Tuesday, March 15, 2011

Market uncertainty reached a crescendo Wednesday night and Thursday last week prompting market pullbacks around the world. Friday we woke up to the horrible news of the tragedy in Japan but US markets managed to rally.

The volatility that has gripped the markets the past few weeks continued. The Dow Jones Industrial Average (DJIA) lost 125 points (-1.03%) to close the week at 12,044 and the S&P 500 gave back 17 points (-1.28%) to close at 1304. For the year, the DJIA is up 4.03% and the S&P 500 is up 3.71%. The Russell 2000 lost 22 points (-2.69%) and for the year is up 2.45%. All major indexes have given short-term sell signals.

Looking at the broad economic sectors the week brought about what could best be described as roll reversals. By that I mean the best performing sectors so far this year took the brunt of the sell-off (I will discuss this phenomena in greater detail shortly). Energy, which had been up double digits was the biggest loser followed by Materials and Technology. Utilities, Consumer Staples, and Telecom were the winners. For the year, Energy still remains #1 up nearly 10% followed by Industrials and Health Care. Telecom, Materials, and Consumer Staples are the bottom three.

The MSCI (EAFE) World Index lost 3.42% for the week and is now up 1.68% for the year. From a country and regional basis, the Middle East as a group is underperforming for the year, while European countries continue to lead. So far in March, the best performing countries are rotating over to the Pacific-Asian region while the Middle East continues to underperform. Peru is the one exception to the regional biases as it remains near the bottom for March and 2011. Another important observation that I have seen from a technical standpoint is that average technical scores of emerging and developed markets that I track have essentially become equal and have started tracking together recently.

The Euro fell slightly against the US dollar losing -0.55% closing at $1.3910 compared to the previous week's close of $1.3987. The weakness of the Euro follows downgrades by Fitch of Greece and Spain by Moody's. These downgrades continue to remind investors that the debt crisis in Europe has not been resolved and that more bailouts may be coming. The Europeans are working on a self-imposed deadline of March 25th to complete work on the new bailout provisions. In meeting this past week, the Europeans did make some tweaks leading into the final summit in two weeks, but the European Central Bank head came away disappointed. I will devote more to this subject after the final meeting.

Gold closed Friday at $1416.10 down $12.30 (-0.86%) for the week and for the year gold is off $3.60 (-0.25%). Gold prices started climbing on Friday as investors reacted to the magnitude of the Japanese disaster and the associated uncertainty.

Oil prices fell last week with West Texas Intermediate (WTI) crude closing at $100.70 falling $4.02 (-3.84%) for the week. This has not slowed the increase of gasoline at the pump and I experienced another ten cent increase paying $3.79 per gallon for premium this weekend. The lack of truly disruptive protests in Saudi Arabia and expected drop in demand from the Japanese as they cope with the earthquake are the two principal reasons for the week's drop. I also believe that Gadhafi will regain control of Libya as the US, the UN, and NATO debate on how to deal with the uprising there. I further suspect that Libyan oil will be bought as normal in the world's markets even after the brutal crackdown in the country. The real story will continue to be the uninterrupted flow of oil to Europe and the US. Disruptions will trigger an economic upheaval and impact negatively on markets worldwide. Other commodities pulled back significantly last week as investors worry about the impact of the earthquake on imports of commodities by the Japanese.

Bonds continued their rally as investors shifted money away from stocks and into bonds. The 10-year Treasury yield closed Friday at 3.397% down from the previous week's close of 3.488%. The Barclays Aggregate Bond Index was up 0.46% for the week and has now been up three of the past four weeks. For the year the Barclays is up 0.63%. The spread between the 10-year Treasury and the 30-year Treasury has narrowed recently as the longer maturity bond shows greater sensitivity to market dynamics (in this case a positive boost in price).

A LOT GOING ON LAST WEEK

The crescendo of market noise seemed to roll over investors late last week spooking the markets and prompting a greater than 2% pull back on Thursday. While the stock markets rallied on Friday to close up slightly, commodity markets continued to fall over worries of curtailed demand in oil and agriculture products from Japan. Before the earthquake dominated the news Friday, five major news stories were dominating the headlines:

• Unrest in Saudi Arabia • The escalation of Libyan violence • A reported monthly trade deficit by China • First time unemployment claims in the US jobs market increase 26,000 compared to a consensus of a 7000 increase • Spain's credit rating was downgraded by Moody's following Fitch's downgrade of Greece earlier in the week

All of these stories together signal a less than vibrant global economy. Whether the impacts are felt immediately or over then next few months or years, the news made investors question the strength of recoveries and challenge beliefs that countries are effectively moving past previous problems. The rally on Friday calmed some fears that an all-out route was not underway, but an unmistakable signal was sent to investors-the continued rally in stocks may be slowing or coming to an end for now.

THE NEW YORK STOCK EXCHANGE BULLISH PERCENT REVERSED

I have been discussing the New York Stock Exchange Bullish Percent (NYSEBP) extensively in recent weeks. Remember that it is an indicator of risk in the market, not a predictor of market performance. I think we all remember the crash of 2008 and we are influenced by our most recent experiences (particularly painful experiences) but we must keep in mind that circumstances are very different in 2011. So while I cannot predict if this is the start of a major correction or a slight pause before resuming growth, what I do know and understand is that after being in a column of X's (demand in control) since September 15, 2010, the NYSEBP is now in a column of O's (supply in control) and that a more defensive posture must be taken. For me this translates to evaluating holdings in all portfolios, raising cash in the weaker holdings, and taking more conservative strategies. In other words, our focus should now be on wealth preservation rather than wealth creation.

The sell-off last week caused particular pain in the energy sector, some parts of the technology sector, and among small and mid capitalization stocks. A quick check of recent performance shows that all of these stocks show that all of these sectors have significantly outperformed the broader market, in other words, these investments have been exceptionally strong on a relative strength basis. So when investors start selling, the first place they look to are investments with gains. Once profits have been taken, they tend to gain more rapidly when pessimism turns to optimism. Just ask yourself, if I were going to sell something because the markets are making me nervous, would you sell an investment with a 20% gain or one that is flat or with a slight loss? This emotion helped guide selling last week and may help you better understand why some of your best investments have been hit harder than the broad market-that role reversal I mentioned earlier.

What do the Point and Figure charts of the DJIA and S&P 500 tell me about support levels? The DJIA and S&P 500 both broke their first support levels of 12,000 and 1300 respectively. They have since rebounded to just above those levels, but they were breached none-the-less. The next intermediate support levels for each index are 11,800 for the DJIA and 1270 for the S&P 500. Both of these support levels are between 2% and 3% below current market levels. While significant, the real support for the markets comes at 11,100 for the DJIA and 1180 for the S&P 500. Breach of either of these levels would break long-term support of these indexes that have been in place since August of 2010.

One final observation. When I examine the Point and Figure Charts of most of my major investments, I do not see a breakdown in those charts. The indicators tell me that most holdings have become "fairly" valued when compared to their prices over the past ten weeks. This is a normal and acceptable market action. If breakdowns do occur, then they must be dealt with at that time.

LOOKING AHEAD

I recognize that a drop in account value is never pleasant and we always prefer to see markets rise. Reality is that the ride is not a smooth one and we will experience pullbacks and corrections periodically. Last week was certainly an example of this. What is important to recognize is not to let you be unduly influenced by recent market actions and remain focused on the process of investing in technically strong investments and sectors.

Small and mid-capitalization stocks remain favored. Equal-weighted indexes over capitalization-weighted indexes. US and International stocks are favored over Commodities, Bonds, and Foreign Currencies. Emerging Markets remain preferred over Developed Markets (although this has essentially become a tie).

My favored sectors are Energy, Consumer Discretionary, and Industrials.

My views of bonds have not changed. Bonds will return bond-like returns. Nothing spectacular. On a relative strength basis, High Yield, Preferred, and Floating-Rate bonds are favored. Intermediate-term corporates continue to perform well.

Commodities are volatile. I continue to believe that oil prices are clearly sensitive to the uncertainty in the Middle East and any threats to supplies in any of the oil producing countries can cause a sharp increase in prices. A falling US dollar will also contribute to an increase in commodity prices in general. Gold is trying to get even for the year. I believe that if you own gold, keep it. Gold remains a hedge against the global uncertainties. I see no reason at this time to sell any commodities in portfolios; however, this does not mean we forget about these positions.

Take a few minutes and review your portfolios. If you feel like raising cash, do so. If you are trying to decide between stocks or bonds, bonds may be attractive for now. If you want to get into the stock market, consider doing so on a step-by-step basis rather than going all in. As this market continues to go forward in 2011, I am getting the sense that sector rotation will be important to watch and take advantage of.

I want to conclude this Update by asking each of you to remember the victims and survivors of the disasters that have struck Japan. The people of Japan have suffered, and continue to suffer, from one of the worst disasters in that country's history. Let us hope and pray that the recovery will be swift and further suffering minimized.

The NYCE US Dollar Index is a measure that calculates the value of the US dollar through a basket of six currencies, the Euro, the Japanese Yen, the British Pound, the Canadian Dollar, the Swedish Krona, and the Swiss franc. The Euro is the predominant currency making up about 57% of the basket.

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, this is a market capitalization weighted index, meaning the largest companies in the S&P 500 have a greater weighting than smaller companies. The S&P 500 Equal Weighted Index is determined by giving each of the 500 stocks in the index the same weighting in the index. 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. The Russell 2000 Index is comprised of the 2000 smallest companies within the Russell 3000 Index, which is made up of the 3000 biggest companies in the US.

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