Monday, November 22, 2010

US and global equity markets lurched to and fro this past week to close essentially flat.Ireland appears to be warming to a European sponsored relief package, China announced an increase in the bank reserve requirement, and Fed Chairman Bernanke aggressively defended his second round of quantitative easing (QE2) policy.

For the week, the Dow Jones Industrial Average (DJIA) gained 11 points (+0.10%)ending the week at 11,203.55. The S&P 500 gained just under 1 point (+0.04%) to close Friday at 1199.73. For the year the DJIA is up 7.4% and the S&P 500 is up 7.6%.

Industrials, Energy, and Consumer Discretionary were the best performing broad sectors last week while Real Estate, Health Care, and Financials brought up the rear. Year-to-date the top three broad economic sectors are Consumer Discretionary, Real Estate, and Industrials while Utilities, Health Care, and Financials remain at the bottom.

The MSCI (EAFE) World Index gained 0.6% on news that Ireland was moving towards accepting aid from the European Union (EU). Latest reports indicate that aid could be in the €50 billion ($68 billion) range. Concerns are mounting that Irish banks are facing ever-growing losses from real estate related debt. China announced, not unexpectedly, on Friday that it was increasing the bank reserve requirement from 17.5% to 18% in an effort to pull money out of their economy to stem rising inflation. China and India were the worst performing countries last week with Ireland, Israel, and Austria the best. For the year, Thailand, Peru, and Indonesia remain the strongest performers while Spain, Ireland, and Italy continue to be the weakest.

The Euro fell slightly last week to $1.3686 from the previous Friday's close of $1.3692. The US dollar's recent strength may come as a surprise to many in light of the Fed's QE2 policy, but it reflects concerns over the longer-term issues surrounding European debt problems. I will discuss this issue in greater detail below.

Oil prices fell $0.40 per barrel closing at $81.60. Gold continued its recent weakness falling another $16 per ounce (-1.2%) to close at $1353.40. Like equities, commodities in general ended the week flat.

US treasury yields fell (bond prices increased) Friday after Mr. Bernanke's remarks defending QE2, but in general bond prices continue to be weak. On Friday the 10-year yields closed at 2.8750%, up from the previous week's close of 2.7889%. Many pundits are scratching their heads over the recent surge in interest rates following the Fed's announcement on November 3rd of additional bond purchases in the open market. But the fact is, rates are rising. Especially hard hit have been municipal bonds and emerging market debt. A number of bond managers I follow have recently commented on the deteriorating muni bond market and their consensus is that the problems are supply-driven and not credit quality related. State and local governments are rushing supply into the market to take advantage of historically low rates, to issue bonds under the Build America Bond program which ends at the end of the year, and because the two-year moratorium permitting AMT tax-free private activity bonds is also expiring at year's end. This supply imbalance is forcing issuers to offer higher interest to attract sufficient buyers. I remain skeptical of this view and believe that there are a lot of states that have serious debt issues including Illinois and California. Emerging market bonds have been hurt by a rising US dollar.


The recent strength of the US dollar is confounding economists. Like all other goods currencies are in essence a good to be bought and sold on the open market), when demand for a particular good increases, so does its price. Investors around the world have been buying US dollars at a greater rate than the Euro and most other currencies.From a technical standpoint, my indicators are suggesting that this relationship can continue for the short-term. However, the longer-term outlook is not as strong.Economists are correct in their concern for the strength of the dollar as the Fed continues to print money to buy our debt. Mr. Bernanke made it very clear on Friday that his overall objective is to help a weak US economy recover and to spur employment. He did acknowledge that a weaker US dollar could result, but he places the blame for much of the US dollar's weakness on countries like China that are manipulating their currencies to keep them artificially low.

While the Fed's monetary policy may contribute to a weaker US dollar, I continue to see problems in Europe as the main determinant in the strength of the US dollar. Ireland will be forced to take aid to stem its banking crisis. I mentioned that the aid package could total $68 billion; however, European financial leaders are uncertain about the final amount. Fallout from Ireland has forced other weak EU countries to pay more for their debt. Spain had a successful bond offering this past week, but at rates higher than they would have preferred. Greece is still a mess, Italy is a mess, and Portugal is a mess. Higher rates put more and more pressure on the solvency of these governments, and the long-term outcome could be insolvency and restructuring. Bankruptcy for short. The situation in Europe reminds me of the tale of the little Dutch boy who averts a crisis by sticking his finger in the dyke to stem the flow of water while awaiting help. In the tale help comes just in time to prevent a catastrophe, the question now is whether or not enough help can arrive to stem the leaks currently flowing from the European debt dyke. Should the worse-case scenario play out, it will be a huge global economic mess. While I do not see this happening in the next couple of years, and it may not happen at all, it must be watched along with the Euro/US dollar relationship.

To the investor, a rising US dollar favorably impacts on US stocks (small and mid caps outperforming large caps), US bonds, and growth stocks. A falling dollar favors non-US stocks, commodities, gold, international bonds, and value stocks.

The technical indicators I follow help provide insight as to what is happening and I will certainly keep all of you apprised of this important issue.

Looking Ahead

A news story that is certain to draw attention in the coming weeks follows an announcement by Federal investigators late Friday that they are nearing the completion of a 3-year insider-trading investigation that, according to an article by the Wall Street Journal, "could eclipse the impact on the financial industry of any previous such investigation." The article states that the investigation centers on more than 30 investment banks, hedge-funds, and expert-network firms. Expert-network firms specialize in providing institutional clients the most up-to-date information about a specific industry and potential deals within that industry. The most well-known name mentioned in the Wall Street Journal article was Goldman Sachs who is under investigation about Abbott Laboratories' take over of Advanced Medical Devices in January 2009. It is doubtful that the market will react broadly on Monday to this news because the investigation focuses primarily on mergers and takeovers from 2007 to 2009; however, individual companies may be hurt and there could be erosion of investor confidence which is already weak. This will be a story I will be following with great interest.

It is too early to say that the recent correction in equity markets is anything more than the normal ebb and flow of the markets. Nearly all of my technical indicators had most stocks, bonds, and commodities in an overbought status. As of the market's close on Friday, many indicators have returned to more normal levels.

The New York Stock Exchange Bullish Percent (NYSEBP) fell last week to 73.71 down from the previous week's close of 75.58. I continue to watch this critical indicator closely for signs of a breakdown. A score over 70 indicates an overbought status of US stocks and that risk levels are high, but does not indicate when a major sell-off may occur. US and International stocks are favored. Commodities remain strong. Bonds appear to be under continued pressure going into next week, but not to the point of reducing current bond allocations at this time. Longer-term municipals and international debt are showing the greatest weakness right now.

Small and mid-capitalization stocks continue to be favored over large caps. Equal-weighted indexes (which will include more mid cap stocks) remain favored over capitalization-weighted indexes. Emerging markets remain favored over developed. China must be watched carefully as investors shy away while the Chinese government takes steps to slow the overall economy in an effort to curb inflation.

This week is a shortened trading week. The markets are closed on Thursday in celebration of Thanksgiving and will close at 1 PM on Friday. As we gather with family and friends this Thanksgiving, I want to extend my sincere hope that you are able to share this holiday with those you love and hold close. I ask that we all take a moment and remember those great soldiers, sailors, marines, and airmen that are unable to be home with their families as they defend each and every one of us.

Happy Thanksgiving!

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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