Thursday, March 14, 2013


It has been three weeks since my last Update and Commentary and a lot has changed and nothing has changed. We have survived the latest dysfunction in Washington known as the sequester, Fitch Ratings downgraded Italy's credit rating following inconclusive elections, data from the European zone continues to indicate that economic growth is proving elusive, and Japan continues to weaken the Yen in an effort to stimulate its domestic economy. In response, the Dow Jones Industrial Average (DJIA) has continued climbing and is now at an all-time high, and the S&P 500 sits just 25 points (1.6%) short of its all-time high (1576.09, October 11, 2007). The question now being repeated over and over again in the media is can
this market continue to go up or will the myriad of issues facing investors wreck the market and dash investors' hopes as happened in 2007?

The DJIA closed last week at 14,397 up 307 points (+2.2%) from the previous week's close and is now up
2.4% in March and 9.9% for the year. Last week's movement was helped by the February Employment
Situation report released Friday showing a nice increase of 246,000 private sector jobs and the unemployment Rate falling to 7.7%. The S&P 500 also gained 2.2% last week and is tracking closely with the DJIA. For the month of March, the S&P 500 is up 2.4% and is up 8.8% for the year. The tech-heavy NASDAQ has actually lagged slightly and is up 7.4% for the year. The mid and small-capitalization
heavy index, the Russell 2000, gained 3.0% last week, is up 3.4% in March,
and is up 11.0% in 2013.

All eleven major economic sectors are positive so far in 2013 with Health Care leading all sectors with a nearly 12% gain followed by Industrials, Financials, Consumer Staples, and Consumer Discretionary (each exceeding the DJIA). Telecom, Information Technology, and Materials are the three weakest performers yet have posted gains of 4.5% or greater.

International stocks continued to rise in the face of troublesome economic data and political turmoil in Europe. Growth has come to a stall in the European Union (EU) as reported by Eurostat. The European Commission's statistical arm is predicting that real GDP growth among the 27 EU members will be just 0.1% for 2013 after a -0.3% rate for 2012. Italy, the EU's third largest economy, has been unable to form a government after the late-February election failed to produce a majority for any party. European stocks pulled back when it became apparent that Italian voters would not elect a pro-austerity group, or any group, leaving politicians unable to reach a consensus and putting austerity initiatives in doubt. Since the elections,
makets have calmed somewhat with the European STOXX 600 posting a 2.3% gain last week (up 5.7% for the year). I believe that investors in Europe remain confident due to the European Central Bank's expressed
willingness to provide any liquidity required to governments should they be unable to borrow enough to meet fiscal deficits. More broadly, the MSCI EAFE index gained 1.7% last week, is up 0.9% for the month, and up 4.9% for the year.

Global currency markets have pushed the US Dollar higher against most key currencies. The US Dollar index has reached a seven-month high has the Euro has fallen 1.3% against the US Dollar and the Japanese Yen has plunged 7.9%. The drop of the Yen is attributable to the newly elected Japanese Prime Minister pushing monetary policy into a more accommodative phase in an effort to spur domestic growth. Not without critics, notably the Chinese, this currency action has helped push the Japanese Nikkei stock index up 18.2% for the year. I believe the fall of the Euro reflects the lingering nervousness surrounding Italy's political turmoil and govement by European investors out of the stagnate economic climate in Europe and into a more robust US economy. Currency investors are also cognizant of the rising interest rates here in the US in reaction to stronger economic data such as the February Employment Situation report.

The total return on bonds remains flat thus far in 2013 as rising interest rates have cut into valuations. The Barclays US Aggregate Bond index is down 0.8% for the year hurt by longer duration US Treasuries and
Corporates. The interest rate on the US 10-year Treasury jumped 0.2% last week pushing the interest rate to 2.056%. This weekly increase was the largest one-week jump on a percentage basis since mid-September of last year. The bond sectors that typically perform well in an equity-driven market such as Preferreds and High Yield are the performance leaders in an indifferent bond market.

Commodities continue to struggle as evidenced by the broad-based UBS Dow Jones Commodity index down 1.3% this year. Gold is down 5.8% year-to-date as investors grow concerned about how much longer the Federal Reserve will continue its accommodative monetary policies and as other asset categories, like equities, become more attractive. Gold closed Friday at $1576.90 per ounce. WTI Oil closed Friday at $91.95 and is up 0.3% for the year. Looking at other commodities, Natural Gas has jumped 11.6% over the past three weeks as cold weather dominates the country and pushing down supplies while wheat has fallen by nearly 12% for the year.

UNDERSTANDING BOND VALUATIONS AND INTEREST RATE CHANGES

Most of us own bonds in our portfolios. In some cases, bonds take up a considerable portion of an individual portfolio either because investors require a source of steady income or because bonds are typically less volatile than stocks, or for both of these factors. I would also include overall performance relative to the other major asset categories as a reason to invest in bonds. Bonds have outperformed the S&P 500 index on average since the start of this century. This has been a great time to own bonds: good performance, low volatility, and income-a perfect brew for investors. However, just as a good wine can turn to vinegar over time, so a bond portfolio can sour right before your eyes. In order to be prepared to protect your bond portfolio, you need to understand some basics about bonds and what determines their valuation. Let's start by looking at the basics.

A bond is a contract between a borrower and a lender. This contract stipulates two basic components-how much interest the borrower will pay and when the borrowed money must be returned to the lender. There can be many covenants surrounding this contract such as the posting of collateral, down payments, or terms to adjust interest payments that can complicate the contract, but it is a relatively simple deal in the end. The
biggest concern a lender has is getting their money back so the credit worthiness of the borrower always factors into the contract. Generally, the more comfortable a lender feels about the borrower's ability to repay, the lower the interest rate the lender will charge. Bond sectors are simply the aggregation of like-type contracts.

Like other financial assets, bond contracts can be bought and sold. If a lender has no interest in selling the contract, then the primary risk the lender takes is whether the borrower can repay the money borrowed. This is known as credit risk. However, if the lender decides to sell the bond contract, the lender and buyer
typically a third party not related to the borrower) must reach agreement on what the bond contract is worth at the time of sale. In determining the value of the contract, the lender and buyer compare the bond contract to similar contracts in terms of  interest rate, the remaining life of the contract, and the credit risk of the borrower. For example, if the bond contract was originally 20 years and there is now 10 years remaining, then the contract is compared to similar 10-year bond contracts. This is where it gets interesting.

Interest rates rarely stay the same over time so it is doubtful that the contractual interest rate paid by the borrower is the same as the prevailing of other similar bond contracts. To equalize the contractual interest
rate to the prevailing interest rate, the value of the borrowed amount, or principal, is adjusted higher or lower. For example, if a bond contract is paying 5% interest but the prevailing interest rate of a similar contract is 3%, then the buyer would be willing to pay an amount greater than the principal to capture the higher interest payments by the borrower. Likewise, if the bond contract is paying 5% but the prevailing rate is 8%, the seller will have to reduce the value of the bond contract to compensate the buyer for lost interest they could have received from other 8% contracts. So if interest rates fall, the value of the bond contract will rise; and if interest rates rise as in the second example, the value of the contract will fall. This explains the inverse relationship between bond prices and interest rates, and reflects what is known as interest rate risk.

For investors, bonds have been a tremendous investment over the past thirty years during which interest rates have generally been on a downward path. The greatest risk for most bond investors over this time
has been credit risk, and this has generally not been a problem except periodically within the higher-risk bond sectors like the High Yield sector. With interest rates at historical lows, investors must be sensitive to the possible impact of rising interest rates on the valuation of their bond portfolios. While interest rate movement is one of the most difficult calls for economists and pundits to make, there is a growing consensus that interest rates will rise at some point in the future. If interest rates do move up, I believe interest rate sensitive bond sectors (like long duration US Treasuries and Corporates) may lose principal. To avoid a loss of principal, I think investors should consider seeking out bond sectors that are not as sensitive to interest rate risk such as Inflation Adjusted, Floating Rates, Preferreds, and High Yield. If you have any questions on this very important topic, please do not hesitate to reach out and ask me.

LOOKING AHEAD

The question on top of everyone's mind today is whether or not this market can continue to rise. Afterall, the last time the DJIA reached this level, a market crisis sent not just the DJIA, but nearly every asset class down by 20%, 30%, or more. While every market is different, and I believe this market is different than that of 2007, it helps to have some historical data to put things in perspective.

Dr. Steve Sjuggerud, investment newsletter author, looked back over 100 years of S&P 500 data (Buyer's Remorse, March 1, 2013, Daily Wealth) and discovered that when purchasing stocks near or at their annual 12-month highs, one year later the S&P 500 was up an average of 9.6%. When the S&P 500 was purchased at or near the annual 12-month low, one year later the S&P 500 gain was 0.0%. This compares to a buy-and-hold strategy gain of 5.6%. Dr. Sjuggerud gave no explanation of why these findings occur, but I believe it is due to market momentum. One or more factors help push markets to new highs, and these factors are not likely to vanish overnight unless there is some shock on the financial system that catches market participants off guard. A recent example of this was the Lehman Brothers bankruptcy, while 9/11 was another. Again, not all markets act the same way and the past is not a guarantee of the future, but data suggests that markets can continue higher. As I have said many times before, the path forward will always include some dips and market corrections along the way, so do not think that this will be a straight road
higher.

The New York Stock Exchange Bullish Percent (NYSEBP) closed Friday at 74.44 and is at virtually the same level as it was at the beginning of February. There have been a couple of small dips, but the NYSEBP has not seriously challenged falling below 70 during this time frame.

There has been no change in the long-term Daily Asset Level Indicator prepared by Dorsey Wright & Associates. Their analysis suggests US stocks and International stocks are the two strongest major asset categories on a relative strength basis. Bonds remains in the third position followed by Currencies, Cash, and then Commodities. Looking below below the major asset categories, middle capitalization stocks are favored, as is growth over value, and equalweighted 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. On a relative strength basis, the top three major economic sectors are unchanged: Consumer Discretionary, Financials, and Health Care. Financials and Health Care have reversed positions since the last update. Industrials is in fourth position followed by Consumer Staples and Real Estate. Energy and Utilities remain as the bottom two sectors. 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 Precious Metals are the favored sectors within the Commodity category.

The coming week has several important economic reports-February Retail Sales on Wednesday, Producer Price Index and Initial Jobless Claims on Thursday, and the Consumer Price Index on Friday. As has been the case for the past year or so, these economic reports have been good, bad, and indifferent with little consistency. I expect nothing new. However, the Retail Sales figures are important and consensus calls for a modest increase from January's number. The Federal Reserve and Housing will be  the focus of the following week. Investors will be parsing every word spoken by Fed Chairman Bernanke for any sign that he will take his foot off the easy monetary policy accelerator. I do not think he will change his general view of the economy or offer any indication that he is prepared to tighten monetary policy any time soon.

As always, it is imperative to be vigilant and not to let the recent market strength lull you into a false sense of expectation that the markets will continue to rise at this early year pace.

My next Market Update and Commentary will be published in two weeks.

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. 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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