Thursday, April 14, 2011

Stock markets were flat in the US this past week while interest rates jumped on growing fears that inflation may be just off the horizon.

The Dow Jones Industrial Average (DJIA) gained 3 points (0.03%) to close at 12,380 and the S&P 500 lost 4 points (-0.32%) to close at 1328. In terms of the average daily point change in closing values of the DJIA, this past week was the second least volatile week of the year coming in at an average daily change of 30.22 points. This is also the third consecutive weekly drop after peaking for the year during the week of March 14th (135.26). For the year the DJIA is up 6.93% and the S&P 500 is up 5.61%. For the week, the Russell 2000 lost 6 points (-0.69%) and for the year is up 7.30%.

Broad economic sectors reflected the mixed returns of the major indexes. Consumer Staples, Health Care and Materials were the top performing sectors and all three outperformed the DJIA. Real Estate, Industrials, and Financials were the bottom three sectors. For the year, Energy leads all other sectors by a wide margin followed by Industrials and Health Care. Health Care has been steadily climbing up the ladder of best performing sectors so far in 2011. The bottom three performing sectors for the year are Utilities, Financials, and Information Technology.

The MSCI (EAFE) World Index gained 1.85% for the week and is now up 4.97% for the year. Japan's Nikkei Stock Index continued to rebound gaining 0.61% last week and has cut its yearly loss to 5.1%. Among stock exchanges, emerging markets in general were again the strongest performers of the week and as a group is regaining strength among the various asset classes. Europe, both developed and emerging markets, remain the strongest performers so far in 2011 around the globe.

The Euro surged last week against the US dollar after the European Central Bank announced, as they had been indicating, that it was raising interest rates from 1.00%to 1.25%. The Euro closed the week at $1.448 gaining 2 cents on the US dollar for the week and it is now up 11 cents (8.31%) for the year. This gain came after Portugal officially asked the European Union (EU) and the International Monetary Fund (IMF) for a bailout. This request had been expected and marks the third European country to seek assistance. The size of the Portuguese bailout is estimated to be €80 billion ($115.8 billion), but it is too early to know just how much will be ultimately needed. Pressure will now shift to Spain as potentially the next country in line for a bailout; however, initially it appears that Spain is getting a vote of confidence in the bond markets indicated by a narrowing spread between 10-year Spanish notes and German 10-year Bunds.

Commodities, especially oil, continued to rise dramatically. West Texas Intermediate closed Friday at $112.79 up $4.85 (4.49%) for the week, and is now up $21.57 (23.65%) for the year. Gold closed at $1474.10 up $46.00 (3.22%) and is now up $54.40 (3.83%) for the year. This sudden strength in oil and gold prices reflects the continuing concerns over the unrest in Libya, Syria, and Egypt; and fears of global inflation. While I have continually suggested that gold is primarily a hedge against uncertainty, the uncertainty that seems to be most in focus is that of the effects of high oil prices on the economies of the US and other countries.

The Barclays Aggregate Bond Index was off 0.31% for the week and this broad bond index is now down three weeks in a row. For the year the Barclays is still up 0.13%. The US 10-year Treasury yield closed up to 3.576% compared to last Friday's close of 3.445%. Rising treasury rates indicate that bond investors are now growing more and more concerned about the prospects of real inflation (especially as high oil prices persist), and concerns over the ever growing supply of new US bonds as the federal government continues to fund its current fiscal debt estimated to be $1.6 trillion. Not surprisingly, inflation protected bonds were the best performing bond category last week.

REFLECTIONS ON THE 1st QUARTER

After getting off to a strong start to the year in January and February, the DJIA and S&P 500 have started to trade sideways in March and April. March brought significant volatility within a month that changed little. So far in 2011 there have been 13 days were the market closed 100 points above or below its previous day's close, and 8 (62%) of those days were in March.

The story of the first quarter has to be the surge in oil and other commodity prices. I have discussed this phenomenon in previous Updates as I commented on how the Fed's very accommodative monetary policy (low interest rates, bond buying by the Federal Reserve-QE2) has kept the US dollar very cheap vis-à-vis other currencies and has been a major factor in higher commodity prices worldwide. But in the case of oil, the unrest in the Middle East has caused investors to hedge against the fear of supply disruptions and also contributed to push prices well over $100 per barrel.

The second major story of the quarter has been the strength or weakness in the US economy. The 4th Quarter, 2010, Gross Domestic Product (GDP) reached just over 3%. The unemployment rate has persisted around 9% and home prices continue to fall. Corporate earnings have been the one real bright spot and contributed to the strength in the stock markets (along with the Fed pumping cash into the economy through QE2). I consider the jobless rate to be a key input to the Federal Reserve's decisions surrounding their actions going forward. With high unemployment, the Fed has maintained an extremely accommodative monetary policy and will be slow to tighten as long as unemployment remains high.

Europe has always been on my radar screen as I have commented frequently on the actions of countries like Germany and France as they try to change decades and even centuries of cultural behavior in less fiscally conservative countries. The bailouts of Ireland and Portugal were accompanied by the fall of political governments in those countries as well. The EU continues to struggle on how best to instill discipline in spendthrift countries. Chancellor Merkel of Germany, whose country will ultimately bear the bulk of the bailout costs, is under increasing political pressure at home losing a series of local elections as Germans are losing patience on their country's role as the EU's pocketbook. I follow Europe closely for two reasons. First, the EU is the second largest economic block in the world behind the United States, and problems in Europe impact on the rest of us. Second, it is illustrative to watch political leaders struggle with out of control spending and borrowing, hostile public labor unions, and efforts to change decades of bad habits. While I strongly believe that the United States is not Europe, there are certain parallels that make the positive resolution of their problems important lessons for the US.

Finally, looking at broad asset classes, oil and commodities have been the best performing asset classes followed by mid capitalization stocks, the S&P 500 equal weighted index, the DJIA, and small capitalization stocks. Energy, Industrials, Health Care, and Materials have been the best performing broad economic sectors. Treasury inflation protection bonds, international treasuries, and high yield bonds have been the best performing bond categories.

LOOKING AHEAD

My basic recommendations have not changed over recent Updates. 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 and I am looking for good investments in that space. Small and mid-capitalization stocks remain favored. Equal-weighted indexes are favored over capitalization-weighted indexes.

My favored sectors have changed. I am now favoring Energy, Health Care, and Materials.

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. 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.

Finally, I would like to make the following observations. As I have said before, small and mid-capitalization stocks have been outperforming large caps for quite a period of time. While my indicators still support overweighting the smaller stocks, large caps have been quietly gaining strength and it is certainly worth adding some high quality large cap stocks to portfolios. Along with large cap stocks, health care stocks have also made a strong rebound recently. China has also been quietly making a comeback after underperforming in 2011.

The real key going forward into the 2nd quarter of 2011 will be the impact of continued high commodity prices on economic growth, growing inflation pressures, and the termination of QE2 (scheduled for the end of June) coupled with the Federal Reserve's ability to navigate the US economy as it reduces stimulative monetary policies. While I applaud the early strength of stock markets so far this year, I remain vigilant to the potential negative impacts facing markets.

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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