Monday, September 30, 2013

Market Update and Commentary September 29, 2013


MARKET UPDATE AND COMMENTARY
September 29, 2013


The apparent reversal of Fed policy just over a week ago unsettled investors causing a readjustment of expectations.

On Wednesday, September 18th, the Federal Reserve released its current economic outlook and announced that there would be no immediate tapering of its bond buying program. This was somewhat of a surprise because Chairman Bernanke had been signaling since his June commentary that the Federal Reserve was ready to begin tapering. Initially stocks rallied; however, both the Dow Jones Industrial Average (DJIA) and the S&P 500 have since been down six of the past seven days. I believe markets reacted to the change in guidance on tapering as well as other aspects of the Federal Reserve’s commentary including the downward revision for economic growth for both the remainder of 2013 and all of 2014. The Fed left the door open to tapering later in the year and consensus indicates that bond purchases will still terminate by the end of 2014. The announcement, in my view, did not help the Federal Reserve’s credibility and raised a number of questions about whether or not Chairman Bernanke deferred to Janet Yellen, the possible successor to Bernanke next year, in this seemingly abrupt change in policy guidance. New uncertainty was introduced by the Fed.

With one trading day left in September, the DJIA and S&P 500 indexes were up three of four weeks in September (last week being the only down week) and the indexes have gained 3.0% and 3.6% respectively so far this month. The Russell 2000 and NASDAQ were positive all four weeks and are up 6.3% and 5.3% for September. For the year, the DJIA is now up 16.4%, the S&P 500 is up 18.6%, the Russell 2000 has gained 26.5%, and the NASDAQ is up 25.2%.

Yields on US Treasuries have fallen since the September 18th announcement. The chart to the left of hourly moves in the US 10-year yield shows that this key yield was trading at about 2.863% just prior to the announcement and has since fallen nearly 24 basis points to close Friday at 2.626%. This helped the Barclays US Aggregate Bond index to post a 1.0% gain in September, and reduce the year-to-date loss of this broad bond index to just under 2%. Bonds have not given much help to overall portfolio returns in 2013, but the recent fall in interest rates has helped a little.

Commodities remain lackluster. The Dow Jones UBS Commodity index is down 1.9% in September and down 8.0% in 2013. After a good July and August, gold has fallen 6.3% in September and is now down 21.8% for the year. WTI Oil fell 5.8% last week but remains slightly positive (+0.5%) for the month. For the year, the cost of a barrel of WTI Oil has increased $16.51 (+18.0%) per barrel closing Friday at $102.87.

EMOTION VS. DATA

I attended a conference this past week in Richmond, Virginia. The conference was sponsored by First Trust Advisors, a money management firm based in Chicago, IL. One of the keynote speakers, Brian Wesbury, is their Chief Economist and, in my opinion, one of the really smart economic guys in this business. I will start with a quote Brian made recently when addressing the impact of Obamacare on the economy. He said, “do not let your political worries pollute your investment philosophy.” Put another way, Brian was suggesting that you cannot let your emotions about what is going on around you influence your investment decisions. This is an important concept in investing. More on this in a moment.


Let me share with you some of the highlights of the conference and Brian’s thoughts.


Investors are suffering from Post Traumatic Stress Disorder (PTSD) following the market collapse in 2008. This was a key point and one that I strongly support. The fear of further losses trapped the average investor in selling low and then remaining on the sidelines as markets recovered strongly.

The revolution in oil and gas exploration is a big deal. The growth of domestic oil and gas production in the US is growing exponentially thanks to activities in the North Dakota Bakken and Texas Eagle Ford Shale areas. These are two of the biggest areas but not the only ones producing oil in the US. The Bakken field alone produced more oil in 2012 than all of Egypt. The Texas Eagle Ford Shale area has more than 2 times the proven reserves of Saudi Arabia. This same theme extends to other areas in Texas, New York, Pennsylvania, and even California. Net oil imports as a share of US consumption has fallen from a high of over 60% in 2005-2006 to around 40% in 2013 and this trend is expected to continue (Source: US Energy Information Agency and First Trust Advisors). In fact, Brian suggested that the US will be the world’s leading exporter of oil in 5 years. This is happening despite of the current opposition of domestic oil exploration by the White House and other federal agencies. The abundance of cheaper energy at home will improve economic prospects to sectors beyond energy especially in manufacturing.

Technology is leading to major improvements in the economy. There is a revolution taking place in technological innovation. One example Brian provided is the incredible advancement in 3-D printing. In case you are not familiar with this new technology, companies are now able to scan an object and then print a three dimensional copy in a matter of hours or minutes. The materials used are polymers and even organic materials. Applications in manufacturing and medicine are growing every day. Other examples highlighted were cloud computing and smart phone technology.

Demographic trends are working in our favor. Of the major world countries, only the US and India will experience labor force growth by 2050. According the Census Bureau estimates, by 2050 India’s population will be 73.8% larger, the US will be 42.4% larger, Brazil will be 29.1% larger (but the rate of growth will be declining), while China’s labor force will decline by 9.8%, Western Europe will decline by 15.6%, Russia’s labor force will fall by 23.9%, and Japan will lose a staggering 43.5% of its population. These numbers have a major influence in supporting economic growth in each country.

Additionally, Brian addressed some of the key issues facing the economy today.

Stocks are higher because earnings have grown, not because of Fed stimulus. After-tax corporate profits are at all-time highs and this is what has propelled the stock market, not quantitative easing (QE).

QE has not held interest rates down. Brian reported that following each round of QE, interest rates were/are actually higher then when each round of QE began.

The more government spends, the higher unemployment rates are. Brian reviewed economic data going back to 1960 and suggested that if you overlay government spending as a percent of GDP (Gross Domestic Product) and compare that to the unemployment rate, there is a high correlation between these important statistics. His conclusion from the data is that the more the government spends within the total economy, unemployment increases, and the weaker the economy is.

This brings me back to the idea of emotion versus data. It is understandable to feel less than optimistic about what is happening today when you take in the daily headlines. Both traditional news and business news headlines are scary and imply the end of American prosperity as we know it. Both political parties have taken their rhetoric to new lows as they try to shape events to their advantage. While I do not dismiss the importance of political actions on the overall strength of the country, I do believe that investors who focus on the data and not the noise will have an advantage over those who let their heart rule their portfolios. And those who regularly read my Market Update and Commentary know, this is precisely what I have been talking about for the past several years. The technical research provided by Dorsey Wright & Associates has guided my guidance without regard to the headlines. I have been consistent in my views that US stocks should be favored, and international stocks—especially developed countries, are also strong. Bonds are next, and I have been avoiding most commodities lately. Please do not confuse this statement with the idea that it is always smoothing sailing, it is not. However, investors have been rewarded for investing in stocks over the past four years. Finally, I must say that risk management is more important than ever. Risk must be managed and be consistent with each individual’s situation.

It is critical to take emotion out of investment decisions and focus on the data.

LOOKING AHEAD

US stocks remain the favored major asset category as tracked by Dorsey Wright & Associates. US stocks continue to hold the number one position while the International stocks asset category is a solid number two. Fixed-income is in third place, Currencies is fourth, Money Market is fifth, and Commodities remain in last place where this category as been since June 21, 2012. Middle and small-capitalization stocks are preferred over large-capitalization stocks. Equal-weighted indexes are preferred over capitalization-weighted indexes. Within the Fixed-Income category, high yield and bank loan bond sectors are favored, while energy is now favored in the weak Commodities category.

Looking at sectors, I favor Biotechnology, Technology, and Health Care.

Barring an unexpected compromise, it looks more and more likely that Congress will not reach a funding agreement for the Federal government beyond Monday at midnight. As it stands on Sunday afternoon, the Senate is not expected to vote on the latest spending bill passed by the House until sometime Monday afternoon. There is little evidence to show that the Senate will pass the bill and if they did, the President has promised to veto the bill. The political drama is high and markets do not appreciate this kind of last minute brinksmanship. I am anticipating that markets will react negatively if Washington cannot get its act together quickly.

It could be a challenging time in the markets this week.

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




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

Tuesday, September 17, 2013








MARKET UPDATE AND COMMENTARY
September 15, 2013


Stock markets have rallied the first two weeks of September even though economic data remains mixed and lacking any real direction.

Just this past week, Jobless Claims fell to a seven-year low of 292,000 (consensus 330,000) while retail sales
disappointed increasing 0.2% (consensus +0.5%).  I should note that there is some concern by economists that the low jobless number could have been partly due to reporting problems in two states and are expecting upward revisions later this week.  The economy appears to remain, however, stuck on a treadmill making little progress in 2013.  The same cannot be said about the stock market.

For the first two weeks into September the Dow Jones Industrial Average (DJIA) is up 3.8%, the S&P 500 is up 3.4%, the Russell 2000 has gained 4.3%, and the NASDAQ is up 3.7%.  International markets have also participated in this two-week rally as the Dow Jones Global ex-US index added 4.7% with help by a strong performance from the emerging markets region.  Bonds continue to struggle under the upward trend of interest rates with the Barclays US Aggregate Bond index down 0.6% for the month.  For the year, the DJIA is now up 17.3%, the S&P 500 has gained 18.4%, the Russell 2000 is up 24.1%, and the NASDAQ is up 23.3%.  The Dow Jones Global ex-US index is up 8.2%, and the Barclays US Aggregate Bond index is down 3.5%.

Opinions of investment experts on why the markets have rallied after a tough August are as diverse as economic data, however, I believe investor fears have been greatly diminished by the ever-decreasing prospect of US involvement in the Syrian civil war.  WTI Oil prices fell 2.1% last week but remain elevated from recent levels closing Friday at $108.21 (+12.1% since the end of June).  Gold, after rallying in July and August, has also pulled back sharply and is down 6.3% for the month and down 21.8% for the year.

RELATIVE STRENGTH

I would like to take advantage of a relatively quiet couple of weeks to spend a few minutes discussing the concept of relative strength.  Those of you that have followed my Update and Commentary for any length of time have heard me refer to relative strength frequently.  It is at the very heart of my analysis of the markets and a tool which I believe offers market insight without any bias or emotion.  It is simple in concept yet robust in application.

To explain how relative strength works with new clients, I like to use a sports analogy.  Back in my July 28th Update and Commentary I talked about this briefly by highlighting the American East division within Major League Baseball.  Let me refresh your memory by showing you the standings on July 18th just after the All Star break.  As you can see, the Tampa Bay Rays and Boston Red Sox were virtually tied after 104 games.  The New York Yankees and Toronto Blue Jays were well behind.  Each game represents a head-to-head competition with other major league teams, and after 104 individual competitions, the Rays and Red Sox were clearly the strongest teams in the division.

Jump forward to yesterday and 46 games later, you can see that the Red Sox have now pushed to the top followed by the Rays.  The Yankees have moved up to third place while the Blue Jays remain fixed in last place. 


Let’s focus on my team, the Yankees for a little more in-depth analysis.  Back in July the Yankees were 54 and 50 meaning they had played 104 games, won 54 and lost 50.  Their win/loss percentage was .519 (they won nearly 52% of the games they played).  However, compared to the Tampa Bay Rays’ record of 62 wins and 42 losses (.596 win/loss rate), they were 8 games weaker.  As of yesterday, the Yankees had improved their win/loss percentage to 53%.  However, they have fallen further behind the first place Red Sox whose win/loss percentage has increased from 59% to nearly 61%.  More specifically, over the most recent 46 games, the Red Sox have won 29 games while the Yankees have won just 25. Therefore, even though the Yankees are slightly improved, they are improving at a slower rate than the division leading Red Sox.  This is the essence of how relative strength works when comparing investments.

The concept for relative strength in analyzing investments works the same way as in sports, except I measure price changes between each stock/investment instead of wins and losses.  Coupled with computer power, it is now possible to make one-on-one comparisons or compare dozens of investments with each other.  I use the services of Dorsey Wright & Associates (DWA) out of Richmond, Virginia, for the software support to do this. 

Additionally, DWA has expanded this simple analysis to broad and powerful uses such as the Dynamic Asset Level Investing (D.A.L.I.) tool.  D.A.L.I. uses a matrix comprised of 1079 different data points divided between six major asset categories (US stocks, International stocks, Bonds, Currencies, Commodities, and Money Market) to determine relative strength relationships.  All 1079 data points are compared to each other daily (1,164,241 separate calculations) to develop a ranking that gives investors an idea which of the six major asset categories are the strongest—just as the standings in baseball do.  Additionally, DWA takes this analysis down to sectors within each major asset category, and for my analysis, customized groups of investments.

Like any investment process or strategy, there are times when that process or strategy will underperform; however, having such a strategy has permitted me to tell my readers that US stocks has been the strongest major asset category since October 24, 2011, during which time the S&P 500 is up about 51%.  By comparison, the MSCI EAFE index (international stocks) is up about 20%, Money Market is flat, the Barclays US Aggregate Bond index is down around 3%, and the DJ UBS Commodity index (broad basket commodity index) is down 10.8%.  I will say again, this process is not fool proof and past performance is not indicative of future returns, however, I do believe there is value in understanding the current relative strength between investments and looking for changes in relationships when they occur.

Remember that relative strength is an unbiased, unemotional way to evaluate the markets.  How else could a die-hard Yankee fan say that if the Red Sox were a stock, I would be buying it going into the playoffs!

LOOKING AHEAD

The coming week offers a number of key economic reports.  As has been the case for some time, I believe the  data will continue to come in mixed and non-directional.  However, the Federal Reserve will release their forecast for the economy at 2 PM on Wednesday followed by a press conference by Fed Chairman Bernanke.  This will be the key event of the week as market observers will again turn their focus towards
any signs of the Federal Reserve reducing their monthly bond purchases.  While I do believe it is very necessary for the Fed to slowly begin reducing bond purchases, any discussion by the Fed has the potential to create volatility in the markets.  Additionally, news over the weekend that Larry Summers has withdrawn his name from consideration as the next Fed Chairman may contribute to some early week movement in markets.

US stocks are still the favored major asset category as tracked by Dorsey Wright & Associates.  US stocks continue to hold the number one position while International stocks is a solid number two.  Fixed-income is in third place, Currencies is fourth, Money Market is fifth, and Commodities remain in last place where this category as been since June 21, 2012.  Middle and small-capitalization stocks are preferred over large-capitalization stocks.  Equal-weighted indexes are preferred over capitalization-weighted indexes.  Within the Fixed-Income category, high yield and bank loan bond sectors are favored, while energy is now favored in the weak Commodities category. 

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




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