Monday, March 21, 2011

We have closed the book on another dramatic week as the world watched the Japanese people struggle to recover from a centuries-powerful earthquake, devastating tsunami, and an on-going fight to gain control of several nuclear reactors that were damaged during this unprecedented natural disaster. Additionally, the UN Security Council passed a resolution late on Friday authorizing UN forces to enforce a no-fly zone over Libya in an effort to prevent further human suffering, China announced that they were yet again raising the bank reserve requirement to help stem inflation, and the US Congress passed another three-week continuing resolution on the 2011 budget as larger fights over spending loom.

Major stock indexes jumped dramatically up and down during the week with 3 of the 5 trading days seeing moves greater than 1% from the pervious day's close. When the dust settled on the week, the Dow Jones Industrial Average (DJIA) lost 186 points (-1.54%) to close at 11,859 and the S&P 500 gave back 22 points (-1.71%) to close at 1279. For the year, the DJIA is up 2.43% and the S&P 500 is up 1.71%. The Russell 2000 lost 8 points (-1.02%) and for the year is up 1.40%.

Within the broad economic sectors here in the US, only Energy and Materials posted modest gains followed closely by Telecom. The bottom three sectors were Utilities, Information Technology, and Consumer Discretionary. These bottom sectors are clearly being impacted by events in Japan. The nuclear energy sub-sector was especially hard hit driving returns down across the entire utility sector. Information Technology and Consumer Discretionary stocks are being impacted by the potential for disruption of manufactured products and parts that may cause serious shortages for manufacturers and retailers here in the US.

The MSCI (EAFE) World Index lost 2.67% for the week and is now down 1.04% for the year. Japan's Nikkei Stock Index, not surprisingly, saw incredible volatility leading to a weekly drop of 9.55%. The MSCI (EAFE) is influenced by Japan with about 22% exposure to that country and helps explain this index's current under-performance. No one region of the world consistently outperformed others last week as Turkey, Greece, the UAE, Slovakia, and Qatar were the best performers while Japan, Australia, Sri Lanka, Peru and Argentina were the worst. Significantly, international stocks as a major asset category have been dropped from the top two emphasized categories on a relative strength basis. I will discuss the ramifications in greater detail below.

The Euro gained against the US dollar adding nearly three cents to close Friday at $1.4182. While economic news was not especially upbeat from Europe last week, I believe the strength of the Euro and the weakness of the US dollar against most currencies is attributable to the Federal Reserve's continued commitment to low interest rates at a time when many central bankers abroad have hinted at possible interest rate hikes to combat growing fears of inflation. For the year, the Euro is now up 8 cents (6.1%) against the US dollar.

Commodities continued to show strength with broad commodity indexes posting modest gains for the week and are among the best performing categories so far in 2011. Gold closed Friday at $1416.10 which is the same price of the previous Friday. Gold sold off sharply on Tuesday but managed to regain those losses by week's end. For the year, gold is essentially flat with a net change of -$3.60 (-0.25%) for the year.

Oil prices added $1.64 last week with West Texas Intermediate (WTI) crude closing at $101.07. The news from the Middle East, particularly Libya and Bahrain, is changing minute-by-minute and fluctuations in oil prices will likely match developments as traders try to make bets on what has become a very chaotic situation. As I have said many times before, the weakening US dollar will continue to foster general commodity inflation in the coming months.

Investors continued to put money in bonds last week as a shelter from the volatility in the equity markets. The 10-year Treasury yield closed Friday at 3.273% down from the previous week's close of 3.397%. The Barclays Aggregate Bond Index was up 0.41% for the week and for the year is now up 1.05%. The fear factor driving investors into bonds has overcome concerns about a growing perception of rising prices and inflation.


There are five "asset categories" that I track on a relative strength basis to help guide my investment recommendations. These categories are US stocks, International stocks, Fixed-income (bonds), Commodities, and Currencies. Using relative strength to determine the rankings reduces personal opinions, gut feelings, or predictions upon which to make investment decisions. To modify a famous quote from Sgt. Joe Friday of Dragnet fame, "Just the prices, ma 'am," clearly illustrates the unemotional basis that guides my recommendations.

Since last summer (August 2nd) International stocks have been one of the two emphasized asset categories (US stocks is currently the other). To arrive at the favored two categories, Dorsey Wright & Associates uses a proprietary mix of indexes from each of the five categories and evaluates each bundle of indexes against the others to see which two are the strongest. Think of it as the football standings in any conference or league. The top two teams in the standings are favored or emphasized over the others. As a final evaluation tool, the emphasized asset categories must also be outperforming cash. This is to protect principal as much as possible. It is important to keep in mind that these relative strength tools are not especially sensitive. It would be counter-productive for the emphasized asset categories to change every couple of days or even weeks.

After last week's market actions, International stocks category fell to third place and was replaced by Commodities. Does this mean that you should run out and sell all of your international investments? No. What it does suggest is that you should begin to trim holdings and reduce your exposure to this category. I look at the technical data of each investment to guide my pruning efforts. The weakest get jettisoned and the strongest can be retained. If you have some questions about the technical strength of your international holdings or about what commodity investments are available, please give me a call.


There continues to be mixed signals from the economic news surrounding world events. While the unemployment and jobs report and corporate earnings reports in the US have shown some strengthening of our economy, other signals are less bullish. The rising inflation threat is quickly being seized upon by many central banks and these bankers are either raising rates now like India and Brazil, or suggesting rate hikes are coming like the European Central Bank, or they are taking measures to curb liquidity in their countries like China's third announcement this year to raise bank reserve requirements. Here in the US, food prices rose 3.9% in February, the largest increase since All in the Family and Sanford and Son were the two most popular shows on TV (1974).

Housing starts in the United States fell in February at the fastest rate since 1984 to reach the second lowest level since this statistic was created after World War II. The lowest level was April 2009 at the height of the fiscal crisis. According to the Commerce Department, new home construction fell 22.5% to an annualized rate of 479,000 homes. These numbers are not adequate to help economic growth and are likely to persist until the foreclosure and short sale homes have finally cleared through the market. How long this will take is anyone's guess at this time.

I will continue to watch events unfold in the Middle East, the European Union's efforts to prop up weak countries, and the efforts of the Japanese to overcome their terrible calamity. I will also monitor the effects on US equity markets in the weeks ahead as the Federal Reserve ends Quantitative Easing 2 (QE2). There is a significant belief by some economists that much of the gains in the US stock markets are attributable to the large amount of liquidity injected into the economy by the Federal Reserve via QE2. What the net impact all of these events will have on financial markets is anyone's guess beyond what we have recently seen.

More than ever, the value of technical analysis such as provided by Point and Figure charts and relative strength analysis is coming to the forefront. With so much uncertainty swirling around investors, these tools offer an unbiased and unfiltered way in which to see the world and react accordingly. The methodology is not perfect by any means, but it certainly helps give insights as to what investors are doing with their money, not what we think they are likely to do. This process is also not short-term based, rather, it is a marathon; just like the difference between speculation and investing.


US stocks continue to remain as an emphasized asset category along with Commodities. I generally like to invest in well diversified commodity indexes to dilute the fluctuations of any given commodity sector.

I fully expect the heightened volatility to remain in the markets for now. This is a result of the greater uncertainty induced by the many events rocking the world and by potential leadership changes in the markets which often accompany such volatility.

Small and mid-capitalization stocks remain favored. Equal-weighted indexes are favored over capitalization-weighted indexes. While International stocks are no longer among the emphasized categories, the European Emerging markets are showing the greatest relative strength in the international area.

My favored sectors are Energy, Materials, and Technology (watching technology carefully).

My views of bonds have changed. While I continue to believe that bonds will return bond-like returns, I am revising my views on high-yield bonds and am now suggesting a reduction in allocations to high yield bonds. The extra risk is not justified by higher yields at this time in my view. Corporate intermediate bonds and international bonds have been the strongest in 2011. I also continue to like senior bank loan investments also known as floating rate bonds.

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.

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.


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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