Tuesday, September 28, 2010

Markets have rallied in September amidst a wall of uncertainty. The Dow Jones Industrial Average (DJIA) gained 252 points (+2.38%) and the S&P 500 added 23 points (+2.05%) to extend the previous week's gains. For the month the DJIA is now up 8.33% and the S&P 500 is up 9.33% pushing both indexes firmly into positive territory. For the year, the DJIA is up 4.14% and the S&P 500 is up 3.01%.

Technology, Consumer Discretionary and Telecom were the best performing broad sectors while Real Estate, Financials and Utilities lagged. Real Estate, Consumer Discretionary, and Industrials have the strongest technical scores indicating greater relative strength over the past six months or so, while Financials, Health Care, and Energy continue to be at the bottom. Small- and Mid-capitalization stocks continue to outperform large cap stocks.

The MSCI (EAFE) World Index posted a weekly gain of 2.77% outpacing US indexes yet again and for the year is now down just 1.02%. This past week bucked the trend in place for most of the year as a number of European countries including Poland, Sweden, the Netherlands, and France, joined Thailand and Israel for top spots in the performance ranking. Chile, Austria and Malaysia were all positive but at the bottom last week. Thailand, Indonesia, Chile, and Malaysia remain at the top of the year's best performing countries of those I follow.

The Euro has surged in recent weeks closing Friday at $1.3491 up 8 cents (+6.4%) in the past two weeks as confidence in Europe grows and a belief that the Federal Reserve will begin to weaken the dollar in order to stimulate the US economy.

Gold has also surged recently pushing over $1300 per ounce recently. The reasons for gold's climb to new heights are tied directly to what is making the US dollar weak-the Fed.

Oil closed last Friday at $76.49 virtually unchanged and locked within the $10 trading band between $70 and $80 per barrel. This appears to be a sign that the oil markets and economic markets may be breaking their link that has been in place for much of the year. I have stated a number of times that oil appeared to be a barometer of the expected view of the global economy; however, it appears that oil is increasingly trading on fundamental market factors such as the swelling inventory of supply keeping a lid on oil prices.

US Treasuries have rallied these past two weeks driving yields back down to a Friday close of 2.6070%. Treasuries, the Euro, Gold, and Oil are all tied to a common view of expected Fed actions.


When the Fed met on September 21st it set the stage for what has happened in the markets since. The Fed implied that the US economy is recovering at a slower pace than it would like, that inflation is lower than desired, and suggested that further "quantitative easing" is possible. This quantitative easing, or QE as the cool people like to call it, is simply how the Fed to sticks more money (money supply) into the economy to spur business activity (and inflation).

The Fed is able to control the money supply by the actions it takes with the Federal Open Market Committee (FMOC). In a simplistic explanation, the Fed simply buys bonds (government, agency and corporate) from banks for cash with the expectation that the banks will then lend the money to businesses to stir the economy. A key byproduct of this action is to keep interest rates low which in turn causes the US dollar to drop against other currencies. Let me explain how this happens.

All economics boils down to two words: supply and demand. Prices move in response to each. Interest rates are a signal of this tug-of-war between borrowers and lenders. By suggesting that the Fed will step in to help the economy expand, borrowers and lenders understand this means the Fed will buy bonds and significantly increase the supply of cash washing through the economy. With this large supply of cash relative to demand, interest rates are held in check. Because interest rates are low, lenders of cash will steer clear of lower returning bonds (i.e. US treasuries) and this in turn dampens the demand for US dollars in international markets pushing the US dollar down in value. See how these are all interconnected?

Finally, many investors fear that this injection of cash into the economy will spur high inflation. How much inflation is anybody's guess. The Fed will try to keep this inflation under control by continuing to manipulate the money supply. If the Fed fails, then there is the chance of much higher inflation. Fear of the Fed's inability to control inflation is prompting the push of gold prices to record highs.

Looking Ahead

The S&P 500 has moved and closed above 1140. This is a positive development for the equity markets and comes after several strong weeks. Not surprising, this move is coupled by US Equities moving into one of the two favored major asset categories (Cash was replaced) as reported by DorseyWright & Associates. International Equities is the other favored asset class. I am increasing my exposure to stocks at this point in time.

I continue to prefer small and mid capitalization stocks for the US market along with the most technically strong sectors such as Real Estate, Consumer Discretionary and Industrial stocks. Emerging markets remain favored with regards to international investments with an emphasis on the Asian markets.

Gold is at record highs and it remains a clear play on uncertainty. Oilappears range bound and I am very uncertain when it will break out one way or the other.

Bonds have continued their strength in 2010. I still favor a slight over-weighting in bonds.

The technical factors regarding the markets are positive and I am adjusting my weightings accordingly. However, there remains an undercurrent of concern about the economy in the form of slow economic growth, high unemployment, failing home prices, the specter of higher taxes, and questionable effectiveness of all the Fed's move to name a few. So while I am pleased at the recent strength in the markets, I remain very wary and on guard.

If you have any questions about the overall relative strength of your portfolio and would like my analysis, please do not hesitate to give me a call.

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.

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