Monday, October 11, 2010

A poor jobs report on Friday increased expectations of Federal Reserve intervention spurring a rise in commodity prices as the US dollar continued to weaken. The Dow Jones Industrial Average (DJIA) closed above 11,000 for the first time since the end of April.

For the week, the DJIA gained 177 points (+1.63%) and the S&P 500 added 19 points (+1.65%) to extend recent gains. For the year the DJIA is now up 5.55% and the S&P 500 is up 4.49%.

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

The MSCI (EAFE) World Index posted a weekly gain of 2.73% outpacing US indexes and is now down just 0.82% for the year. Turkey, Peru, and Spain were the strongest countries I follow while Chile, Thailand, and Indonesia took a breather and lagged. On a broader basis, Developed Markets led the way with China and Japan showing renewed strength. Ireland made headlines towards the end of the week when Fitch Ratings and Moody's Investors Service both downgraded the country's sovereign debt one notch, but Ireland's markets shrugged off the news and were up along with most European countries for the week.

The Euro's surge against the US dollar continued last week closing at $1.3929 up from the previous Friday's close of $1.3790. This move brings the Euro to levels not seen since late January. The dollar is falling against most other currencies as well and this trend is generally responsible for the recent increases of commodity prices.

Gold gained another $33.30 an ounce closing at $1345.50. These record high prices have launched debates about whether gold is now at "bubble" levels or supported by market fundamentals. Likewise, oil also climbed and remains above the $80 level closing at $82.66 up $1.08 from its October 1st close. Oil pulled back slightly Friday on news of an extended port workers strike in France cutting off most crude delivers in that region. The expectation is that record high seasonal inventories in refined products will draw down as a result.

US treasuries rallied again after the jobs report with the 10-year yield closing at 2.392% well below last week's close of 2.625%. This was the largest weekly move on a percentage basis in 2010 and speaks volumes about investors' expectations.

RAMIFICATIONS OF HIGH US UNEMPLOYMENT

Friday's jobs report sent the bond market surging with expectations that the Fed is likely to renew Quantitative Easing (QE) in November. I have addressed QE in recent Weekly Updates, but I believe the importance of this topic warrants another review. QE is implemented by the Federal Reserve purchasing securities (i.e. US Treasuries) on the open market for the purpose of injecting liquidity (cash) into the economy. This new cash (the Fed prints the dollars they use for QE) flows into the economy and is eventually expected to result in positive outcomes such as renewed lending by banks and strong economic activity. Cash is the gasoline that runs the economic engine and QE is an octane boost.

The impact of this new wave (or anticipated wave) of QE generated cash into the economy ripples throughout the US and global economies resulting in:

Falling interest rates: we saw on Friday the 10-year US Treasury yields fall dramatically simply in anticipation. The 2-and 5-year yields are at record lows.

Falling US dollar: Global investors seek higher interest rates elsewhere so US dollars are sold to buy the currencies of the other countries that investors are buying bonds in.

Increasing US exports: or so the theory goes. As the US dollar weakens, US goods become cheaper abroad giving American products a price advantage. This increases economic activity here in the US.

Increasing likelihood of "currency wars:" Other countries wishing to protect their own markets and manufacturers may also attempt to push the value of their currencies down. Japan, Brazil and South Korea have all taken measures recently to do just this.

Increasing commodity prices: the vast majority of commodity contracts around the world are priced in dollars. Foreign commodity buyers must exchange their currencies for US dollars effectively lowering the cost to those buyers. Americans in turn see higher commodity prices as lower prices abroad spur greater demand.

Raises expectations of future inflation.

Excess US dollars can find their way into equity markets causing stock prices to rise.

If this sounds like the world is getting extremely interdependent, it is. Countries all act in their self-interest and when things get out of balance as may be happening; this can put significant pressure on all economies.

Treasury Secretary Timothy Geitner spoke on Saturday (October 9th) to an International Monetary Fund (IMF) gathering of world economic leaders arguing that some currencies are significantly undervaluedtranslate this to mean, "China, you need to let the Yuan appreciate to make US goods in China cheaper." The Chinese have historically resisted calls of action by the United States, and this time is no different. Also, because the Chinese peg their currency to the US dollar, their goods remain competitively priced all over the globe. Expect a lot of discussion ahead on the role of the IMF in negotiating currency disputes between countries.

Looking Ahead

There is a lot going on right now. Earnings season has just gotten underway, the US economy continues to struggle, jobs are not being created, US banks are suspending foreclosures assuring the housing recovery will be even longer and more painful, and the mid-term elections are looming just a few weeks away.

Equity markets around the world continue to rise.

This is when relative strength analysis helps bring clarity to the barrage of seemingly unrelated economic data hitting investors.

Based upon current analysis I continue increasing my exposure to equity markets. Broadly speaking, US and international equities are preferred; however, commodities are making a strong showing recently and I will be looking to add more commodities to portfolios. Small and mid-capitalization stocks are preferred over large cap, equal-weighted indexes are preferred over capitalization-weighted indexes, and I continue to favor Real Estate, Consumer Discretionary, and Telecom among broad economic sectors. Recently, the Materials and Industrials sectors have shown excellent relative strength and are worth watching.

My guidance on international markets remains unchanged. Emerging Markets are preferred over developed ones; however, the relative strength advantage of emerging markets is narrowing making most international investments good for now.

The weak US dollar has certainly caused commodities to increase. Gold is holding strong at record levels and remains firmly positive on a relative strength basis. I would be cautious about entering into new positions here, but would retain existing positions. There may be an opportunity to purchase gold on a pull back. Oil and oil service stocks are showing strong technical moves and are attractive.

Bonds continue to rally and are very expensive right now. Looking at my broad asset categories, bonds have fallen below commodities and rank only above currencies at the present time. However, many bonds continue to provide a solid investment in portfolios and I am not looking to reduce positions for now. Investment grade corporates, preferred, emerging markets, high-yield, and intermediate-term treasuries have the best relative strength in my opinion.

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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