Tuesday, November 9, 2010

US equity markets reached their highest levels in two years following an announcement by the Federal Reserve that it will purchase up to $600 billion in long-term US treasuries through the end of June 2011 in an effort to jump start the economy and inflation causing a surge in commodity prices. Additionally, mid-term elections promise to slow down the high-tax, big government agenda pursued by the last congress; and a higher than expected private sector jobs report buoyed investors.

For the week, the Dow Jones Industrial Average (DJIA) gained 326 points (+2.93%)closing the week at 11,444.08. The S&P 500 added 43 points (+3.60%) to close Friday at 1225.85. For the year the DJIA is now up 9.7% and the S&P 500 is up 9.9% and are levels not seen since September 2008.

Financials, Energy, and Real Estate were the best performing broad sectors last week while Health Care, Consumer Staples, and Utilities brought up the rear. Year-to-date the top three broad economic sectors continue to be Real Estate, Consumer Discretionary, and Industrials while Health Care, Utilities, and Energy have lagged. The strength of the financial sector can be attributed to reports that the Fed may allow healthy banks to resume paying dividends.

The MSCI (EAFE) World Index kept pace with US markets gaining 3.41% for the week. Emerging markets outpaced developed markets as investors continue to take on more risk and as the US dollar continues to weaken. For the year the MSCI (World) is firmly positive up 5.7%. For the week, the top performing markets that I follow were Hong Kong, China, and Australia while Spain, Italy, and Ireland were the weakest. For the year, Thailand, Peru, and Turkey have been the best performers while Spain, Italy, and Ireland have been the worst. The weak European countries cannot shake concerns about their ongoing debt problems.

The Euro continued to gain against the US dollar as the Fed signaled that it would hold interest rates down by purchasing long-term US treasuries. For the week, the Euro closed at $1.4032. The general weakening of the US dollar is having significant ramifications on commodity markets.

Oil prices jumped $5.42 per barrel closing at $86.85 for a weekly gain of 6.66%. Gold closed at $1397.70 gaining 2.96% for the week. The commodity story is not a uniform one. Sugar, cotton, and corn are all subject to the variances of supply and demand as weather patterns influence production and supply; while gold and other precious metals certainly reflect general uncertainty about the US dollar. Oil is certainly influenced by the value of the dollar, but also reflects supply figures and overall expectations of global growth.

With all the news from the Fed about its bond purchase program, US treasuries have remained relatively stable with the 10-year rate closing Friday at 2.5412%. This is only slightly below its close two weeks ago at 2.5624%. I think it is safe to say that the markets had already priced the Fed's announcement into yields.

RAMIFICATIONS OF THE FED'S ANNOUNCEMENT TO BUY BONDS

I have pointed out in previous Weekly Updates that the Fed's program to buy bonds (also known as QE2 for Quantitative Easing Round 2) would boost all asset classes. Stocks because many of the dollars printed by the Fed will find their way into the stock market, bonds because interest rates will be held down, and commodities would gain because of a weak dollar. This has happened and while many investors are certainly happy to see markets and valuations rise, concerns about the direction of US monetary policy is being voiced by leaders from Europe, China, and other parts of Asia. In general, foreign leaders are worried about how the weakening US dollar will negatively impact their exports abroad and create asset bubbles in their own economies. I have also commented about fears of currency wars erupting between countries and there continue to be signs of this possibility. Secretary Geithner is traveling abroad in advance of the next G20 meeting November 11-12 in Seoul and is finding pushback from preliminary meetings with finance officials. Domestically, concerns about the Fed's ability to stoke the economy without losing control of inflation remain as well.

MID-TERM ELECTIONS AND OTHER NEWS

The generational gains by Republicans in the House of Representatives and among state legislatures around the country signals change is coming. I will leave the broad ramifications of what form this change will take to the many, many pundits who comment on such things. What I will say is that there will certainly be a degree of gridlock in Congress and expect the next two years to be a lead up to the 2012 presidential campaign. What I believe we all want is for our government to focus on a healthy business climate and job creation. While the jobs report on Friday indicated an increase of 151,000 private sector jobs created in October, this pace of job creation is very anemic and will not make a dent on overall employment. An unemployment rate stuck at 9.6% will not contribute to the long-term economic recovery of the US. My hope is that Congress and the President will get serious about focusing on government policies that encourage growth, not inhibit it.

Looking Ahead

There was an incredible amount of news that impacted the markets last week. Most of it positive and the markets have reflected that by reaching two year highs.

The New York Stock Exchange Bullish Percent (NYSEBP) closed Friday at 75.07 and is well above the overbought line of 70. What I find interesting is that while the markets have reached two year highs, the NYSEBP is below the most recent high of 82.39 on September 17, 2009. This indicates that fewer stocks are participating in the market's gains and indicates a "divergence" from previous market highs.Remember, this statistic does not say that a correction is certain in the near-term, but it does indicate that the chances of a pull back have increased.

US and International stocks are favored. Commodities are very strong. Bonds are simply treading water (not a bad thing), and currencies are very uncertain at this point.

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 markets and this relationship has strengthened recently.

The Dow Jones Corporate Bond Index and the Barclays Aggregate Bond Index both gained last week, albeit slightly. I believe bonds are a solid holding at this time, but I am cautious about new investment in bonds with maturities greater than 10 years. I am focusing on short to intermediate-term bonds. As cash sloshes around the world, emerging market bonds are becoming attractive.

Risk levels remain elevated. This does not mean that a correction is imminent, but adding positions should be done so incrementally and any pullback would be considered a buying opportunity.

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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