Wednesday, March 7, 2012

In a week which saw the Dow Jones Industrial Average (DJIA) close above 13,000 for the first time since May 2008, and the NASDAQ index reach 3000 for the first time in over 12 years, the markets finished the week flat. There was plenty of news for investors to digest: gold falling nearly $72 (-4%) an ounce on Wednesday, rumors of a pipeline fire in Saudi Arabia, generally improving economic data at home, and the successful debt sale by the European Central Bank (ECB); however, investors were unfazed and unmoved.

For the week, the DJIA fell just 5 points (-0.04%), the S&P 500 added 4 points (0.28%), and the NASDAQ led all US indexes with a 0.42% gain. The Russell 2000 index that includes more middle and small capitalization stocks fell the sharpest losing nearly 3% for the week. Moves in the Russell 2000 often capture investor sentiment towards riskier stocks because of the exposure to smaller companies, and last week signaled that some risk exposure was being trimmed. February 2012 finished out strong and the overall performance of stocks in the first two months of this year ranks among the best since 1987. For the year the DJIA is up 6.22%, the S&P 500 is up 8.91%, the Russell 2000 is up 8.30%, and the NASDAQ is up a strong 14.24%. As a point of comparison, the four major indexes were all up just about 6% at this same point last year.

Consumer Discretionary, Financials, and Information Technology were the best performing sectors last week easily bettering the DJIA, while Energy, Industrials, and Materials were the worst performers. For the year, Information Technology, Financials, Consumer Discretionary, Materials, and Industrials have all posted double-digit gains while only Utilities remains in negative territory down over 2%.

International stock indexes, like US indexes, posted mixed returns with the European-heavy MSCI EAFE index posting its worst weekly returns of 2012 dropping some 0.78%. Lingering concerns about the successful implementation of the private investor Greek bond swap has raised fears that the second Greek bailout may become stalled. Additionally, concerns arose about the ability of other European Union (EU) governments' ability to meet pledged debt and budget reduction goals this past week when Spain's Prime Minister announced that his country would not reach the goals set for 2012. I still believe that the EU will resolve all remaining issues and give Greece the approved €130 billion loan on schedule. Emerging markets was the best performing international sector for the week and remains firmly in the lead of any major stock index, domestic or international, so far in 2012.

Commodities fell broadly last week after gold and oil posted negative returns for the week. Gold prices dropped $68.10 (-3.83%) an ounce for the week, and WTI Oil fell $2.92 (-2.66%) a barrel to lead most other commodity sectors downward. The Dow Jones UBS Commodity Index (a broad-based commodity index) lost 1.11% last week, and is now up 4.98% for the year. Oil prices pulled back after reports of a possible pipeline malfunction in Saudi Arabia turned out to be false. The drop in gold followed comments by the US Federal Reserve Chairman Ben Bernanke on Wednesday that gave investors the impression that another round of quantitative easing would not be forthcoming. Each round of quantitative easing results in more easy money in circulation. Easy money depresses the value of the US dollar, which in turn leads to lower commodity prices abroad, increasing global demand, and thus prices here in the US. In the long run easy money hurts everyone in the US through higher prices, low interest rates, and negative real return on many investments. Natural gas was the best performing commodity sector and remains extraordinarily volatile. Grains and other agricultural sectors managed to be modestly positive last week along with some industrial metals.

The US dollar gained against all the major currencies last week. The Euro fell two-and-a-half cents (-1.93%) to close Friday at $1.319 marking the largest one-week drop by the Euro in 2012. Worries about Greece "closing the deal" with the EU bailout and Bernanke's comments here that he was unlikely to weaken the dollar further brought investors back to the US dollar. The Federal Reserve remains committed to low interest rates for the foreseeable future, but it looks for now that there will not be any more new money creation to achieve that goal. The strengthening of the US dollar was also partially responsible for the drop in precious metals and oil last week.

US bonds maintained last week. I say maintained because there has been very little movement in bond indexes so far in 2012. The Barclays Aggregate US Bond index added 0.21% matching the previous week's gain of 0.21%. For the year this widely watched index is up 0.94%. The US Treasury 10-year moved above 2% last week put closed Friday at 1.977%--the same rate as the previous Friday. The US Treasury 30-year gained slightly to close at 3.108%. Every major European 10-year sovereign interest rate fell again last week as the ECB issued another €529.5 billion in low interest loans under the Long Term Refinancing Operation (LTRO). As of close of market on Friday Italy and Spain had sub-5% 10-year yields and this has taken a great deal of pressure off EU governments for now. Emerging market debt, preferreds, and high quality corporate bonds were the best performing bond sectors for the week while short-duration international sovereigns, Treasury Inflation Protection notes, and high yield bonds were the worst. For the year, preferreds, international, and high yield remain the best performing sectors while everything US Treasury-related, especially long-duration, have been the worst.

ARE THE MARKETS LOSING STEAM?

Anytime a key stock index reaches a nice round number as we did this week when the DJIA reached 13,000, investors inevitably question whether the markets have become too extended and if a pullback is imminent. Fair questions especially in light of what has happened over the past decade or so. Before I give you my thoughts on these subjects I will begin by saying I have no idea if the market has reached its peak for 2012 or whether or not we have a ways yet to go. I cannot predict interest rates, or stock prices, any more than I can tell you with certainty who is going to control the White House in 2013. I am not afraid to admit this to you because I am being completely honest and I am also in great company...100% of every other financial advisor and economist in the country has no idea either. But, and this is important, I can certainly offer you insights to where the markets are and what trends I am seeing and this is what I will offer in this Update.

One of the key indicators I use to evaluate the markets is the New York Stock Exchange Bullish Percent (NYSEBP). I discussed this indicator last week and said that the current level of the NYSEBP (76.2%) suggests there is greater risk in the market today. Any reading over 70% signals higher risk. I have also said that the markets are overbought meaning that when looking at prices over the past ten weeks, investments are trading at the very upper end of their price distribution curve. All of this suggests that the likelihood of a pause, pullback, or correction has increased. Markets never go up or down in one constant direction, there are always runs counter to the longer trend imbedded in any bull or bear market. However, there is empirical statistical data to reinforce gut instinct, and I much prefer data to instinct.

Another data point that I am watching is the rate of increase in the NYSEBP. For the first five weeks of the year, the NYSEBP was improving by 5% to 8% each week as the NYSEBP rose from 53% (start of year) to the 76% it is today. Over the last four weeks this number has been dropping meaning that the rate of increase has begun to slow signaling that fewer and fewer stocks are showing first-time point and figure buy signals. This past week saw the first negative number of the year as the NYSEBP fell 0.8%. This suggests that the "easy" part of the move upwards is over for now. It does not mean that indexes cannot go higher as stocks continue their rally and demand remains fully in control of the markets. It is just a cautionary note and one I am watching.

Finally I evaluate how far overbought or oversold the markets become. The S&P 500 is currently overbought by 81.8%. This number is high, but not alarming so. Moving above 100% becomes worrisome and anything over 150% is clearly flashing danger for a pause or correction. Currently the most overbought sector is emerging market bonds which is overbought by 191% while the most oversold sectors are managed futures and long-duration treasuries. If you own either sector you understand that these sectors have not performed well in 2012.

In sharing this information I am not trying to make everyone an expert in some of the technical analysis I follow, but rather to help provide some insight into how I see the markets. There are tools that help judge risk levels and provide some indication of the likelihood of something happening in the markets. Today the likelihood of a pause, pullback, or correction (or simply losing steam) is greater than it has been in quite a while. I do not know if and when this will happen, but it suggests patience at this point in time.

LOOKING AHEAD

The amount of information flooding into the news cycle for investors is staggering. There must be a dozen important stories coming daily from Europe about the debt crisis, Iran and the problems in the Middle East, and how our own economic situation here is becoming increasingly positive. When all of this is blended into the soup du jour, coupled with the strong move by most stock markets in 2012, it is not surprising to see the markets take a pause as they have these past couple of weeks.

Going into the week the US stocks asset category is the strongest, on a relative strength basis, of the five major asset categories I follow. Within the US stock asset category, I continue to favor mid-capitalization growth stocks and equal-weighted indices (which tend to overweight mid-capitalization stocks). Every major economic sector is currently favored with Consumer Discretionary, Information Technology, and Real Estate the strongest on a relative basis.

Commodities remain the second-ranked asset category followed by Bonds, Currencies, and finally International stocks. Within commodities I continue to favor energy and precious metals. The recent weakness in energy and gold is not especially troublesome at this point but certainly must be followed. A surge in the US dollar would provide a headwind to rising commodity prices going forward.

Within the bond asset category, I like International bonds, a mix of high yield and quality corporate bonds, and inflation protection bonds. One of the unfortunate by-products of the Federal Reserve's low interest rate policy is that many conservative investors, especially those who rely on bonds for their income, are being forced into more risky bonds in search of yield/income. With greater risk comes the need for greater vigilance.

For international investors I like the emerging market sector with emphasis on the Asia/Pacific region. Turkey, India, and Brazil have all be exceptionally strong so far in 2012. The volatility within emerging markets raises risk for investors so be sensitive to this risk.

It is a relatively quiet week for major economic reports. The regular Initial Jobless Claims report will come out at the usual 8:30 AM Thursday time, but this is likely to be eclipsed by the Employment Situation report on Friday morning. Expectations are for the unemployment rate to remain steady at 8.3% with a slight drop in non-farm payroll job creation.

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 financial events and situations.

Investments in commodities may have greater volatility than investments in traditional securities, particularly if the instruments involve leverage. The value of commodity-linked derivative instruments may be affected by changes in overall market movements, commodity index volatility, changes in interest rates, or factors affecting a particular industry or commodity, including international economic, political and regulatory developments.

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.

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.

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, this is a market capitalization weighted index, meaning the largest companies in the S&P 500 have a greater weighting than smaller companies. The S&P 500 Equal Weighted Index is determined by giving each of the 500 stocks in the index the same weighting in the index. 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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