Friday, April 13, 2012

Markets reacted negatively to the release of the minutes from the Federal Reserve's Open Market Committee (FOMC) meeting this past week after the FOMC indicated that it was unlikely to offer another round of quantitative easing (QEIII) in the near term. Also making investors nervous was the weak auction for Spanish debt and the sharp drop in the creation of new jobs announced (121,000 new jobs vs. 201,000 expected) Friday morning by the Department of Labor's Bureau of Labor Statistics. These major news events permeated most markets to some degree last week.

For the week, the Dow Jones Industrial Average (DJIA) lost 152 points (-1.15%), the S&P 500 fell 10 points (-0.74%), and the mid- and small-

capitalization heavy Russell 2000 gave back 1.46% in the holiday-shortened trading week. The NASDAQ outperformed the other major US indexes by losing just 0.36%. The DJIA matched its worst one-week performance in 2012 of just two weeks ago, and the S&P 500's drop was its worst weekly pullback of the year. The drop in the more volatile Russell 2000 was the third worse out of four weekly losses so far in 2012 for this broad index, while the NASDAQ posted only it's second down week this year. For the year the DJIA is up 6.9%, the S&P 500 is up 11.2%, the Russell 2000 has gained 10.4%, and the NASDAQ continues to lead all major indexes with a gain of 18.2%.

Every major US economic sector saw declines last week. Consumer Discretionary bettered all other sectors with a slightly negative return for the week followed by Consumer Staples, Health Care, Information Technology, and Utilities. Energy, Financials, Materials, and Industrials were the bottom four sectors and all returned less that the DJIA. For the year, Information Technology, Financials, Consumer Discretionary are the top three performing sectors and are all ahead of the S&P 500. Utilities, Energy, and Telecom are the bottom three with Utilities the only sector with a negative return so far in 2012.

International stocks underperformed US stocks last week by a wide margin. The European-heavy (two-thirds Europe, one-third Japan) MSCI EAFE index was down 3.05% over renewed debt concerns in Europe. Spain has become especially worrisome following a particularly weak bond offering last week and a corresponding surge in interest rates for its sovereign debt. The yield on Spanish 10-year debt jumped nearly one-half percent to close last week at 5.757%. Italian debt jumped at nearly the same rate, and the French 10-year is now close to breaching the 3% yield hurdle.

The Dow Jones UBS Commodity index posted yet another weekly decline giving back just under 0.2%. This broad commodity index is now down four of the past five weeks and is up just 0.7% for the year. WTI Oil added $0.11 (0.1%) per barrel to close Friday at $103.31. Gold posted its third worst weekly loss for 2012 losing $41.80 (-2.50%) per ounce closing at $1630.10. I believe the price of gold has come to reflect investor fears over the amount of currency in circulation both in the US and abroad. When the news from the FOMC minutes was released last Tuesday saying that the Federal Reserve is likely to sit tight on a third round of quantitative easing for now, gold investors immediately sold because expectations of currency inflation were greatly diminished. My belief is that commodity prices are a proxy on two important issues: supply and demand, and currency valuations. Supply and demand is basic economics. The stronger an economy, the greater the demand, and if commodity production cannot keep up with demand, prices jump. The value of the US Dollar is also driven by supply and demand, but is heavily influenced by the monetary policies of the Federal Reserve, and because most commodity contracts are valued in the US Dollar, a cheaper US Dollar means commodity prices tend to rise and vice versa. There are many factors weighing on the price of commodities and thus commodity prices can be difficult to predict leading to greater volatility as data reaches the markets. I continue to believe, however, that commodities remain a possible hedge against rising inflation.

The Euro had its sharpest one-week pull back this past week on the weakness in the Spanish bond market losing almost three cents (-2.03%) to close Friday at $1.306. Correspondingly, the US Dollar Index, a basket of foreign currencies measured against the US dollar had its best one-week performance for the year gaining 1.36% for the week. The Euro is now up just 0.9% for the year reflecting the great uncertainty and direction of the markets at this time.

Bond markets rebounded nicely last week after QEIII was taken off the table for now. The Barclays US Aggregate Bond Index was up 0.49% for the week, and is up 0.82% for the year. As I noted last week, the bond market is still just drifting along and influenced by the many nuances of the Federal Reserve and its somewhat activist monetary policies. I will discuss some of the issues surrounding QEIII in the next section. The 10- and 30-year US Treasury interest rates both fell with the 10-year yield closing the week at 2.177% compared to the previous Friday's close of 2.214%. The US 30-year yield settled at 3.328% down from the previous week's close of 3.341%. For now, the US Treasury remains the go-to place for "safe haven" investors from around the world. Extended duration US Treasuries were the best performing bond sector for the week while international treasuries was the worst. For the year, preferreds, international inflation protected, and high yield are the best performing bond sectors while extended duration US Treasuries and corporate are the weakest.

TO QE OR NOT TO QE?

William Shakespeare sure had a way with words and here I am liberally quoting from the great English bard some 400 years later. However, unlike Hamlet, I am not contemplating suicide but rather looking at the impact of the Federal Reserve's decision to opt out of QEIII for now (based upon last Tuesday's release of the FOMC meeting minutes), and whether the poor jobs report this past Friday will raise the possibility of QEIII returning to the active policy mix.

Let me begin by saying that I personally believe the markets are overly obsessed with the concept of QEIII. I would like to see the Fed sit on the sidelines for now and let the US economy exist without constant tinkering from the Fed. But Mr. Bernanke's active chairmanship at the Fed forces investors to constantly evaluate his interventions, or possible interventions, in the markets. So whether or not I like it, here I am talking about QEIII. Central bank operations is not the stuff for exciting reading, but I ask that you to bear with me because this is important.

For those of you who may not be entirely familiar with QE let me quickly summarize for you. QE is the Federal Reserve's slightly indirect route to printing more money and putting it into circulation within the economy. The belief is that more money in circulation will help by providing more funds to the banks to lend, give asset prices a boost giving investors more confidence, and will keep interest rates down thus encouraging more borrowing. I would add one additional objective-keeping government borrowing costs low so the impact of borrowing trillions of dollars does not blow up spending budgets with excessive interest payments.

I refer to QE as QEIII today because the Fed has already under taken QEI and QEII, so their next effort will be QEIII. How the Fed puts money into the market varies between QE's but boils down to buying US Treasuries in the open market and getting cash into the economic system. QEI was straight bond buying-create money and buy bonds. QEII, also known as Operation Twist, targeted longer duration (>7 years) bonds for purchase. What makes QEII slightly different is that the Treasury used shorter duration bonds that were maturing as the source of cash to buy the longer duration bonds. The Fed has contended that QEII would have minimum inflationary pressure on the economy because the net supply of money would be unchanged. QEII is expected to conclude by the end of June which helps explain the recent preoccupation with QEIII.

Last week the Fed said it would not implement QEIII and hold steady on monetary policy for now because the economy is improving. The improvement is not as robust as the Fed would like, but it is improving. The Fed also said that it expected the unemployment rate to remain elevated for the time being even as the economy slowly improves. The Fed has been telegraphing this position for some time so I was a little surprised by the immediate and negative impact the release of the minutes had on stock markets Tuesday and Wednesday. The jobs report on Friday was also is in line with the Fed's earlier comments, but the larger than expected drop has caused observers to ask again if the Fed will now consider QEIII?

The constant tinkering by the Fed in the markets is one of the major factors why investing has become so difficult today. You just don't know how and by how much the Fed will enter into the financial markets. I am very skeptical that one poor jobs report will be enough to sway the Fed when it meets again April 24th and 25th. Therefore, I believe that investors will increasingly turn their attention to corporate earnings, inflation data, and economic data for market guidance. I believe the Fed will continue to wait on QEIII for the time being.

LOOKING AHEAD

Last week's economic data reinforced my belief that the US economy resembles a toddler riding a bike on training wheels-unsteady, uncertain, but upright and moving forward. Market data over this past weekend indicates that markets may open to the downside at the very start of the week, but there is much more going on then just a single jobs report that may influence markets for the week. I must remind everyone that the European debt crisis is like a volcano that is rumbling beneath the surface. Rising interest rates in Spain and Italy are especially troubling, but Europe has so much further to go before this region stops being a drag on the world economy. Here in the US, the 1st quarter earnings season is upon us and most stories I have read are raising concerns that corporate earnings will not be as robust as they have been.

For now, my views about the markets developed through the Dorsey Wright & Associates (DWA) relative strength analysis is unchanged. US stocks remains the strongest asset category followed by Commodities, Bonds, International stocks, and Currencies. US stocks retain a very sizable lead over the other categories with the others clustered closely together. Mid-capitalization stocks are favored, growth is favored over value, and equal-weighted indexes are favored over capitalization-weighted ones. On a relative strength basis, DWA puts Consumer Discretionary, Information Technology, and Financials as the three strongest economic sectors.

Key US economic data releases this coming week will be focused on inflation with the International Trade and Producer Price Index reports coming Thursday morning and the Consumer Price Index report on Friday morning. All three of these reports are expecting very modest improvements. Following last Friday's Employment Situation report, investors will be very interested in Thursday morning's Initial Jobless Claims report. Consensus is calling for a slight uptick from first time jobless claims of 357,000 last week to 359,000 this week.

Finally, last Friday was an exciting day here in Virginia Beach. As I am sure most of you have heard, a Navy F-18 Super Hornet jet crashed shortly after takeoff into an apartment complex. The pilots survived as did everyone on the ground. Each of us in our own way has much to be thankful for and I will be forever grateful that Esther survived without a scratch. Tough times lay ahead as the families try to recover their property losses.

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.

TIPS are U.S. government securities designed to protect investors and the future value of their fixed-income investments from the adverse effects of inflation. Using the Consumer Price Index (CPI) as a guide, the value of the bond's principal is adjusted upward to keep pace with inflation. Increase in real interest rates can cause the price of inflation-protected debt securities to decrease. Interest payments on inflation-protected debt securities can be unpredictable.

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 ®, CRPC ® 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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