Friday, December 17, 2010

US equity markets continued to show strength in a week that was marked by high drama on Capital Hill and China announced another 0.50% increase in their banking reserve requirements in the face of continued inflation worries. European debt problems fell back into the shadows and commodities took a breather, while Euro fell against the US dollar and US treasuries continued their sell-off.

For the week, the Dow Jones Industrial Average (DJIA) gained 218 points (+1.95%) ending the week at 11,410.32. The S&P 500 gained 16 points (+1.28%) to close Friday at 1240.4. For the year the DJIA is up 9.4% and the S&P 500 is up 11.2%.

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

The MSCI (EAFE) World Index lost 0.9% marking the 5th consecutive week this broad international index has fallen under the heavy burden of debt concerns in Europe. Also hit hard were some of the darlings in international investing this year and past: Turkey, China, and Brazil. Israel, Ireland, and Austria were the best performers last week. China remains the focus of the investment media and most traders. More on that below.

The Euro fell 1.8 cents against the US dollar last week to close Friday at $1.3229 from the previous week's close of $1.3414 and is virtually unchanged for the month. Much of the US dollar's strength continues to come even as the Federal Reserve remains committed to its bond purchase program (QE2). The reasons for the rise of the US dollar in the face of QE2 have several components. First, international investors are buying US dollars to buy treasuries as rising yields make them more attractive. A second, and perhaps dominant reason, is safety. As investors fear what is happening on a global stage-particularly in the Euro Zone, the US dollar continues to be the place park cash. The strength of the US political system trumps other fears like inflation.

Gold gained and oil pulled back last week as commodities in general fell slightly on worries that as the Chinese central bank continues to restrain growth, global demand for commodities will fall as well. The general trend of commodities has certainly been positive and I believe in a growing economic scenario, this trend will continue.

Bond investors continue to see portfolio values fall as interest rates rise. Rates on the benchmark 10-year treasury closed Friday at 3.229% from the previous Friday's close of 3.0167%. The last time rates were at this level was late June of 2010. Municipal bonds continued their pullback primarily on concerns that Congress may not extend the Build America Bond (BAB) Program. BAB's are state and local government issued bonds whose interest payments are partially subsidized by the federal government. The program has been very popular with states that have the greatest debt problems including California, Illinois, New Jersey and New York. The program has come under scrutiny by Republicans over concerns that the program allows states to continue issuing debt for spending they cannot afford and the federal government is incurring additional financial obligations.

CHINA CONCERNS

China released data over the weekend showing inflation for November jumped to 5.1% year-over-year (YOY). This follows October's YOY increase of 4.4% and these increases clearly have the Chinese central government concerned. Over the weekend, China announced that it would raise yet again the bank reserve requirement from 18% to 18.5%. This move is designed to withdraw money from the Chinese economy by reducing the amount of money lent by Chinese banks. The greatest worries about the Chinese economy are focused on real estate development. Depending on who you read, some analysts believe the Chinese have massively over-built and everything from shopping malls to apartment buildings remain empty and unsold. China is not as transparent as Western countries but these concerns about the underpinnings of the Chinese economy must be watched closely.

Because nothing is all one way or the other, November export data for China showed a 34.9% YOY increase in exports and can be interpreted as a clear positive for US and European demand which bodes well for bulls. This is a great example of the general tug-of-war that currently exists between pro-growth bulls and cautious outlook of the bears.

The pause in commodity prices this past week can also be attributed to fears of a slowdown within China. If demand, or expectation of demand, goes up; commodity prices will likely follow.

Looking Ahead

At a recent conference I attended, Bob Doll (Vice Chairman of BlackRock) said that there are times when the economy and stock market do not necessarily move in tandem. Times like this are a good example of this view. The jobs report released on December 3rd showed unemployment jumping up to 9.8% and many pundits say 10% is not far behind. Home prices remain stuck or decreasing. I read a report in Bloomberg which said that nearly 24% of all homes in the US are currently worth less than their mortgages. Yet the stock market is showing renewed strength.

The cross currents in the global economy are impacting the markets with the equity markets winning out recently. The two major issues facing investors are the fears related to excessive borrowing by the developed economies and the sustainability of the economic recovery. The bears fear mounting debt will stifle economic growth, while the bulls see the world economy rebounding and growth rates returning to more normal levels. It appears that the headline of the day drives market returns.

The stock market is also watching the debates in Washington over the tax rates and other fiscal policy issues in Congress. Do not underestimate the importance the markets are placing on a satisfactory resolution of the compromise reached by the President and the Republicans.

When there is so much uncertainty about how the economy is going, the value of the technical research I use with Dorsey Wright and Associates is even more important. Looking at the current market technicals, the New York Stock Exchange Bullish Percent (NYSEBP) closed last Friday and a very strong 77.55. 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. Stocks are favored over bonds. Mid and small-cap stocks are preferred over large cap, and growth is favored over value. Another change occurred in the Dorsey Wright Dynamic Asset Level Indicators (DALI) where Real Estate fell out as one of the favored sectors. This adjustment is not a reason to sell real estate investments; rather it is more a move to place these investments under greater scrutiny. International stocks continue to be favored. I prefer emerging markets and recommend staying away from developed Europe. Equal weighted indexes are preferred over capitalization weighted indexes.

I remain committed to maintaining an investment within commodities as a hedge against rising prices. If manufacturing remains strong in China, commodity prices are likely to continue rising.

US bonds continue to pull back as interest rates rise. I will repeat my view that bonds should remain within portfolios at this time and December can be a difficult time as inventories can get skewed. Bonds have pulled back from an overbought status to an oversold status, but for the most part have not violated support lines and should therefore be retained in portfolios. Like real estate, this pullback warrants close scrutiny.

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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