Wednesday, May 26, 2010

Weekly Market Update - May 23, 2010

This past week saw markets around the world tumble as uncertainties about nearly every economic topic left investors wondering just how bad it might get.

For the week, the Dow Jones Industrial Average (DJIA) lost 427 points (-4.02%) closing at 10,193. The S&P 500 fell 48 points (-4.23%) closing at 1088. May has been a tough month with the DJIA off 7.4% and the S&P 500 down 8.34%. The year is now negative once again with each of the major indexes off a little more than 2%.

The MSCI (EAFE) World continued its weakness falling 4.44% for the week, it is down 12.65% for the month, and over 14% for the year.

The Euro managed to gain 2 cents against the dollar moving from $1.236 to $1.2568. The Euro's downward trend, however, continues to worry investors and will have serious implications for all global economies.

Commodities in general have continued to show weakness. Oil continued to slide closing the week at just under $70.04 per barrel down about $1 from the previous Friday's close. Gold fell just over 4% for the week closing at $1176.10. Oil is falling on concerns about weak global growth and a stronger dollar, while the movement of gold is less specific. As economic concerns grow in Europe and in the minds of investors around the world, it would be intuitive to expect gold to increase as buyers snap up the metal as a hedge against inflation, sovereign debt defaults, war, you name it. However, that did not happen last week. One report I read suggested that investors were selling gold to settle margin calls against equity trades they had made. This was causing gold to more closely move with equity prices, not as a separate hedge. However, if equity prices stabilize, the demand for gold may overtake margin-related sales and the price of gold could again start rising.

Demand for US treasuries remained strong and the 10-year bond closed at 3.261% compared to 3.4571% last week as global investors sought safety in US government bonds. This is likely to lead to lower home mortgage rates and smooth the transition as the Fed curtails its direct purchase of home mortgages in the open market. Corporate bonds continued to show strength-a trend that is likely to continue for now.

Last Week Was a Mess

I am not going to break down the variety of issues that helped drive markets down last week. You have likely heard news coverage of most, and I have discussed nearly all of them in previous updates.

As a quick summary they include: the Euro Zone/Euro/Greek debt crisis, unexpectedly bad weekly jobless numbers (on-going high unemployment), concerns and uncertainty surrounding the Finance Reform Bill working its way through Congress, the on-going oil spill disaster in the Gulf of Mexico, and I will throw in concerns about North and South Korea going to war for good measure.

One additional factor in the Euro Zone crisis was German officials announcing unilaterally that their country was temporally banning naked short-selling and naked credit-default swaps of Euro Zone government bonds. Additionally, Germany included 10 banks into the mix of banned securities as well. The US took similar temporary measures in 2008; however, in the case of Germany, markets were especially rattled because of the apparent lack of coordination between Germany and other members of the European Union (EU)-raising concerns about the ability of EU governments to effectively coordinate actions to stem the current crisis and create an effective long-term solution to the sovereign debt problem.

Is it Time to Buy?

With the dramatic sell-off last week, the talking heads on TV are all asking, "is now the time to buy stocks?" "Will last week be the bottom of the current sell-off or will the markets continue to fall?" Everyone has an opinion and maybe half of them will be right-but no one knows which half it will be.

Those of you who have been working with me for any amount of time know that I do not make predictions. I don't because no one can consistently be on the right side of market prognostications. Predictions are fun to read, and sometimes they offer some sense of security because we find someone's views that match ours and thus confirm for us we are doing the right thing. However, I have learned after years in the securities business to depend on quantitative market indicators that are based upon relative strength analysis coupled with point and figure charting-not instinct or intuition.

As a quick review, I follow five major asset categories: US equities, international equities, commodities, currencies, and fixed income. Using rigorous relative strength analysis, each major category is compared to the other and the strongest prevail. Before an asset category can be favored, it must also prove stronger than cash on a relative strength basis. If it is not, cash is recommended.

Equities, either international or US, have been favored since April 2009. As of Friday, neither was. International equities were dropped on May 6, 2010, and replaced by cash. US equities, however, remained in favor-until market close on Friday when this category was replaced by fixed income.

Based upon quantitative analysis, the answer to the question of the day is no. It does not appear that now is the time to buy equities.

Looking Ahead

I have discussed the need for discipline in the face of so much market uncertainty. Discipline and commitment to follow the quantitative guidance provided by the in-depth relative strength analysis provided by Dorsey Wright & Associates. As Tom Dorsey said in a podcast over the weekend, you don't have to be the fastest around the track; you need to make it around the track.

One of the frustrating aspects of this type of investment strategy is that we will always be late coming into a bull market and a little late getting out of a bear market. This is because enough of a trend must be developed before the change is made. You do not want to be bouncing in and out of the markets every day or week; rather you want to make changes when there are major shifts in trends. This frustration can be compounded when markets fail to provide any real direction and trade sideways or when a major trend is reversed.

For now, a clear signal has been sent. Equities are not favored. Bonds and cash are. Safety is the key. Does this mean the markets are headed straight to the bottom? Hardly, I would expect the market to rise and fall as it normally does but with a downward trend-for now.

I cannot predict how long this "no equity" (or reduced equity exposure) will last. The last time both favored asset categories did not include US or international equities was January 4, 2008. International equities re-entered as a favored asset category on April 13, 2009. US equities returned on September 4, 2009. Only market action will drive the quantitative changes that in turn will lead to changes in the favored categories.

I am recommending investment in quality bonds, especially corporate intermediate-term. A portion of the investment can also include some quality international bonds.

Gold is expensive at this time and not as safe an asset class as you may believe. However, I am watching all commodities closely to see if there is an appropriate time to bring into portfolios.

Treasuries are very strong, however, I remain extremely concerned that treasuries are very expensive at this point in time and new positions should be entered into thoughtfully.

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.

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.


Paul Merritt, MBA, AIF(R). CRPC(R) 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. 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. Securities and Advisory Services offered through Commonwealth Financial Network(R), Member FINRA/SIPC, a Registered Investment Adviser.