Tuesday, October 19, 2010

Ben Bernanke and the Federal Reserve remained the focus of economic news this past week while interest rates on US treasuries moved up sharply. Concerns over the mortgage foreclosure process pushed banking stocks down sharply.

For the week, the Dow Jones Industrial Average (DJIA) gained 56 points (+0.51%) and the S&P 500 added 11 points (+0.95%) continuing recent gains. For the year the DJIA is now up 6.09% and the S&P 500 is up 5.48%.

Information Technology, Consumer Staples, and Energy were the best performing broad sectors last week while Financials, Health Care, and Utilities brought up the rear. For the year, Real Estate, Consumer Discretionary, and Industrials have been the three best sectors while Financials, Health Care, and Utilities have lagged.

The MSCI (EAFE) World Index posted a gain of 1.28% marking it highest weekly close in 2010 and outpacing US indexes yet again. For the year the MSCI (EAFE) is now up 3.19%. Israel, China, and Peru were the strongest countries I follow while India, Japan, and Taiwan lagged. On a broader basis, developed markets again led the way with China continuing to show strength. For the year, Thailand, Peru, and Indonesia have been the best performing countries while Spain, Italy, and France have been the worst.

The Euro continued to gain against the US dollar last week closing at $1.3977 up from the previous Friday's close of $1.3929. However, the momentum of the gains against the dollar slowed even in the face of Fed Chairman Bernanke's speech on Friday where he essentially reaffirmed a policy that will continue to weaken the US dollar albeit a little more slowly than the markets had been anticipating.

Gold continued its historic run gaining another $26.30 an ounce closing at $1372.00. As I have stated recently, these prices reflect the continuing uncertainty about the strength of paper currencies (read inflation) and an underlying lack of confidence in the global economy. Oil closed down $1.41 at $81.25 last week but still above that important $80 per barrel level. Supplies remain high, but the strike in France continues to negatively impact European refining output. There are now 62 crude-laden ships waiting for the port strike in Fos-Lavera to end so they can discharge their cargo.

US treasuries fell broadly as concerns entered into the market that the Fed's Quantitative Easing (QE) has already been priced into the market and that the ongoing easy money policies represented by QE will lead to inflation in the future. The 10-year yield closed at 2.567% up from 2.392% the previous Friday. Just as the previous week's interest rate move down was the largest one week move this year, this week's interest rate gain was a close second in terms of the size of the move. I said last week that the large drop spoke volumes about investors' expectations; this week's near reversal of that move speaks loudly about how uncertain investors have become. Corporate bonds were also hit with most bonds losing a small percentage of their values. Greatest losses among all bonds were found among the longer-term bonds which are more interest rate sensitive than intermediate or short-term bonds.

IT'S THE FED OVER AND OVER AND OVER AGAIN

The dominating economic story for the third week in a row is the Federal Reserve and its focus on stimulating the US economy by increasing the money supply through the purchase of securities through the Fed's Open Market Committee. My previous two Weekly Updates have addressed this subject in detail. This week's news was mostly focused on Fed Chairman Ben Bernanke's speech Friday morning in Boston where he made several key points:

Inflation is too low. He stated that he thought the appropriate core inflation rate should be 2%.

Unemployment is too high and needs to come down.

The Fed will take further steps to stimulate the economy such as holding short-term rates down and adding liquidity to the economy-more quantitative easing.

The equity markets may be hoping for a huge injection of new cash into the economy, but Bernanke did not give this indication. He also expressed concern over the lack of historical empirical evidence regarding the effectiveness of the non-traditional central bank tools he is employing. The bond markets appear to be rethinking the threats of inflation (if the Fed does less QE it could translate into higher rates), and the commodity markets are driven by a weaker dollar and economic fears.

WHAT ELSE IS GOING ON?

The foreclosure mess has hurt the banks and has cast uncertainty about the ability of the housing market to recover sooner rather than later. The issue revolves around technical processing procedures and not about mortgage holders who are current on their loans being forced from their homes. Home foreclosures in September reached a record 102,134. Additionally, foreclosure filings rose three percent to 347,420. This number represents one out of every 371 households in America. The rate of foreclosures should drop as moratoriums take hold. The net result will be slowing down foreclosures for now and extending the mess that the US housing market has become. Banking giants Bank of America and Wells Fargo each lost 9% of their stock value and Citigroup lost nearly 6% last week.

Initial jobless claims gained 13,000 to 462,000. The lack of job creation continues to be a serious issue.

Consumer sentiment as measured by the Thomson Reuters/University of Michigan index of consumer sentiment fell in October to 67.9. This follows a drop in September as well. The historical average of this index when the economy is in a recession is 74.1and 90.4 in expansions. The economy may be expanding, but not at a rate that is making the consumer feel particularly good.

There was good news last week in the form of retail sales which rose 0.6% in September across most retail sectors. Only clothing and department store sales dropped. Because the consumer remains such a significant part of the economy, this was a very good report.

Looking Ahead

I have said many times that I am not a prognosticator. I do not have the ability to predict what financial markets will do, nor can anyone else for that matter. However, I can look at the technical indicators and get a sense of where we are and what that means to you.

The New York Stock Exchange Bullish Percent (NYSEBP) closed Friday at 69.87 and has been improving week after week. A reading of 70 indicates that the markets have become "overbought." While this statistic does not say that a correction is certain in the near-term, it does indicate that the chances of a pull back have increased. The NYSEBP peaked on April 26th at 80.69 and fell back to 37.6 by June 8th. What this tells me is that there is more risk in the market, not less; and new equity positions should be carefully considered before entering.

All major international indexes are all positive right now with demand clearly in control.

The Dow Jones Corporate Bond Index has pulled back slightly but remains positive while the Barclays Aggregate Bond Index, with its heavy weighting in US treasuries, has turned negative. I am not suggesting reducing current bond holdings, but I am watching this trend closely.

The Dorsey Wright & Associates Dynamic Asset Level Indicators have International and US Equities favored. Commodities recent positive move has pushed Bonds to fourth and Currencies remain last. Small and mid capitalization stocks are favored over large cap, and equal-weighted indexes favored over capitalization-weighted indexes. Emerging markets remain favored on a relative strength basis, but developed markets have come back strongly in the past two months.

The markets have the feeling that they may be reaching an inflection point. The technical indicators that I follow are signaling higher risk levels. If or when they turn is unclear; however, positions must be watched closely. Earnings season will begin in earnest this week and investors will be listening closely to corporate earnings and, more importantly, corporate outlooks as the overall economy continues to be very sluggish. The mid-term elections are just a few weeks away and investors may begin to anticipate a more business-friendly Congress emerging.

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.

Sincerely,

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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