Monday, April 18, 2011

Stock markets remained flat yet again this past week as investors search for clarity about inflation concerns, economic strength, renewed European debt concerns, and soaring commodity prices. US bond markets, however, had their best one week performance in 2011.

For the week, the Dow Jones Industrial Average (DJIA) lost 38 points (-0.31%) to close at 12,342 and the S&P 500 lost 8 points (-0.64%) to close at 1320. The markets lack of direction has been in place for the past six weeks. Since March 1st, the DJIA has added just 115 points (+0.94%) while the S&P 500 has lost 8 points (-0.57%). Contrast that to the previous three months (December 1st, 2010 to February 28, 2011) when the DJIA and S&P 500 gained 1220 points (11%) and 115 points (12%) respectively. Pundits and economists can debate the cause of each ebb and flow of the market endlessly, but let me sum it all up for you in one sentence: investors have no idea what to do! In other words, supply (selling pressure) and demand (buying pressure) have been balanced for the last six weeks as investors try to figure out what is going on. I will look at the major issues of the past week which may shed some light on why investors are uncertain about the direction of the markets, but until the buyers or sellers begin to take charge, this pause in the markets will continue.

For the year, the DJIA is up 6.60%, the S&P 500 is up 4.93%, and the Russell 2000 is up 6.55%.

Broad economic sectors reflect the uncertainty of investors. Last week's worst performer, Real Estate, was this week's top performer. Consumer Staples and Health Care remained in the top three. The year's top performer, Energy, was the worst performer along with Materials and Financials. The general sell-off of some commodity and commodity-related stocks hurt the Energy and Materials sectors. For the year, Energy continues to lead all other sectors by a wide margin followed by Health Care and Industrials.

The MSCI (EAFE) World Index lost 1.10% for the week and is now up 3.82% for the year. Japan's Nikkei Stock Index lost 1.81% last week and for the year is down 6.2%. Developed markets out-performed emerging markets and now lead emerging markets slightly for the year. For those of you who read the Update regularly, you are seeing a pattern emerging in the international markets, or should I say a lack of a pattern. There has been no consistent advantage in 2011 to be in either Emerging markets or Developed markets.

The Euro pulled back slightly last week against the US dollar over growing concerns that the European debt crisis may be reemerging. The Euro closed the week at $1.443 losing one-half cent to the US dollar. Concerns grew last week in Europe over Greece's ability to meet debt obligations even after last year's bailout. European Union (EU) leaders are strongly opposed to restructuring Greece's debt (defaulting on existing debt and replacing with new debt that may not make existing bondholders whole); but the German's are floating the idea. The EU wants to avoid restructuring at all costs because their leaders fear that this move would hurt all European bonds. Part of the motivation behind the German's consideration of restructuring is because Chancellor Merkel is facing enormous political pressure at home. Ms. Merkel's Christian Democratic Party has been losing key local elections around the debate over Germany's nuclear energy policies following the destruction of the Japanese reactors, and because German's are growing increasingly discontent about bankrolling countries they believe have been irresponsible in their spending. The yield on Greek 10-year bonds has risen to beyond 13% and, maybe even more worrisome, the cost to insure Spanish debt has been creeping upwards. I will continue to monitor this fluid situation closely.

Except for precious metals, commodities saw a pullback last week. West Texas Intermediate oil closed Friday at $109.66 down $3.16 (2.78%) for the week as traders focused on some generally positive economic news here in the US as the core Consumer Price Index (CPI) rose just 0.1% for the month and consumer confidence was up as well. At the same time, I paid $3.99 for a gallon this week for premium gasoline as gas prices surge across the country. March saw gasoline prices rise 5.6% for an annualized inflation rate of nearly 70% (fuel and food prices are excluded from the core CPI data). Gold prices reached record levels and closed the week at $1486.00 up $11.90 (0.81%) as investors seek protection against the growing uncertainty both here and abroad about inflation levels and currency valuations.

The Barclays Aggregate Bond Index had its largest one week gain in 2011 closing up 0.85%. For the year the Barclays is now up 0.98%. The US 10-year Treasury yield moved down to 3.411% compared to last Friday's close of 3.576%. The core CPI rate strongly influenced bond investors as they believe that real inflation is not a near-term risk. Long maturity treasuries were the best performing bonds last week as would be expected. International bonds continued to perform well as did treasury inflation protection notes (TIPs) and high quality corporate bonds. For the year, international TIPs and treasuries, high-yield, and preferreds have been the best performing bond categories.

PLAYING CHICKEN WITH INFLATION

The US Consumer Price Index for April showed a rise in core prices of just 0.1% and is up 0.5% on a seasonably adjusted rate. The CPI is up 2.7% on a year-over-year basis which I believe is within the guidelines of what the Federal Reserve would consider acceptable. Even though the core CPI increase was low, energy prices surged 5.6% and food increased 1.1%. While these numbers are excluded from the core rate because of the volatility of commodity prices, they still impact each and every one of us who must consume gas and food each day. Wage growth is flat so extended high energy and food prices will eventually translate into reduced spending by consumers in other sectors.

In Europe and the Far East, inflation is a much bigger immediate concern. At the International Monetary Fund's semi-annual meeting in Washington, DC, this week, the Chinese representative said inflation was his country's number one economic concern. To back up those words, the Chinese just announced a few hours ago that they were going to raise the bank reserve requirement yet again 0.5% to 20.5% in an effort to reduce liquidity in their banking system. This move has been coupled with a series of increases in their short-term federal interest rate.

Also at the IMF conference, a sharp divide has developed between developed and emerging countries over capital flows into emerging markets. Emerging market countries are upset with the United States for its extraordinary accommodative monetary policy which has resulted in a flood of cheap US dollars around the world causing the price of commodities and other goods to skyrocket. This has created inflationary pressures in those countries and places enormous pressure on local governments to fight inflation by raising interest rates curbing economic growth. So it is understandable why emerging market governments are not happy. Emerging market countries blame the US and the Federal Reserve in particular for allowing our own domestic policies to override the importance of having a credible monetary policy for the world's reserve currency. The United States counters this criticism by saying that many countries (China in particular) artificially control their currencies to protect their exports. US Treasury Secretary Geithner said that capital flows between countries would be balanced if currencies were allowed to fluctuate. I believe Mr. Geithner is correct in his belief, however, I also believe that the leaders representing the emerging market countries are also correct in their views that we are keeping our currency cheap by the Federal Reserve's monetary policies (low interest rates and QE2). Because the US dollar is the world's currency reserve, our policies (like it or not) have an enormous influence on the rest of the world. If the US fails to act responsibly, then other countries will look for an alternative to the US dollar as the reserve currency. Whether or not that is practical or even possible is for later debate.

In the meantime, the Federal Reserve is playing a game of chicken with US monetary policy. I strongly believe that much of the stock markets' gains in the past six months have come at the hands of Mr. Bernanke's policies. If he get's it right and stimulates the US economy to growth and prosperity without inducing a spike in inflation, then we will all win. If, however, Mr. Bernanke cannot get the economy on solid footing before the onset of inflation, then we can expect tough economic times ahead. Investors are telling us by the sideways movement of the markets for the past six weeks that they have no idea how this game of chicken will be resolved. I include myself as one of those who has no idea how this will turn out. But I do believe that a degree of caution is warranted and that the relative strength tools I use will help provide answers about Bernanke's success going forward.

LOOKING AHEAD

I am sounding a bit like a broken record in that my basic recommendations have not changed over recent Updates. There simply has been no change to the relationships between stocks and bonds, US and International stocks, or Commodities and Currencies over the past few months.

I continue to favor US stocks and Commodities. I believe that international investments should be closely evaluated and only the strongest technical investments retained. I do not have a heavy bias towards developed or emerging markets; however, emerging European countries have been the strongest performers. Small and mid-capitalization stocks remain favored. Equal-weighted indexes are favored over capitalization-weighted indexes.

I currently favor the Energy, Health Care, and Materials sectors. I will continue to hold onto other sectors that I have bought because their performance has not warranted any changes.

I believe that inflation protection notes should be looked at closely for inclusion into portfolios along with international bonds and corporate bonds.

Commodities are a volatile asset class to invest in so expect wide swings. I prefer energy investments above all others; however, if you chose to invest in other commodity vehicles I would encourage you to invest in a broad basket of commodities rather than try to pick between specific commodities. I still like gold as a hedge against the uncertainties facing investors today. Silver is also performing well and is currently at 30-year highs.

The markets have a lot to digest in the coming weeks. We have begun the earnings reporting season for the 1st quarter and all eyes are on corporate bottom lines. Europe will continue to be interesting and I am anxious to see if there will be any impact of China's move to raise the bank reserve rate on markets. And finally, there is the on-going political debate here about the size of the US debt, tax levels, and government spending. The outcome of these debates will affect all of us, but I do not believe the impacts will be seen in the near term.

One final note. I want to express my sympathies to many of my neighbors in the Hampton Roads community who suffered serious damage last evening after we were hit with some of the most deadly spring storms seen in this region in 20 years. Fortunately, those of us near the ocean front of Virginia Beach were spared from the storm's serious effects.

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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