Monday, September 13, 2010

Markets posted gains for the second week in a row. Bonds have come under pressure.

The Dow Jones Industrial Average (DJIA) gained 15 points (+0.14%) and the S&P 500 added 5 points (+0.46%) to extend last week's gains. For the year the DJIA is now up 0.33% and the S&P 500 is down 0.50%. Consensus among the financial media attributes gains to growing confidence that a second recession will be avoided.

Biomeds, Drugs and Oil Service were the best performing sectors last week while Semiconductors, Textile and Household Goods were the worst. From a technical standpoint, Real Estate, Telecommunications and Utilities have the strongest scores while Health Care, Financials and Energy are at the bottom. Keep in mind that scores measure longer trends and do not reflect week-to-week changes necessarily.

The MSCI (EAFE) World Index posted a weekly gain of 0.91% outpacing US indexes, but remains down 5.2% for the year. Hong Kong, Sweden and Israel were the strongest and Spain, Belgium and Austria were the weakest of the countries that I follow. Developed European markets trailed the US and most other international regions with the Far East (less China and Japan) generally leading the way. International securities remains one of my two favored asset classes (Cash is the other) while US stocks, Commodities, Fixed Income, and Currencies sit on the sideline for now. Emerging markets remains the favored international category.

The Euro fell against the dollar closing at $1.2677 compared to last week's close of $1.2893.

Gold pulled back $4 an ounce closing on Friday at $1247.10. Gold continues to be a safe haven for investors against the uncertainty in world markets.

Oil added just under $2 per barrel to close $76.54 (+2.6%) from last week's close of $74.60. Oil has held up despite good inventories on hand and a strengthening dollar. I continue to believe that the price of oil is a referendum by energy traders on their global economic expectations.

US Treasuries continued a recent trend of rising rates which corresponds to negative price movement for individual bonds. The yield on the 10-year Treasury rose to 2.7936% from last week's close of 2.7133%.


For the second week in a row the longer-term treasuries were the worst performing sector of the bond market. Collectively, the broad bond market was down about 0.50% while the long end (20-30 year maturities) was down over 1%. For the year, long-term Treasuries have been the best performing sector of the bond market. Many investors have considered the long end of the Treasury bond market to be highly priced (myself included). Investors have been buying Treasuries at historically low yields as a safe haven from the uncertainty surrounding the markets both at home and abroad. The two questions overhanging the bond markets are 1) whether or not investors will continue to accept extremely low yields or will they demand higher yields, and 2) does the recent rise in interest rates mark the beginning of a trend toward higher rates? The answer to these questions has enormous implications for policy makers, taxpayers, and investors because 60+% of all outstanding US debt matures over the next three years and will need to be refinanced. If rates rise substantially, the cost to taxpayers will be huge and squeeze the federal budget dramatically at a time when the commitment of tax dollars is growing.

For bond investors, higher rates will result in falling valuations. Investors who have poured billions and billions of dollars into bond funds could find their portfolios covered in more red ink. We must keep our eyes on the bond markets and not become complacent.


Concern over the strength of European banks has again come back into the news. When the results of the stress tests on the European banks by the Committee of European Bank Supervisors were released earlier in the summer, the markets were calmed because only 7 of the 91 banks evaluated had to raise capital. European stocks have rallied and the Euro has gained significantly. This debate over the stress tests will undoubtedly continue, but the answer will be found in the performance of the sovereign debt of Spain, Portugal, Italy, Ireland and Greece. This is another issue that must be watched carefully.

On a positive note, global banking regulators met in Basel, Switzerland, this weekend to hammer out new rules regarding reserve requirements for banks. Banking reserves are assets banks are required to hold to offset losses of band loans and other investments. The requirements were raised to 7% from 2% to 4% currently. The US wanted the new rules to take effect in 5 years but ultimately comprised to 9 as the Europeans were concerned that moving too fast could hurt their economies. I believe this is a positive move in the long run because it will help reduce the risk of future bank failures.

Looking Ahead

The coming week is the year's third Triple Witching which occurs when stock options, futures and futures options all expire on the same day. Friday, September 17th, will be the third such "triple witching" of 2010 (the last is in December). I mention this only because Triple Witching weeks have seen higher than normal volatility in markets as measured by the difference between the high and low of the week. Volatility does not care about direction. Over the past 20 years, 13 years have been up and 7 down.

I continue to watch the S&P 500 for a move above 1140 which will be a short-term indicator of strength and break the upper band in place since June.

I continue to prefer mid and small capitalization stocks. I believe large cap stocks paying a strong dividend (greater than the 10-year treasury) are especially attractive because stocks generally do well when interest rates rise. However, if the market becomes more risk tolerant, then these large cap stocks are likely to underperform the small and mid cap segments of the market. If interest rates continue to rise, bonds will lose value while stocks at least have a chance to maintain their values.

Gold is holding its value and is strong on a technical standpoint. Oil appears range bound for now, but I watch both commodity prices closely for trends.

Bonds remain under pressure. I favor corporate intermediate term bonds. High Yield bonds have shown strength in the face of a stronger equity market. International bonds, while a strong performer for the year, are under pressure recently and worth watching.

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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