & Poors has placed 15 of the 17 Euro Zone countries under review for downgrades early in the week and also placed several major European banks under review. No doubt this news helped to push EU member countries to move closer to a unified financial organization.

GROUND HOG DAY?

I am getting tired of writing about the EU debt crisis and you are probably getting tired of reading about it. However, because of the impact the EU debt crisis has on all financial markets, I have continued to remain focused on what is going on across the Atlantic.

I am suffering from writer's fatigue because it every week seems to be just more of the same. The bond markets throw a temper tantrum, interest rates jump, and then EU leaders come together announcing that this time they must get things fixed. After much deliberation, the EU ministers walk away from the table announcing that they have taken new strides to address the problem, markets jump, and then after investors have time to dig into the details, the markets pull back and we repeat the cycle...wash and rinse, wash and rinse, wash and rinse is how I have characterized this process. I cannot get the image of Bill Murray's character in the movie Ground Hog Day out of my mind.

Last week, the EU did make some important strides towards fiscal union as every EU member, except Great Britain, agreed to subject their individual country's budgets to greater EU oversight and control. Each of these country leaders must now go back to their respective parliaments and get legislative changes passed to implement these new agreements. In the meantime, the European Central Bank (ECB) under new leadership has shown a greater willingness to help out the region in the short-term by lowering interest rates for the second time to 1.0%, offering unlimited 36-month credit to EU banks, and cutting the reserve requirements for commercial banks from 2% to 1%. In sum, these changes are all a positive step, however, as investors have been burned before, there was not a rally in the stock markets.

I believe that the debates that are underway in the EU are long overdue. The British were never fully enamored with EU. They never surrendered the Pound for the Euro, and Prime Minister Cameron was the only EU member to not vote for the new fiscal controls. This has caused old conflicts to resurface as Der Spiegel said that "the British still hadn't finished mourning over their lost empire," and "instead of turning toward Europe, Britain looked west to the US... (a)nd to this day, the UK feels much closer to America than it does to the frogs and the krauts on the other side of the English Channel." Rather strong rhetoric coming from Berlin, but I think the German's are forgetting the price the British paid in blood and treasure (and the help provided by the US) to defeat the likes of the Kaiser and Hitler which is still in the minds of many Britains. So considering the history of the 20th century in Europe, it is understandable that the British do not want to give up sovereignty to the folks across the Channel.

So as we wait and see about the latest version of EU fixes I continue to watch for prospects of economic growth in the EU. With all of the attention focused on unified fiscal policies, the structural impediments to long-term growth remain firmly entrenched. The International Monetary Fund is estimating EU growth for 2012 at an anemic 1.3%. We can only wonder if the political leadership in Europe understands that the real crisis in Europe is spending growth that substantially exceeds economic growth. A situation that we must also be concerned with here in the United States.

LOOKING AHEAD

The past six months in the markets have been driven by headlines emanating from Europe. We often hear commentators discussing "risk on" and "risk off" days. I discussed this concept in an earlier Weekly Update (October 28, 2011). A quick summary:

On days when Risk is On we generally see the following:

Stocks UP US Bonds DOWN International Bonds UP Commodities UP US Dollar DOWN

On days when Risk is Off we generally see the opposite:

Stocks DOWN US Bonds UP International Bonds DOWN Commodities DOWN US Dollar UP

Risk on or off is going to be determined by how successful the EU is at implementing the latest policy goals and re-establishing confidence in their sovereign debt. The jury is out and I would have a 50-50 chance of being right on predicting which scenario might prevail. The non-directional market this past week is just another indicator of the uncertainty felt by investors.

I do not believe that leaving the equity markets is fully warranted and continue to retain exposure to stocks, however, I continue to underweight European equities. So how do you look at the markets today with all the uncertainty? I believe a balanced approach is warranted. This means building a portfolio with both risk on and risk off assets.

I maintain that there should continue to be exposure to growth stocks, especially within the mid-capitalization space (risk on), however, I also believe that high quality blue chip stocks paying good dividends is a less risky option for equities (partial risk off). In the bond space, I favor a good blend of US (risk off) and International bonds (risk on), exposure to inflation protection (risk on), and high yield (risk on). While Commodity exposure provides a hedge against inflation (risk on).

The upcoming week will include several important reports from the federal government which should provide assessments about the current state of the US economy including: Retail Sales (Tuesday); Jobless Claims, Producer Price Index, Industrial Production, and the Philadelphia Fed Survey (Thursday); and the Consumer Price Index (Friday). Retail sales will be particularly important because it will include the first full week of holiday shopping.

As the year draws to a close expect the bumpy ride to continue. I am continually assessing investments to insure that they are technically and fundamentally sound. Give me a call if you have any questions.

The NYCE US Dollar Index is a measure that calculates the value of the US dollar through a basket of six currencies, the Euro, the Japanese Yen, the British Pound, the Canadian Dollar, the Swedish Krona, and the Swiss franc. The Euro is the predominant currency making up about 57% of the basket.

Currencies and futures generallyare volatile and are not suitable for all investors. Investment in foreign exchange related products is subject to many factors that contribute to or increase volatility, such as national debt levels and trade deficits, changes in domestic and foreign interest rates, and investors' expectations concerning interest rates, currency exchange rates and global or regional political, economic or fi nancial events and situations.

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 Dow Jones UBS Commodities Index is composed of futures contracts on physical commodities. This index aims to provide a broadly diversified representation of commodity markets as an asset class. The index represents 19 commodities which are weighted to account for economic significance and market liquidity. This index cannot be traded directly. 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.

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