Tuesday, May 3, 2011

Markets continue to post gains on the news of solid corporate earnings and negative economic reports. The weakness of the US dollar has been dominating the headlines of most of the financial media over the past several days following the remarks of Federal Reserve Chairman Bernanke that he would continue to support an "accommodative" monetary policy for the foreseeable future.

For the week, the Dow Jones Industrial Average (DJIA) gained 305 points (+2.44%) to close at 12,811 and the S&P 500 gained 26 points (+1.96%) to close at 1364. The markets shrugged off the initial 1st quarter Gross Domestic Product (GDP) announcement that economic growth had slowed to 1.8% and that first time unemployment claims jumped unexpectedly to 429,000 marking the second week in a row that this statistic has been over 400,000. For the month, the DJIA gained 3.98% and is now up 10.65% for the year. The S&P gained 2.85% in April and is now up 8.43% for the year. The Russell 2000 followed suit gaining 2.32% for the week, gained 2.58% in April, and is up 10.42% for 2011.

Among the broad economic sectors, Real Estate, Utilities, Health Care and Industrials all bested the DJIA's strong performance last week. Materials, Consumer Discretionary, and Telecom were the bottom three but posted acceptable gains. For the year, Energy, Health Care, Real Estate, and Industrials have all topped the DJIA while Financials, Telecom and Utilities bring up the rear. Again, all sectors have posted positive gains so far in 2011.

The MSCI (EAFE) World Index gained 2.34% for the week, is up 5.58% for the month, and up 8.40% for the year. European countries dominated global markets in April with especially strong growth coming from Germany, Poland, Belgium and even Ireland. Peru, Egypt and Greece were the bottom three countries. For the week, developed markets decidedly outperformed emerging markets. For the month, the BRIC countries: Brazil, Russia, India, and China were essential flat or even slightly negative and underperformed many countries.

The Euro posted a very strong two and a half cent gain (+1.77%) against the US dollar closing Friday at $1.481 its highest level since July 2008. For the year, the Euro has gained over 14 cents (10.78%) on the US dollar. The story on the US dollar has two essential components-monetary policy and fiscal policy. The monetary policy is set by the Federal Reserve, and Mr. Bernanke's commitment to very low interest rates has sent investors flocking abroad to purchase higher yielding foreign bonds. The second component, which I highlighted last week, is fiscal policy. Investors are growing increasingly skeptical that the United States will resolve its growing deficit problem before the next presidential election in 2012. The ever growing supply of US bonds can eventually be expected to put downward pressure on bond prices (Econ 101 supply and demand principal) causing rates to rise. If investors lose their appetite for risk, this anticipated trend will be either slowed or even reversed.

Commodities continued their rise last week. West Texas Intermediate oil closed Friday at $113.93 up $2.63 (1.46%) for the week. April saw oil rise 6.84% and for the year oil is now up 24.90%. The story is the same as it has been for the past few months as a weaker US dollar, instability in the Middle East oil producing region, and an every increasing demand for oil from new consumers in China and Brazil contributing to the rise. I remain concerned that as oil prices remain high, consumers will have fewer dollars to spend in other parts of the economy causing the recovery to sputter. Whether oil prices continue to increase or remain at current levels, the central issue is the duration of these higher prices. The longer oil remains above $100 per barrel, the greater the negative impact on the US and global economies.

Gold gained $52.60 an ounce (+3.50%) to close at another all-time high this past week at $1556.40 per ounce. After losing $85.90 (-6.05%) in January, gold has gained $222.60 over the past three months with $116.50 of that gain coming in April alone. Gold is the currency of uncertainty and recent gains have come from the continuing decline of the US dollar and, I believe, a growing speculative demand as investors want to participate in the seemingly unstoppable rally.

I will repeat last week's observation about the broader basket of commodities. It is not a coincidence that as the US dollar's weakness deepens, the price of commodities continue to rise. I will also add another important point to keep in mind, commodities are very volatile. If investors suddenly lose their appetite for risk, they are likely to return to the US dollar and the upward trend in commodity prices could reverse sharply. Watch the US dollar against international currencies and you will get a sense of how commodity prices may act.

The Barclays Aggregate Bond Index posted its third straight week of increases gaining 0.67% last week. This broad-based US bond index was up 1.36% for the month of April and is now up 1.82% for the year. The US 10-year Treasury yield fell from 3.402% to 3.283% last week following a strong demand for Treasuries at the end of the week. The bond market likes subdued economic data and the slowing of the GDP in the 1st quarter calmed investors' fears of inflation and contributes to the belief that the Federal Reserve will not need to raise interest rates for the time being. International bonds were again the best performing bond sector last week (and this year) followed by long duration Treasuries, preferreds, high yield, and corporates. Treasury Inflation Protection Notes (TIPs) gained slightly last week and remain one of the best performing bond sectors for 2011.

THE ONLY GAME IN TOWN

Mr. Bernanke gave the first-ever press conference by a fed chairman following a meeting of the Federal Reserve Open Market Committee this past week. The press conference reminded me of what has become the essence of the modern political "debate," victory is measured not by scoring strong points against your opponent, but rather by avoiding mistakes. And that is precisely what Mr. Bernanke did, he said nothing we did not already know and did so without saying something he shouldn't.

After the hype leading up to the press conference , we are left with the reality of what the Fed is doing or going to do. What we do know is that Mr. Bernanke believes the economic recovery is proceeding at a "moderate pace," and that the labor market is improving "gradually." He acknowledges that commodity prices have risen significantly since last summer causing inflation to pick up; however, it is his judgment that the inflationary pressures are "transitory" and "longer-term inflation expectations have remained stable and measures of underlying inflation are still subdued." Therefore the Federal Reserve will take QE2 (buying bonds) to its conclusion to the end of June and continue to target a federal funds rate of between 0 and ¼ percent.

I hate spending time dissecting what the Federal Reserve is going to do or not do. What it thinks about inflation today or tomorrow, and if there is going to be another round of quantitative easing or not. There are a lot more interesting topics in the news today like Donald Trump's colorful language, a royal wedding, or unfortunately the terrible news coming out of the south following the deadly tornado outbreak. Yet here I am, talking about Mr. Bernanke and the Fed. This is a necessity not a choice. In the total absence of any sound fiscal policy developments in Washington, DC, the Fed is the only game in town, and I do believe that his policies are having an enormous impact on financial markets here and around the world.

The discussion now is how successfully the Fed will transition from an extremely accommodative monetary policy to a more normal one. The first step has already begun. Bernanke has announced the end of QE2 on June 30th. Although not entirely clear, the Fed will continue to take the proceeds from maturing bonds within its inventory and purchase new bonds for an undetermined period. This is accommodative, but not nearly as much as the policy of creating new money to put into the economy (QE2). If the Fed stops reinvesting entirely, then this will be the next logical step to pull money out of the economy gradually. Next, the Fed could go so far as sell bonds in its portfolio. Selling bonds has the effect of reducing the supply of money in circulation. Finally, the Fed can raise the federal funds rate which acts as a break on economic activity. Raising rates will also be a powerful signal to global investors and may draw money back into the US dollar for investment within higher yielding investments here. All of these steps will impact stocks, bonds, commodities, which is why I am spending my Saturday afternoon writing about it.

Is Mr. Bernanke right when he says that oil prices and other commodity prices are transitory or that the GDP's dip is also temporary? I have no idea. Quite frankly, I do not believe Mr. Bernanke knows either. No one person has the ability to look into the future and predict what will happen. What I do believe is that if Mr. Bernanke is wrong, it will be a costly error in terms of reducing the value of cash, CD's, and other fixed-coupon investments. If there is any lesson to take away from all of this is that we must be flexible and adaptive investors. What works today is probably not going to work tomorrow. We must also keep our eye on the markets and have at least a basic understanding of macro economics and how these factors will impact investments.

LOOKING AHEAD

I am intrigued by the old market adage, "Sell in May and go away." On the surface there is an enormous volume of research that supports this saying. The Stock Trader's Almanac has an interesting chart which shows that if you invested $10,000 in the market on November 1, 1960 and sold on April 30, 1961 and followed that pattern all the way through 2010 you would have earned $609,852. If you invested $10,000 using the opposite strategy, you would have lost $379. While I do not believe that every year will fit this profile, I do believe that we should be aware of this fact and act accordingly if indicators warrant.

My current investing guidance remains unchanged. I favor US stocks and commodities. International stocks also remain attractive, but country or sector selection must be carefully managed. After yet another week of uncertain performance by emerging markets, it is clear that the tug-of-war between developed and emerging markets is undecided and it is difficult to do anything other than invest in the most technically sound international investments.

I continue to favor equal weighted indexes over capitalization weighted ones. Mid and small cap growth have been the strongest categories in the stock markets and remain over weighted. I am aware of some improvement in the large capitalization space; however, good performance may be found in US corporations with strong earnings abroad.

I continue to favor Energy, Materials, and Health Care among the broad US sectors, but the narrow gap in performance after Energy and Health Care make most sectors attractive other than Financials.

Commodities and oil in particular, remain attractive in the face of the global uncertainties of supply and the weakening US dollar. Gold and silver remain as a hedge against the unknown both here and abroad.

Bonds remain steady and are providing bond-like returns. International bonds have benefited by the flow of capital in search of higher yields, while the more risky bonds have done well in the US. I continue to like preferreds, high yield, floating rates, and corporates. Treasury Inflation Protection Notes continue to offer protection against higher interest rates. Although long-duration bonds outperformed last week as interest rates pulled back, I consider these too risky to own in the face of an expectation of rising rates at some point in the future.

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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