Wednesday, December 22, 2010

US equity markets continued their recent strength while Europe remains stymied as it sorts out the on-going debt crisis giving strength to the US dollar. US treasuries staged a small rally at the end of the week, and there was little news from China to move the markets.

For the week, the Dow Jones Industrial Average (DJIA) gained 82 points (+0.72%) ending the week at 11,491.91. The S&P 500 gained 4 points (+0.28%) to close Friday at 1243.91. For the year the DJIA is up 10.2% and the S&P 500 is up 11.6%.

Health Care, Consumer Discretionary, and Materials were the best performing broad sectors last week while Financials, Real Estate, and Technology brought up the rear. Year-to-date the top three broad economic sectors are Consumer Discretionary, Industrials, and Materials while Utilities, Health Care, and Financials remain at the bottom. Real Estate has fallen out of the top three broad sectors for the year for the first time in many months (it remains 4th on the list) so I will continue to watch this sector closely.

The MSCI (EAFE) World Index lost 0.1% for the week and is now up 2.6% for the year. Chile, Sweden, and Taiwan were the top performing countries I follow this week while Indonesia, Turkey, and Vietnam were the bottom three. For the year, Thailand, Chile, and Indonesia are the top performing countries and Spain, Italy, and France are the worst. The European debt crisis emerged as the number one financial story this week and I will discuss in greater detail below.

The Euro fell 0.5 cents against the US dollar last week to close Friday at $1.3181 from the previous week's close of $1.3229. The US dollar has posted gains against the Euro for the past five of six weeks as investors shun the Euro over continuing European debt worries and improving US bond yields.

The 10-year treasury closed the week at 3.3376% up from the previous week's close of 3.229%. The bond market's volatility and yields have been rising as investors are eyeing renewed strength and optimism in equities. The long-end of the yield curve (bonds with maturities 20 years and greater) has been hardest hit. All bonds rallied a bit on Thursday and Friday as investors started taking advantage of the recent price declines and news that there was an outside chance that the Build America Bond program could be renewed in the next Congress. Trading in municipal bonds is expected to be light as the year comes to a close.

Overall commodities posted gains for the week. Gold fell slightly closing at $1376.00 Friday from the previous week's close of $1384.90. Oil increased to $88.07 per barrel from the previous week's close of $87.79. Gold continues to be a hedge against uncertainty in global markets and oil's value reflects expectations of coming global growth and demand.

THE COUSIN EDDIE OF FINANCIAL MARKETS

For those of you who do not watch the Vacation movies regularly like I do, you may not be familiar with Cousin Eddie. Cousin Eddie is the uninvited family member who arrives at Chevy Chase's house at the worst possible times and overstays his welcome. The European debt crisis is the Cousin Eddie of global financial markets.

At the heart of this crisis is the realization that this problem is enormous and will not go away without major structural changes. Greek protesters have taken to the streets again, the Irish government fell after accepting the European Union (EU) and International Monetary Fund (IMF) bailout, and Spain is now under increasing pressure from the bond market as fears grow that its banking system cannot survive without massive support (and lots of Spain's debt is also owned by Germany, France and others). In response, the EU's finance ministers just completed the last summit for 2010 and announced an agreement to replace the current emergency rescue fund with a permanent crisis-finance program. The proposals call for greater enforcement powers for the EU and European Central Bank (ECB) to dictate actions to be taken by the bailed-out country and discipline them for not adhering to those guidelines. In other words, the EU is coming to grips with the fatal flaw of having a common currency without a means of controlling the spending and borrowing activities of its member nations. It is the equivalent of giving your Cousin Eddie a credit card with no limit and always being on the hook for paying his bills-eventually you will grow tired of using your own hard earned money to pay for his spendthrift ways. To help control Cousin Eddie you put limits on his spending and require that he start making payments to you.

Brian Carney and Anne Jolis wrote an excellent column titled, "Toward a United States of Europe" in the Wall Street Journal's weekend edition (December 18, 2010) discussing the challenges facing the EU. The article highlights comments from French Finance Minister, Christine Lagarde, who says that for the EU to work, its countries are going to need greater coordination between member countries if the EU is to survive. The individual members of the EU are going to have to answer more and more to the EU and ECB. Also at stake is nothing less than the sovereignty of individual nations. Germany is at the top of the list of countries who do not want to bailout weaker, more undisciplined, member nations. However, an argument can be made that the German's have little choice because failure of the EU would do enormous economic harm to Germany and global financial markets. In the end, the EU could end up like the United States with a strong central/federal government and satellite countries/states. The question remains if independent nations are prepared to give up their sovereignty for the good of the European Union.

The resolution of the European debt crisis is of great importance to all of us. You may be asking why this matter should be a major concern of the United States. It is not our debt, we don't have the Euro as our currency, but the fact is global financial markets are extremely intertwined. This interrelationship of the banks internationally is similar to concept of the Federal Reserve's decision to bailout AIG at the height of the US economic crisis. AIG was perceived, because of its relationship with nearly every major bank and investment firm in the US, as too important to fail. Europe and the United States are intertwined and so what happens in Europe will impact on us here.

Looking Ahead

The momentum behind equities, especially US stocks, has continued to build. With Congress passing a continuation of the Bush-era tax rates, the defeat of the $1.2 trillion omnibus spending package in the Senate, and the release last week of a positive report on the leading economic indicators, there is some basis for this momentum. It is hard to tell how much movement will occur in US stock markets near-term because I believe much of that news is already factored in.

I am not, however, an unconstrained bull. I do believe that we are closing out 2010 on a relatively positive note and I am glad for that. I also believe that continued exposure to stocks is warranted at this time, but I also realize that there continue to be headwinds on the economy that must be watched closely. At the top of my list of concerns are the persistently poor housing market and an unemployment rate that is approaching 10%. So while I continue to invest in stocks, I am looking over my shoulder for any signs of market deterioration. Again, the benefit of following a technical discipline from data provided by Dorsey Wright & Associates is that it helps to strip away the emotion and clutter surrounding the headlines each day.

There were no changes in my overall technical indicators last week. The New York Stock Exchange Bullish Percent (NYSEBP) increased slightly from 77.55 to 77.82. A reading over 70% is an indication that stocks are strongly favored but risk for a correction is present. Stocks are still favored over bonds. Mid and small-cap stocks are preferred over large cap, and growth is favored over value. I prefer emerging markets and recommend staying away from developed Europe. Emerging markets have been showing weakness recently, but it still tops my list of key indicators on a relative strength basis so I will continue recommend these investments in portfolios. I remain committed to maintaining an investment in commodities as a hedge against rising prices.

Bonds improved slightly this week and I maintain that bonds should remain within portfolios at this time. Many bond sectors have performed well this year and I remain committed to bonds in allocations appropriate for varying risk tolerances.

I hope that during this holiday season each of you has the opportunity to gather with your families and friends and share the joys that come from such camaraderie. In the final analysis what we ultimately have is each other and the love and kindness shared together. I again ask that we remember the brave men and women who are not able to be with their families as they defend our shores from those who do not share our values.

Happy Holidays!

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.

Emerging market investments involve higher risks than investments from developed countries and also involve increased risks due to differences in accounting methods, foreign taxation, political instability, and currency fluctuation. The main risks of international investing are currency fluctuations, differences in accounting methods, foreign taxation, economic, political or financial instability, and lack of timely or reliable information or unfavorable political or legal developments.

The commodities industries can be significantly affected by commodity prices, world events, import controls, worldwide competition, government regulations, and economic conditions. Past performance is no guarantee of future results. These investments may not be suitable for all investors, and there is no guarantee that any investment will be able to sell for a profit in the future.

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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