Monday, June 13, 2011

Markets continued to drop falling for the sixth straight week as investors worry over ongoing bad US economic news on the jobs and housing sectors, renewed worries over the European debt crisis, and signs of a slowdown in Asia especially China.

For the week, the Dow Jones Industrial Average (DJIA) lost 199 points (-1.64%) to close at 11,952 and the S&P 500 lost 29 points (-2.24%) to close at 1271. So far in the month of June the DJIA is down 4.92% and the S&P 500 is off 5.52%. The Russell 2000 continues to be more volatile losing 3.54% last week and is now down 8.11% for June. For the year the DJIA is up 3.23%, the S&P 500 is up 1.06%, and the Russell 2000 is now down 0.52%. While the sell-off which began the first week of May has been the longest since 2002, the losses are below last summer's declines. Over a nearly identical timeframe last year (April 26th to June 7th) the DJIA was down 13.2%compared to this year's decline of 7.5% from May 2nd through last Friday. The S&P 500 dropped 13.9% compared to this year's decline of 7.3%. Both indexes bottomed out on July 1, 2010, with total losses of 15.2% and 15.8% respectively. While the pundits are busy trying to determine where the bottom will be, I do recognize that the speed on this year's correction has accelerated in June and markets can go either way at this point.

All eleven broad economic sectors were down last week for the second week in a row. The best performing sectors were Utilities, Consumer Staples, and Health Care. All three of these sectors were down less than the DJIA and S&P 500. The worst performing sectors were Real Estate, Information Technology, and Consumer Discretionary. For the year, Health Care, Energy, and Consumer Staples are the best performing sectors while Financials, Information Technology, and Materials are the worst with all three now posting negative year-to-date returns through Friday.

International markets also faired poorly. The MSCI EAFE (World) Index was down 2.45% for the week, it has lost just over 4% for the month of June, and is now up just 0.28% for the year. For the month, Turkey, Mauritius, Pakistan, Columbia, and Russia are the top five performing countries up between 1.4% and 2.4%. Sweden, China, Cyprus, Norway, and Canada are the five bottom performing countries so far in June with loses ranging from between -6.1% to -7.6%. There has been no recent clear-cut region of the world which has consistently outperformed yet Europe still holds the bulk of leaders for the year. The United States is 58th out of the 64 countries I follow for June and is 28th out of 64 for 2011. The key issues facing international markets today are the European debt crisis, a China slowdown, and the impact of the large flow of US dollars into the emerging market countries.

Gold posted a loss of $14.40 (-0.93%) last week to close at $1528.70. The weakness in gold can be attributed to the gains posted by the US dollar and the perceived global economic slowdown taking pressure off of inflationary concerns. Oil was down as well losing $1.28 per barrel to close at $98.92. Oil had been holding above $100 per barrel as the world watched the OPEC ministers vote to hold production at current levels; however, the Saudis have made it clear that they are going to increase oil production by 1.5 million barrels. The Saudis have said publically that they would like oil to trade in a $70 to $80 range as they believe this optimizes their revenue while limiting moves into alternative energy sources. Overall, commodities posted a minimal drop of about -0.17% for the week.

The Barclays Aggregate Bond Index posted its eighth straight week of increases gaining 0.09% for the week. This broad-based US bond index is now up 3.53% for the year. The US 10-year Treasury yield continued to fall closing at 2.97% from the previous week's close of 2.99%. As I said last week, when rates fall this low, the bond market is signaling a very, very weak economic recovery. I believe the real question going forward will be how long the bond markets tolerate our outsized debt? This question is all the more important as the Federal Reserve has said that it does not intend to pursue bond purchases into a third round of Quantitative Easing (QEIII). Long-term bonds, both corporate and government were the best performing sectors for the week while high yield and international treasuries were the worst. For the year, international treasuries and extended duration bonds have been the best performing sectors while high yield and short-duration bonds have been the worst (excluding interest payments).

WHAT THE HECK IS GOING ON?

I am intrigued with the ebb and flow of good and bad economic news in the media. I have often commented to my clients that the media has a "bull rolodex" and a "bear rolodex" depending on the direction of futures early each morning as they book guests to speak on the meaning of that day's market movements. Lately, there have been very few bulls.

There are very legitimate concerns regarding both the US and global economies. Here in the US we are facing an extremely stubborn and high unemployment rate of 9.1%. Housing is in trouble and appears to be heading for a double dip. The Federal Reserve's accommodative monetary policy (QEII) has not stimulated housing or helped unemployment rates. The primarily beneficiary of QEII has been stock market and with that ending for now, it is anybody's guess what will happen when the Fed completes its $600 billion bond purchase program on June 30th. The Fed has been clear that it will not cut their easy monetary cold turkey, so they are expected ease their way into a less accommodative monetary policy over an extended timeframe by reinvesting its current bond holdings back into new bonds as they mature. Simultaneously Washington seems to be hopelessly deadlocked over the debt limit and deficit spending.

The Europeans are not in agreement on how best to deal effectively with Greece as Germany's concerns are now back on center stage. According to an excellent article Saturday in the Wall Street Journal, Germany's lower house of Parliament "approved a motion that private bondholders [should] bear partial responsibility for any further aid to Greece." This non-binding stance puts Germany's parliament directly at odds with the European Central Bank and to a lesser degree Germany's own center-right Chancellor. Recognizing the domestic challenges she faces, Angela Merkel still believes that a European debt crisis must be avoided or the German recovery could be at risk. I generally do not try to predict outcomes, but in this case I do believe that the Europeans will find a way to work this out because the consequences of failing to do so would be far worse.

China is further off the radar but also important. Among other issues, there have been reports recently that Chinese real estate is starting to drop in value placing strong GDP growth numbers at risk of slowing down. Sound familiar? The Chinese will find it challenging to manage growth in the face of an increasing number of non-performing loans.

All of these issues are weighing heavily on the minds of investors both bond and equity alike. This is not the time to become complacent and I will be reaching out to my clients this week to review portfolios.

LOOKING AHEAD

The last few weeks have been challenging. Corrections, and we are certainly in the midst of a correction, are always unpleasant experiences. Over the years I can recall economists talking about the frequency of 5% or 10% corrections in the markets and that they are normal and healthy. What I also recall is just how lousy we feel during such corrections. So for now, we are in a tough time. So let's be smart about our decisions not emotional.

From a technical perspective the markets have not changed materially. Most of my key market indicators remain oversold but still above their long-term support lines. US stocks and commodities remain the two strongest asset categories. US stocks are still favored over bonds and cash, and international stocks are still in a reasonable third place of my five major asset categories. Small and mid-capitalization stocks are favored over large caps. It is important to keep in mind that this strength is due to the outperformance over the past twelve months where small and mid-caps have significantly outperformed large caps. Recently, small caps have underperformed large caps and I am in favor of taking profits in these areas if the losses are too great for you.

Commodities have been the best performing category lately. Losing just 0.17% compared to 1.64% in the DJIA is just an example of this outperformance. However, headwinds are building for commodities. A stronger US dollar will curb growth of commodities values right off the top. More significantly, however, could be the impact of a slowing global economy especially in heavy commodity consuming China. Additionally, if growth continues to remain very subdued, inflationary pressures will lesson and I would expect to see commodities give back some of their gains. I will be watching the technicals very closely.

Sectors remain a tough call. In this current environment, defensive and non-cyclical sectors (Utilities, Health Care, and Consumer Staples) can be expected to outperform. I remain very bearish on the Financial sector. The mortgage and housing mess will continue to weigh on returns as will the debit card loss in the Senate. In case you were not following that particular vote, the Senate upheld an obscure clause in the Dodd-Frank bill this past week limiting the ability of banks to charge "swipe fees" on debit card purchases. This bill has just transferred $12 billion in revenue from the banks to the major retailers.

Bonds continue to perform well. I would not become complacent in your investments. Any number of macro economic factors could impact bond values. I continue to steer clear of long-term bonds, especially treasuries due to their high valuations. I do not like treasury inflation protection notes (TIPs) because I do not believe the government properly accounts for inflation. However, if you do not have access to floating-rate bonds (bank loans), then TIPs remain your only alternative to rising rates. I continue to prefer international bonds, preferreds, and corporates. If Congress and the White House do not fix the debt problems here, floating-rate bonds will be a good alternative.

This coming week will offer another round of important economic data and I would expect the markets to react strongly either way to that information. Retail sales will come out on Tuesday, the Consumer Price Index on Wednesday, and that all important weekly new jobless claims data on Thursday to mention some of the more important releases. Remain diligent and call me if you have any questions or concerns.

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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