Tuesday, October 15, 2013

MARKET UPDATE AND COMMENTARY OCTOBER 13, 2013

MARKET UPDATE AND COMMENTARY
October 13, 2013


Washington is a mess while the rest of America pushes on.

I believe this pretty much sums up where we are as our nation enters the third full week of a federal government shutdown.

The stakes are very real, but markets here and abroad have not overreacted at this point. Volatility has increased, but most key US and international indexes are higher two trading weeks into the month.
Both the Dow Jones Industrial Average (DJIA) and S&P 500 are up 0.7% so far into October. The technology-heavy NASDAQ Composite has gained 0.5% for the month, while the small- to mid-capitalization dominated Russell 2000 was down 0.3%. For the year, the DJIA is up 16.3%, the S&P 500 is up 19.4%, the NASDAQ has gained 25.6%, and the Russell 2000 still leads all major US indices with a year-to-date gain of 27.7%.

Traditional safe-haven assets, gold and US Treasuries, have both fallen in value since the shutdown. Gold has fallen $56.20 (-4.2%) per ounce in the past two weeks closing Friday $1270.80 per ounce. After a brief rally earlier in the summer, gold has now fallen $403.70 (-24.1%) for the year. The yield on the US 10-year Treasury has increased nearly 8 basis points in October to close Friday at 2.688%. Recall that bond values drop when interest rates increase. The Barclays US Aggregate Bond index is down a fraction for October and off just over 2% for the year. In general, bonds have not contributed any real gains to overall portfolio returns.

Every major economic sector is positive since the shutdown began. Real Estate, Financials, and Utilities are all up over 2% for the month. For the year, Health Care (+31%), Consumer Discretionary (+30%), and Industrials (+27%) are the top performing sectors, while Real Estate (+6%), Utilities (+14%), and Materials (+14%) are the weakest.

International stocks continue to perform well. The Dow Jones Global ex-US index, a very broad international index, is up 1.2% in October while the European-heavy STOXX 600 index is up 0.4%. Emerging markets added to their recent gains rising 3.9% for the month. For the year, the Dow Jones Global ex-US index is up 9.7%, the STOXX 600 is up 11.4%, and the Dow Jones Emerging Markets Total Stock Market index is down 3.6%.

While the rhetoric in Washington is reaching new lows of civility and investor fears are heightened, the markets have, for the most part, stayed on the sidelines.

MARKET TIMING

The greatest aspect of my job is my clients. When asked by friends about what I do for a living I always begin my answer by saying, “I work with really terrific people!” My clients come from all walks of life, they each have unique and fascinating life stories, they work hard, and are successful. Moreover, unlike other professions that tend to be more transactional relationships (i.e. real estate sales, mortgage brokers, or sadly—divorce attorneys); my relationship with clients is ongoing, regular, and very interactive. Over time, I get to know a lot about not only my clients but also their families, their goals, and their aspirations. They also ask me a lot of tough questions about the markets and their investments--especially during times like these. This is how we learn about each other, and for me, I get the true measure of each person’s risk tolerance. From this comes the necessary level of understanding that allows me to develop an appropriate investment strategy for each client and family.

One of the tough questions I have been asked over the past two or three weeks is whether we should sell given the growing crisis in Washington. My answer begins by saying that I cannot time the markets. In fact no one can—period! I then follow with a question of mine, “what signal would you use to time your re-entry into the markets?” From there I explain the difference between trend following (which I believe in) and market timing (which I do not). I conclude my answer by analyzing the current data the markets are providing. I always conclude each Market Update and Commentary with a summary of this information.

I would like to devote a few comments to what market timing is and how it differs from trend following.

Market timing is making buy and sell decisions based upon predictions about the future. Numerous technical analysts have developed models in an attempt to predict the future and then trade accordingly. While it may be possible to predict future actions occasionally, it is very difficult to do it consistently. Trend following is ongoing analysis that studies relative strength of investments and making buy and sell decisions based upon which investments have the strongest relative strength. There is no effort to predict the future in trend following, rather decisions are made by the belief that trends come and go—sometimes for extended periods, and, I believe, it is better to own investments that are trending in a positive manner. Trend following is also very adaptive when trends do change.

Looking at today’s circumstances with the dysfunction in Washington, I believe that after watching the markets over the past couple of weeks, it is possible to generalize that markets tend to go down when a deal looks unlikely, and markets rally when a deal (or the possibility of a deal) is in the works. Do I know whether Congress can work out an immediate deal, or whether the President will allow the Treasury to default on debt to make a point, or if the Federal Reserve will begin tapering tomorrow or in 2014, no I don’t. Neither does anyone else. Even if I did, the speed of events and the swift news cycle, you can be right one minute and wrong the next. So I do not believe it is possible to time the market, and I will continue to rely on the trend data provided by Dorsey Wright & Associates to guide my investment recommendations.

LOOKING AHEAD

The brinksmanship in Washington is reaching a fever pitch. Both sides are firmly entrenched and there seems to be little public discussion by our political leaders over how to get an agreement about the budget or the debt ceiling. The government shutdown is proving to be a non-event because the vast majority of government is still running and all those furloughed workers will receive all back pay. The debt ceiling is another matter. The decision to default sits directly with the President. According to the Wall Street Journal, the US Treasury takes in roughly $200 billion per month and owes interest on the debt of about $25 billion each month so there is no legitimate reason not to pay interest. The Treasury could issue new debt to retire the old debt without raising the debt ceiling. So any default will rest squarely with the White House despite much of the reporting in the media.

No one believes that President Obama will default on the debt because that would do grievous harm to the United States and its standing in the world. This is why I believe that it is extremely doubtful that the President will allow the country to technically default on any debt. Should he choose otherwise, there will be, in my opinion, great stress in the markets.

The data I follow also suggests that the odds of default are minimal at this time. 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. Small and middle-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.

I currently favor the Technology (Internet), Health Care, and Industrials sectors.

We are facing yet another week of Washington dysfunction. The statutory debt ceiling is expected to be reached this Thursday (October 17th). It is completely uncertain how this will play out, however, I continue to believe some last minute, short-range deal, will be reached. I also believe that volatility in the markets will continue if negotiations continue to drag out.

As I said in my last Update and Commentary, it will be an interesting couple of weeks ahead.

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




Paul L. Merritt, MBA, AIF®, CRPC®
Principal
NTrust Wealth Management

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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. The Dow Jones Global ex-US index represents 77 countries and covers more than 98% of the world's market capitalization. A full complement of subindices, measuring both sectors and stock-size segments, are calculated for each country and region.