Market returns were mixed this past week following a 205 point drop (-1.5%) in the Dow Jones Industrial Average (DJIA) on Friday.  Several third quarter earnings “misses” by Google, Microsoft, McDonald’s, Chipotle Mexican Grill, and General Electric among others raised concerns about the strength of the economy.  Markets have been unforgiving towards companies when their earnings have not met expectations.  Chipotle shares fell 16.3% last week and are down 29.2% over the past month, Microsoft is down 7.8% over the past month while losing 1.9% last week, and GE lost 2.0% last week and is down just 1.0% for the month.  The largest company in the world in terms of market capitalization, Apple, has fallen 13.6% from its recent mid-September high.  The common theme among all of these companies is that revenues are not growing as fast as they had been, and margins are getting squeezed.  McDonald’s and Chipotle are facing higher food costs, Google is lacking pricing power for its services as more users focus on mobile devices, and Apple is seeing competition explode in the mobile device space.  The Wall Street Journal reported Saturday that, “nearly six in 10 companies are reporting weaker sales than Wall Street expected, and revenue for the S&P 500 is expected to slip slightly below where it was a year earlier by the time all reports are tallied.”  The markets have taken notice.

Despite Friday’s loss, the DJIA gained 15 points (0.1%) for the week and the S&P 500 gained 0.3%.  The Russell 2000 fell 0.25% and the tech-heavy NASDAQ lost 1.3%.  Three weeks into October, the DJIA is off 0.7%, the S&P 500 is down 0.5%, the Russell 2000 has dropped 2.0%, and the NASDAQ has given back 3.6%.  With 42 weeks now completed for 2012 (yes, there are only ten weeks left in the year) all the major indexes are up led by the NASDAQ’s 15.4% gain followed by the S&P 500 which is up 14.0%.  The Russell 2000 is up 10.8% and the DJIA is up 9.2%

Like the major indexes, performance by the major economic sectors was mixed.  Materials led the eleven sectors with a gain of over 2%.  Utilities, Financials, Energy, and Real Estate followed and were all up between 1% and 2%.  Information Technology was the weakest sector losing just over 2% followed by Telecom, and Consumer Staples.  For the year, Financials is now the best performing sector with gains of just over 21%.  Consumer Discretionary, Health Care, and Telecom have all returned greater than 18%.  Utilities, Energy, and Consumer Staples are the weakest sectors but all have positive gains for the year.

International markets did well for the week.  The MSCI (EAFE) index was up 2.5% and the European-only STOXX 600 gained 1.7%.  The Asia/Pacific region helped the MSCI (EAFE) index with a solid 2.1% gain (its best performance in the past five weeks).  The Emerging Markets region gained 1.0% and the Americas region added 0.4% for the week.  In Brussels, the European Union (EU) held a major summit on Thursday and Friday agreeing to create an EU-wide banking regulator with the ability to recapitalize banks with funds directly from the European Stability Mechanism (ESM).  However, the European leaders did not announce a schedule or amount for Greece’s next round of bailouts, and Spanish President Rajoy continued to retreat from seeking money from the ESM for his country’s troubled finances.  Markets reacted negatively to the news about Greece and Spain on Friday.  I remain firm in my belief that Europe has a very long way to go before it is out of trouble and I believe that economic weakness in Europe is beginning to hurt China and is a contributing factor to weak revenue growth here in the US. 

Bond sector performance was also mixed last week.  Overall, the Barclays US Aggregate Bond index was down 0.2% for the week.  US Treasury yields increased over the week making extended duration Treasuries the poorest performing sector of the week.  The US 10-year yield closed Friday at 1.766% compared to the previous week’s close of 1.660%.  The US 30-year yield finished the week at 2.937% up from the previous Friday close of 2.833%.  Spain saw the yield on its 10-year sovereign fall to 5.372% from the previous week’s close of 5.625% although the yield did rise slightly on Friday after the EU announced that Spain had not asked for bailout funds.  The game of chicken continues to play out in Europe.

The US Dollar index fell 0.1 % last week principally on the strength of the Euro, which closed Friday at $1.302 to the US Dollar.  The Euro is now virtually unchanged over the past two weeks reflecting the ongoing uncertainty of currency traders.  I believe that a strong Euro is one of the key signals for the “risk on” trade with investors.  For now, it appears that traders believe that Europe will get its act together, just not yet.   

The Dow Jones UBS Commodity index fell 0.4% last week marking the third consecutive week of declines for this broad commodity index.  WTI Oil lost $1.81 per barrel (-2.0%) closing Friday at $90.05.  It appears that oil traders are feeding off the news coming from corporate earnings reports and are growing concerned that the overall decline in US and global economic activity will translate to decreased demand for oil.  The price of gold fell $38.10 per ounce (-2.2%) to close Friday at $1721.60.  Over the past two weeks, gold has now fallen $59.20 per ounce (-3.3%).  Reviewing a number of different gold analysts’ comments about recent trading, about the only consistent themes I could find is that traders are like most investors today—uncertain, and that most of the effects of the Federal Reserve’s third round of quantitative (QEIII) easing was fully discounted into the price of gold when it was trading at the upper $1700’s.  It appears that gold has pulled back as investors question the efficacy of QEIII. 

RELIVING THE CRASH OF OCTOBER 1987

This past Friday marked the 25^th anniversary of the Crash of 1987 or Black Monday as it is often called.  At the time, I was a young US Army captain teaching ROTC at the University of Cincinnati and pursuing my Masters in Business Administration.  I clearly remember walking into the offices of the business college’s graduate program around 2 PM and hearing everyone talking about the “crash” that was underway.  I was just an interested spectator of the markets that day, and the pain felt by investors did not have a direct impact on me.  Over time, I grew fascinated about what had happened and what led up to that fateful day when the DJIA lost 508 points representing 22.6% of the market’s value.  My interest was so keen that I ended up writing my MBA thesis on “portfolio insurance,” one of the culprits blamed for the staggering loss that day.  In the end, I came to understand that many factors contributed to the huge sell-off that Monday in October.  With the anniversary date just passed and a 205-point sell-off, I could not help but take time to use some of the tools I use today and compare that timeframe to today’s markets.  Using data provided by Dorsey Wright & Associates and Google, it is possible to go back and look at what happened just prior to the crash and afterwards.

The New York Stock Exchange Bullish Percent (NYSEBP) is the key technical indicator I follow.  This indicator provides me with an idea of the overall trend in equity markets by looking at the nearly 3000 stocks that trade on the New York Stock Exchange (NYSE).  At any moment in time, a stock is either in a buy or sell signal using point and figure charts (I will not cover the concept of point and figure charts here, but if you have questions, just call me).  The NYSEBP adds up all of the stocks on a buy signal and divides that by the total number of stocks on the NYSE.  The result is the NYSEBP.  The higher the NYSEBP, the stronger the markets.  Additionally, the NYSEBP can either be increasing or decreasing.  If it is increasing it means that investors are generally buying stocks (demand is in control), while when it is decreasing, investors are selling stocks (supply is in control).  The value of the NYSEBP is that it is dependent upon the collective actions made by many traders over a wide swath of stocks.

The second indicator I look at is momentum.  In this case, the monthly momentum.  Simply put, the monthly momentum indicator takes any investment, in this case the DJIA, and compares its current average to its moving average over the past five months.  If the DJIA (or any stock or index for that matter) is trading above its moving average, that is a bullish signal.

Looking back to 1987, the DJIA closed out September at 2596.28 and was up a strong 27% through the first nine months of the year.  The DJIA continued to rise the first couple of days in October nearly reaching the highs of the year that had been achieved in late August.  However, a troubling signal had been flashed by the NYSEBP on September 4^th when this important indicator reversed to signal that supply was now in control.  So while the DJIA continued to climb for another month, the NYSEBP was retreating.  As Tom Dorsey of Dorsey Wright & Associates likes to put it, “the generals were still on the field fighting while the soldiers had all turned and fled.”  Additionally, the monthly momentum had reversed by the end of September.  The broad market was weakening while the key index was climbing masking possible trouble to many investors.

Today, there is a lot of worry out there.  The DJIA had a 205-point sell-off on Friday.  The Europeans are a mess, the fiscal cliff is rapidly approaching, investors are nervous about the elections, and the US and global economies are slowing.  The Investment Company Institute reported that for the week ending on October 10^th investors were pouring cash into bond investments and cutting positions in their stock investments.  Unlike 1987, however, the NYSEBP has held its ground in October and stocks remain in demand.  In other words, the soldiers are still on the field fighting.  Additionally, the monthly momentum for the DJIA recently turned positive after being negative since June.  With all the worry in the minds of investors and negative headlines, the markets are saying that stocks are still favored.  Reality and perception are not always the same.  From a technical standpoint, today is very different from 1987.

LOOKING AHEAD

Last week’s economic data did little to change the view that the economy is plodding along.  Some data was good, some mediocre, some not so much.  Traders will now turn their attention to this week’s data looking for trend signals.  This is how investors have spent most of the year and this week will be no different.

The key economic events for the coming week are the release of the first estimate of the third quarter Gross Domestic Product (GDP) on Friday and the Federal Open Market Committee (FOMC) meeting Tuesday and Wednesday.  The GDP number is extremely important, and as I said last week, the number (and all data reported between now and November 6^th) will be heavily scrutinized because it is the last GDP report prior to the election.  Consensus is expecting an increase to 1.9% compared to 1.3% in the second quarter.  The FOMC meeting is not expected to produce any headlines.  The Federal Reserve’s last meeting set the FOMC’s policies for the next few quarters, so investors are expecting little more than a confirmation of the previous monetary policy announcements.  September new home sales will be released on Wednesday morning.  This is an important report because housing remains such a critical component to the US economy and may give some insight to the third quarter GDP number.  Consensus is anticipating a slight increase in new home sales to an annualized rate of 385,000.  Initial Jobless claims on Thursday morning is expected to report a slight decrease from last week’s rate of 388,000 to 372,000.  Finally, September Durable Goods Orders will be released on Thursday.  Consensus calls for an increase to 7% from August’s unexpected decline of 13.2%.  All of the week’s reports may offer some insight into how the GDP number will look on Friday morning.

The NYSEBP gained 0.93 to close Friday at 66.26.  As I noted earlier, the soldiers are still on the field and demand remains firmly in control.  The NYSEBP would have to fall to 61.38 in order to reverse and put supply in control of stocks. The CBOE Volatility Index, referred to as the VIX, and is a measure of future volatility in the stock market, did rise last week and finished the week at 17.06 compared to last week’s close of 16.14.  Although elevated from the previous week, the VIX remains somewhat subdued.

The Dorsey Wright & Associates analysis of the markets has remained unchanged for most of the summer and now into the fall.  Data indicates that US stocks and Bonds are the two favored major asset categories followed by Foreign Currencies, International stocks, and Commodities.  Middle capitalization stocks are favored, as is growth over value, and equal-weighted indexes over capitalization weighted indexes.  Equal-weighted indexes are those where each stock in the index is weighted the same, while in capitalization-weighted indexes the larger stocks have the largest weighting consistent with their size relative to the other stocks.  The relative strength sector weightings favor Consumer Discretionary, Health Care, and Financials.  Financials pushed Real Estate to the fourth position this past week, but it would not cause me to sell or reduce Real Estate positions at this time.  US Treasuries and International Bonds are favored in the Bond category, while US and Developed Markets are favored within the International stock category.  Energy and Agriculture are the favored sectors within the Commodity category.

Paul L. Merritt, MBA, AIF^®, CRPC®

Principal

NTrust Wealth Management

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

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.

Emerging market investments involve higher risks than investments from developed countries and 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.  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 CBOE Volatility Index - more commonly referred to as "VIX" - is an up-to-the-minute market estimate of expected volatility that is calculated by using real-time S&P 500^® Index (SPX) option bid/ask quotes. VIX uses nearby and second nearby options with at least 8 days left to expiration and then weights them to yield a constant, 30-day measure of the expected volatility of the S&P 500 Index.

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.

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 generally are 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.

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. 

 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 and is a capitalization-weighted index meaning the larger companies have a larger weighting of the index.  The S&P 500 Equal Weighted Index is determined by giving each company in the index an equal weighting to each of the 500 companies that comprise 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 Russell 2000 Index Is comprised of the 2000 smallest companies of the Russell 3000 Index, which is comprised of the 3000 biggest companies in the US.   The NASDAQ Composite Index (NASDAQ) is an index representing the securities traded on the NASDAQ stock market and is comprised of over 3000 issues.  It has a heavy bias towards technology and growth stocks.  The STOXX^® Europe 600 is derived from the STOXX Europe Total Market Index (TMI) and is a subset of the STOXX Global 1800 Index.  With a fixed number of 600 components, the STOXX Europe 600 represents large, mid, and small capitalization countries of the European region

Investors turned cautious this past week shifting money away from stocks and into safe-havens like US Treasuries and the US Dollar.  A report issued by the International Monetary Fund (IMF) and the downgrade of Spanish sovereign debt by Standard & Poor’s refocused concerns about the effectiveness of the European Union’s (EU) efforts to deal with the on-going debt crisis in Europe.  While here at home, the consensus is growing that earnings for the 3^rd quarter will not be as robust a previous quarters due to the slowing global economy.  I believe that companies have trimmed every bit of fat out of their budgets and therefore, if any real growth is going to emerge in profits, it will have to come from revenue growth, not spending cuts.

The Dow Jones Industrial Average (DJIA) fell 281 points (-2.1%) last week for its worst weekly loss since the week ending June 1^st some 19 weeks ago.  The S&P 500 lost 2.2%, and the Russell 2000 gave back 2.4%.  The technology-heavy NASDAQ lost 2.9% as Apple fell 3.5%.  Let me take a brief moment to describe how the NASDAQ Composite index is constructed.  The NASDAQ is like many indexes and is a capitalization-weighted index.  This means that the weighting given to Apple and other companies within the index is in direct proportion to the market size of each company.  Apple is the largest company in the world in terms of market capitalization (total number of shares outstanding multiplied by the current share price) and makes up just over 9% of the NASDAQ, so the performance of Apple greatly influences the performance of the NASDAQ. 

For the year, the DJIA is up 9.1%, the S&P 500 is up 13.6%, the Russell 2000 has increased 11.1%, and the NASDAQ has gained 16.8%.

Not a single major economic sector was positive last week.  Real Estate and Utilities were the best performing sectors losing less than 1%.  Energy, Financials, Consumer Staples, and Industrials followed in order of performance and all outperformed the DJIA.  Information Technology, Consumer Discretionary, and Telecom were the weakest and all lost more than 2%.  For the year, Consumer Discretionary, Health Care, Financials, and Telecom are the strongest performing sectors while Utilities, Energy, and Industrials are the weakest.

The protests that greeted German Chancellor Merkel in Greece early in the week or Wednesday evening’s downgrade of Spanish sovereign debt to one notch above junk by S&P failed to shake European markets.  This leads me to believe that some of the obvious bad news is already discounted into European stocks.  The STOXX 600 fell a modest 1.7% for the week while the MSCI (EAFE) index fell 2.1%.  The Emerging Market region was the best performing region losing just 0.5% for the week while the Asian/Pacific region fell 1.5%.  I remain, as I have all year, skeptical about international markets and European markets in particular.  I remain skeptical first because the technical indicators provided to me by Dorsey Wright & Associates in Richmond, Virginia, have placed international equities either in last or next to last place relative to the other four major asset categories in 2012.  Second, I do not believe that the EU is progressing quickly enough to alter fiscal policies anchored in bloated government-dominated economies toward more robust private sector-based economies.  Therefore, I believe the risk/reward attributes of European stocks are not attractive. 

I mentioned at the top of the Update that US Treasuries regained some popularity last week as a safe-haven investment and that was reflected by the 10-year and 30-year yields falling over the past week.  The 10-year yield fell from 1.737% to close Friday at 1.660%, while the 30-year yield fell from 2.965% to 2.833%.  The latest move in Treasuries marks the third time in six weeks that their prices have risen (yields down).  What I see, especially in the 30-year yield, is that each successive high has been higher than the previous high, and that each successive drop in yield has been higher than the previous drop.  Higher highs and higher lows in yields provide a longer-term upward trend to interest rates, and I will be watching this closely to see if a trend is developing.

The rally in longer duration US Treasuries helped bonds outperform stocks last week.  The Barclays US Aggregate Bond index was up 0.4% for the week and is now up 4.4% for the year.  The best performing bond sectors last week were the long duration US Treasuries and corporates along with high quality corporate and emerging market sovereign debt.  Treasury inflation protection notes (TIPs), mortgage-backed bonds, and short duration international treasuries were the weakest performers losing less than 0.5% for the week.  Yields on Spanish, Italian, and French sovereign debt all fell like US Treasuries.  The drop in Spanish debt may be perplexing in light of S&P’s downgrade, buy yields did drop.  I will attempt to explain the market’s reasoning shortly.

The US Dollar index gained 0.4% last week marking the third week out of the past four that the US Dollar has strengthened against a basket of foreign currencies.  The Euro lost almost a penny (-0.6%) against the US Dollar to close Friday at $1.295.  Worries about the European debt crisis continues to keep currency traders off balance and unsure about the success of the EU, European Central Bank (ECB), and the IMF in dealing with the current situation on the ground.  I believe the recent US Dollar weakness over the past several months was influenced by the Federal Reserve’s decision to engage in another round of Quantitative Easing (QE III), however, the effect of that policy on currency traders has lessened and most attention is now focused on the EU.  Traders can be a finicky lot, so next week may bring an entirely different story (think US elections and fiscal cliff) and an entirely different set of behaviors.

Commodities pulled back for the second week in a row with the UBS Dow Jones Commodity index falling 0.6%.  Natural gas and oil prices were both higher last week.  Natural gas because of lower than expected inventories.  Oil, according to reports, because of fears over political uncertainty in the Middle East coupled with the increasingly hostile activities on the Turkey/Syrian border.  The Organization of Petroleum Exporting Countries (OPEC) went to great lengths to reassure markets and told the IMF at its meetings last week that OPEC was prepared to insure adequate supplies for world consumers.  Despite OPEC’s efforts, WTI Oil still jumped $1.94 per barrel (2.2%) to close Friday at $91.86.  Gold fell $21.10 per ounce (-1.2%) to close at $1759.70.  I believe that anytime the US Dollar strengthens, as it did last week that helps push down or hold gold prices steady.  There were also reports that China had slowed gold imports over the past few months, and China’s activities have a huge influence over commodity prices, including gold. 

IS SPAIN PLAYING A GAME OF CHICKEN WITH THE EU?

Oh boy.  Here I go again writing about Europe and the debt crisis.  For those of you who read my Updates regularly know how tired I have become writing about Europe and their economic and debt mess, yet events in Europe compel me to pick up my pen and address this subject once again.  My focus this week is on Spain and the dangerous game of chicken I believe that country is playing and what it means to us.

The game of chicken takes on many forms from benign games little kids will play to the more serious life-and-death games countries play with each other.  The one thing all players have in common is that they try to outlast their opponent even in the face of perceived or real doom.  Each  player believes the other will flinch first and victory will be to the steely-nerved one, but if neither makes a move, both players will suffer.  This is precisely the game, I believe, that Spanish President Mariano Rajoy is playing with the EU.

Before the Olympic Games in London this past summer, ECB President, Mario Draghi, assured the world he would do “whatever it takes,” to keep the euro together.  A couple of days prior to Mr. Draghi’s comments on July 26^th, the yield on the Spanish 10-year sovereign bond reached 7.69% and Spain was on the verge of economic collapse.  When markets closed just a day after Draghi’s comments, the yield on Spain’s 10-year had fallen to 6.74%.  Not perfect, but clearly much better than earlier in the week.  Since then, Mr. Draghi has outlined a specific plan for any EU country to obtain aid and the EU has formalized its bailout mechanism now known as the European Stability Mechanism (ESM).  The Germans, who have never been enamored with bailouts, were able to drive one key concession in the structuring of the ESM, and that concession was that a government would have to formally request the bailout.  Now you might think that is a rather innocuous concession, but just look at the three previous countries that sought and received bailouts:  Greece, Portugal, and Ireland.  The political parties in power at the time of the bailouts were all voted out of office at the first national elections following the bailout.  The political price to pay for seeking a bailout can be extremely high.

Spanish President Rajoy certainly understands this.  He also understands that with the S&P’s downgrade of his country’s debt, it is more clear than ever that his efforts to stabilize Spain and turn things around has either not worked, or are not working quickly enough.  Spain has the highest unemployment rate (25.1%) in the EU, and Spanish banks require over €100 billion ($129.5 billion) of recapitalization.  The economy is in recession and shows no sign of improving.  Demands on the government treasury are increasing, not decreasing.  Yet the yield on Spanish 10-year debt fell following S&P’s downgrade.  Are investors mad?  No.  They believe that Rajoy will be forced sooner, rather than later, to formally request a bailout.  With the ESM in the mix, Spanish bond investors believe they have downside protection on their investments and are willing to buy Spanish bonds.  Rajoy also understands that without having to go to the ESM so far, his bond yields have fallen dramatically and he has been able to refinance most of the debt Spain has coming due in 2012.  Pressure has been relieved and all of this accomplished without approaching the EU and having conditions established over Spanish sovereignty that would certainly be part of any bailout from the ESM.

How long can this last?  This is the game of chicken Rajoy is playing.  He is betting that he can get things turned around in Spain before the markets turn on him and drive up borrowing costs thus forcing him to go to the EU and the ESM.  Critics say that Rajoy should go to the ESM now while the debt levels are still manageable and expectations were that the S&P downgrade would make him understand the necessity of that course of action.  If Rajoy does not tap into the ESM and he cannot turn the country around, the cost of the bailout will increase significantly hurting not only Spain but also the EU, and jeopardizing the entire global economic balance.  I believe that Rajoy should act now, and that the longer he waits, the more uncertainty will creep into the markets, and the more unpleasant the outcome will have on the global economy.

LOOKING AHEAD

The coming week is going to be busy in terms of new economic data which is certain to keep all the talking heads buzzing on TV.  Given the proximity to the presidential election, every economic data point is going to be scritinized and dissected ad nauseum.

September retail sales get things kicked off Monday morning.  Retail sales is an important number because two-thirds of the US’s Gross Domestic Product (GDP) is based upon consumer consumption.  Consensus calls for a slight decrease from 0.9% in August to 0.7% in September.  The September Consumer Price Index and Industrial Production numbers will be released on Tuesday.  Prices are expected to increase at a slightly lower rate (0.5% vs. 0.6% in August), and Industrial Production is expected to increase 0.2% after falling 1.2% in August.  This will be an especially politically sensitive number, I believe.  New Housing Starts will be released Wednesday morning and are expected to continue increasing over previous monthly numbers.  The annualized rate for new home construction in September is expected to be 765,000 compared to 750,000 in August.  The Jobless Claims report on Thursday will also be carefully watched for political reasons.  Last week’s number of 339,000 was an unexpectedly sharp improvement, but was quickly discounted after it was learned that the Bureau of Labor Statistics had not included California’s number in their data.  This week, a arge upward revision is expected on the previous week’s number along with 765,000 new claims for last week.  Friday will conclude with September Existing Home Sales.  This number is expected to decrease from an annualized rate of 4.82 million homes to 4.75 million.  As I noted, with the presidential elections so close, all of these number will come under extraordinary scrutiny, but as we have seen most of the year, there is really nothing newsworthy in the numbers other than what we already know—economic growth is stuck in slow-motion.

The New York Stock Exchange Bullish Percent (NYSEBP) fell 1.03 to close Friday at 65.33.  This marks the third down week in the past four following two very strong weeks in early September.  I sense that momentum is waning and that this indicator feels like a plane stalling at the apex of a climb.    For now, however, there appears to be enough power in the engine to keep the plane right where it is, but I will be watching to see what direction the bullish percent moves from here.  The CBOE Volatility Index (VIX) has increased slightly over the past couple of weeks, but remains at a subdued 16.14.  Finally, the Standard and Poor’s 500 index is now 3% oversold, meaning that the current value of the index is about neutral based upon the past ten weeks of activity.

The Dorsey Wright & Associates analysis of the markets indicate that US stocks and Bonds are the two favored major asset categories followed by Foreign Currencies, International stocks, and Commodities.  Middle capitalization stocks are favored, as is growth over value, and equal-weighted indexes over capitalization weighted indexes.  Equal-weighted indexes are those where each stock in the index is weighted the same, while in capitalization-weighted indexes the larger stocks have the largest weighting consistent with their size relative to the other stocks.  The relative strength sector weightings favor Consumer Discretionary, Health Care, and Real Estate.  Information Technology has fallen from third position to sixth on a relative strength basis.  US Treasuries and International Bonds are favored in the Bond category, while US and Developed Markets are favored within the International stock category.  Energy and Agriculture are the favored sectors within the Commodities asset category.

Sincerly,

Paul L. Merritt, MBA, AIF^®, CRPC®

Principal

NTrust Wealth Management

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

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.

Emerging market investments involve higher risks than investments from developed countries and 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.  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 CBOE Volatility Index - more commonly referred to as "VIX" - is an up-to-the-minute market estimate of expected volatility that is calculated by using real-time S&P 500^® Index (SPX) option bid/ask quotes. VIX uses nearby and second nearby options with at least 8 days left to expiration and then weights them to yield a constant, 30-day measure of the expected volatility of the S&P 500 Index.

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.

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 generally are 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.

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. 

 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 and is a capitalization-weighted index meaning the larger companies have a larger weighting of the index.  The S&P 500 Equal Weighted Index is determined by giving each company in the index an equal weighting to each of the 500 companies that comprise 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 Russell 2000 Index Is comprised of the 2000 smallest companies of the Russell 3000 Index, which is comprised of the 3000 biggest companies in the US.   The NASDAQ Composite Index (NASDAQ) is an index representing the securities traded on the NASDAQ stock market and is comprised of over 3000 issues.  It has a heavy bias towards technology and growth stocks.  The STOXX^® Europe 600 is derived from the STOXX Europe Total Market Index (TMI) and is a subset of the STOXX Global 1800 Index.  With a fixed number of 600 components, the STOXX Europe 600 represents large, mid, and small capitalization countries

of the European region.

Equity markets, both here and abroad, reversed their recent losing trends and posted solid gains for the first week of October.  The big economic headline last week was the official US unemployment rate falling to a four-year low of 7.8%.  Although markets rallied strongly on the news Friday morning, they did not hold much of the day’s gains and closed well below earlier session highs.

For the week, the Dow Jones Industrial Average (DJIA) added 173 points (1.3%).  The S&P 500 gained 1.4%, the mid- and small-capitalization dominated Russell 2000 and tech-heavy NASDAQ both increased by 0.6%.  For the week, at least, larger companies were favored over smaller ones.  As we kick off the 4^th quarter, the DJIA is now up 11.4% for the year.  The S&P 500 is up 16.2%, the Russell 2000 has risen 13.8%, and the NASDAQ is up a strong 20.4%.

Financials and Health Care were the best two performing major economic sectors gaining over 2.5% each.  They were followed by Consumer Discretionary, Consumer Staples, Industrials, and Telecom.  All of these top sectors out-performed the S&P 500 for the week.  Information Technology and Energy were both slightly negative on the week and the laggards among sectors.  For the year, Consumer Discretionary, Health Care, Telecom, and Financials are the leading sectors while Utilities, Energy and Real Estate are the bottom three.  All sectors, however, remain positive and only Energy and Utilities are underperforming the DJIA.

International stocks were up nicely this past week.  The MSCI (EAFE) index gained 1.2% for the week while the European-focused STOXX 600 added 2.1%.  The Asian/Pacific and Emerging Market regions lagged gaining 0.1% and 1.1% respectively.  European investors have continued to be buoyed by Mario Draghi’s (European Central Bank President) commitment to his own version of quantitative easing for European Union (EU) countries.  Most of the EU is in recession, unemployment is at record levels, and it appears that Greece is hopelessly addicted to continued bailouts.  Yet the stock market continues to go up.  I believe this reflects the power of monetary policy in today’s economic environment.  I remain uncomfortable making any significant investments in international securities, especially European securities, and have avoided this major asset category so far in 2012.  However, I do believe that European leaders will make every effort to keep Greece within the EU and to maintain the strength of the Euro.  Even if they are successful, I believe Europe will struggle to create any real economic growth and will have trouble outperforming the US and emerging markets going forward.

US Treasury yields reversed course and the 10-year gained 0.11% to close Friday at 1.737%.  The 30-year yield also added 0.14% to close the week at 2.965%.  Analysts suggested that the sell-off in US Treasuries was the result of the unexpected drop in the unemployment numbers thus increasing the chances that the Federal Reserve would delay or curtail its recently announced bond purchases (QEIII).  No one knows at this point how the Federal Reserve will act, but yields on Treasuries did jump on Thursday and Friday.  Spanish and Italian sovereign 10-year yields fell and closed Friday at 5.686% and 5.054% respectively.  I found it interesting that Bill Gross of PIMCO revealed that he purchased both Spanish and Italian debt on news that the ECB would begin buying EU sovereign debt.  Reintroducing the private sector into the mix has to be a good thing for European bond markets for now.  The question in Europe remains, however, when will the Spanish government officially request the ECB to step in and purchase Spanish debt?  Overall bonds were generally down last week with the Barclays US Aggregate bond index dropping 0.2%.  Extend duration government bonds was the worst performing sector while international sovereign debt and international inflation protected bonds were the best performing sectors..

The US Dollar index fell 0.8 % last week and the Euro gained 1.4% against the US Dollar to close Friday at $1.303.  The sell-off in the US Dollar is a result, I believe, of the Federal Reserve’s accommodative monetary policy that weakens the US Dollar, and because of the ECB’s own easy monetary policy that reduces the attractiveness of the US Dollar as a safe haven investment.  However, there remain many unknowns about Europe today.  How the EU handles Greece’s continued bailout needs, or Spain’s expected request for ECB intervention in its own bond purchases, and how effectively the EU moves in making meaningful structural changes to the way it governs financial affairs between member countries has to be resolved.  All of these, and more, are issues that will influence markets, including currency markets, over the coming months.    

Commodities pulled back last week with the UBS Dow Jones Commodity index falling 0.5%.  Oil captured most of the commodity headlines as oil prices swung widely during the trading sessions primarily on news of gasoline shortages and rationing in California.  For the week, WTI Oil closed at $89.92 per barrel (-2.4%) for the week and is now down 9% since the start of the year.  A slowing global economy and weakening US Dollar continue to weigh negatively on oil prices.  Gold added $6.30 (0.4%) per ounce to close Friday at $1780.80.  For the year, gold has 13.7% and, I believe, continues to reflect investor concerns over Federal Reserve monetary policy that weakens the US Dollar.

UNEMPLOYMENT REPORT AND OTHER THOUGHTS ABOUT THE ECONOMY

As I noted at the top of this week’s Update, the unemployment report made a splash when announced on Friday with the overall unemployment rate dropping from 8.1% to 7.8%.  This news, however, was accompanied with another weak monthly jobs gain of 114,000.  I am not going to spend time explaining the nuances between the household survey and the establishment survey, or to speculate whether there was political manipulation of the numbers, but I will say that the report was not nearly as robust as it appears on the surface.  I believe the markets agree with this observation because the DJIA only closed up a modest 35 points on Friday.

The household survey, which is the basis for the overall unemployment rate, indicated that 873,000 new jobs were created in September.  This is the largest monthly job gain in 30 years.  What the survey also showed was that two-thirds of every new job was a part-time job.  What prompted a jump of 582,000 part-time jobs?  I think you need to look no further than another statistic that shows 1.2 million long-term unemployed have lost their unemployment benefits so far in 2012.  So while the headline number looks like a strong move in the right direction, the surge in part-time jobs does not lead, I believe, to long-term economic growth necessary to move the Gross Domestic Product (GDP) above 2%.

Another discussion that has been part of the political dialogue this fall has been the effectiveness or lack of effectiveness of the stimulus bill passed at the beginning of President Obama’s term.  Scott Grannis who publishes the Calafia Beach Pundit blog, made an interesting observation this past week.  His breakdown of the $840 billion stimulus spending package showed that 75% of spending went in the form of transfer payments.  Some of the examples he used to illustrate the transfers included the “cash for clunker” program, the first time homebuyer tax credit, education spending, and tax subsidies.  Spending in these types of programs does not create wealth, it simply takes it from one private citizen and gives it to another.  Scott also said that spending for infrastructure and transportation, the “shovel-ready” projects, amounted to only $65.5 billion or just 8% of the overall spending plan.

I put these two observations together to emphasize that economic growth must come from a truly expanding economy where real wealth is being created which in turn supports a growing and robust private sector economy.  This has simply not occurred.  I believe our “plow horse” economy is growing because most Americans get up every day determined to be productive and work hard for themselves and their families.  This is why my faith remains firmly grounded in the American worker and economy.

LOOKING AHEAD

Banks and bond markets will be closed Monday in observance of Columbus Day.  Stock markets will be open.

Key US economic reports are limited this week.  The International Trade report for August will be released Thursday morning.  Consensus for this report is for the trade deficit to increase by $2 billion from July’s $42 billion to $44 billion.  The larger the trade deficit, the bigger the drag on the US GDP.  Energy imports are a big part of what drives the US trade deficit, and so energy prices do matter.  Additionally, exports can be hurt by weak European and other regional economies. So if we are exporting less due to a slowing global economy and energy imports rise, you get higher deficits.  The Initial Jobless report is also scheduled for release on Thursday morning as it is every week.  Consensus calls for first time claims to reach 370,000.  The Producer Price Index for September will be released on Friday.  This report tracks prices paid by domestic producers of goods and services and gives insight to future prices consumers may end up paying.  Experts are expecting the monthly change to drop from an increase of 1.7% in August to an increase of 0.8% for September.  The year-over-year core (less food and energy) increase is expected to remain unchanged at 0.2%.  As has been the case with most economic data for the past six months or so, the mediocre results are not contributing to a dynamic and robust economy.

The New York Stock Exchange Bullish Percent (NYSEBP) rose 0.40 to close Friday at 66.36.  The recent weekly up and down movement of this critical broad market indicator reflects the uncertainty found in the markets.  However, the NYSEBP is in a column of X’s meaning that demand is in control, and with a reading of 66.36, two-thirds of US stocks on the New York Stock Exchange are in a buy signal.  These numbers favor US stock ownership at the current time.

The Dorsey Wright & Associates analysis of the markets have remained unchanged for most of the summer.  Data indicates that US stocks and Bonds are the two favored major asset categories followed by Foreign Currencies, International stocks, and Commodities.  Middle capitalization stocks are favored, as is growth over value, and equal-weighted indexes over capitalization weighted indexes.  Equal-weighted indexes are those where each stock in the index is weighted the same, while in capitalization-weighted indexes the larger stocks have the largest weighting consistent with their size relative to the other stocks.  The relative strength sector weightings favor Consumer Discretionary, Health Care, and Information Technology.  US Treasuries and International Bonds are favored in the Bond category, while US and Developed Markets are favored within the International stock category.

Paul L. Merritt, MBA, AIF^®, CRPC®

Principal

NTrust Wealth Management

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

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.

Emerging market investments involve higher risks than investments from developed countries and 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.  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 CBOE Volatility Index - more commonly referred to as "VIX" - is an up-to-the-minute market estimate of expected volatility that is calculated by using real-time S&P 500^® Index (SPX) option bid/ask quotes. VIX uses nearby and second nearby options with at least 8 days left to expiration and then weights them to yield a constant, 30-day measure of the expected volatility of the S&P 500 Index.

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.

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 generally are 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.

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. 

 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 and is a capitalization-weighted index meaning the larger companies have a larger weighting of the index.  The S&P 500 Equal Weighted Index is determined by giving each company in the index an equal weighting to each of the 500 companies that comprise 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 Russell 2000 Index Is comprised of the 2000 smallest companies of the Russell 3000 Index, which is comprised of the 3000 biggest companies in the US.   The NASDAQ Composite Index (NASDAQ) is an index representing the securities traded on the NASDAQ stock market and is comprised of over 3000 issues.  It has a heavy bias towards technology and growth stocks.  The STOXX^® Europe 600 is derived from the STOXX Europe Total Market Index (TMI) and is a subset of the STOXX Global 1800 Index.  With a fixed number of 600 components, the STOXX Europe 600 represents large, mid, and small capitalization countries of the European region.