Tuesday, June 7, 2011

A slew of bad economic data pushed markets lower for the fifth consecutive week while US Treasuries rallied and the US dollar weakened on news that the Europeans were reaching an agreement regarding Greece.

For the week, the Dow Jones Industrial Average (DJIA) lost 290 points (-2.33%) to close at 12,151 and the S&P 500 lost 31 points (-2.32%) to close at 1300. The poor start in June follows a down month in May where the DJIA dropped 1.88% and the S&P 500 lost 1.35%. The Russell 2000 has been more volatile losing 3.36% last week and 1.96% in May. For the year the DJIA is up 4.96%, the S&P 500 is up 3.38%, and the Russell 2000 is up 3.12%.

All eleven broad economic sectors were down last week. The best performing sectors were Utilities, Health Care, Energy, and Real Estate which were down between 1% and 2% beating the broad equity indexes. The worst performing sectors were Consumer Discretionary, Materials, Industrials, Telecom, and Financials with all but Financials down more than 3%. Defensive sectors were favored over more cyclical sectors.

International markets outperformed US markets last week with the MSCI (EAFE) World Index losing 0.22% for the week. Strength was found primarily in Europe as it became more apparent that the European Union (EU), the European Central Bank (ECB) and the International Monetary Fund (IMF) were nearing agreement on further funding of Greece's debt. The Germans who initially resisted the EU and ECB's efforts to offer further assistance to the Greeks backed down and have essentially cleared the way for additional bailouts. With the private bond market demanding near 25% interest rates, it is not expected that the Greeks will be able to access the private bond markets for the next several years keeping the EU/ECB/IMF triumvirate on the hook to finance Greece's government. While the short-term reaction is a stronger Euro and equity markets, I do not see how this situation can continue indefinitely. The former Federal Reserve Chairman, Alan Greenspan, said it plainly Friday morning on CNBC's Squawk Box when he said countries like Greece will remain in the EU only as long as northern Europeans are willing subsidize southern Europeans. As soon as they stop, Greece will be forced to default on its debt. Mr. Greenspan went on to further say that he believed that the Euro was an "unworkable scheme." Time will certainly tell, but I tend to agree with him. The key question therefore is-when will the northern European countries stop supporting the southern European countries?

The Euro rebounded strongly last week as Greece's funding problems were apparently settled for now. Coupled with the bad economic data showing a clear slowdown in the United States and the expectation that the Federal Reserve will not raise interest rates anytime soon, the Euro added almost three and a half cents against the US dollar to close Friday at $1.463. After a very weak start in May, the Euro has now posted three consecutive weeks of advances against the US dollar with the largest gains coming this past week.

Gold posted a gain of $7.30 (0.48%) last week to close at $1543.60. The strength in gold reflects the continued uncertainty in the global economy and fears of currency weakness. Oil lost 0.18% but still closed over $100 per barrel at $100.57. The weakening US economy is putting downward pressure on oil demand and prices, but the US dollar weakness continues to help push commodity prices higher. Commodity prices overall posted a slight gain last week, with a broad basket commodity index gaining 0.32% led by gains in cotton, sugar, and coffee. For the year, cotton, silver, and coffee have all performed exceptionally well albeit with exceptional volatility.

The Barclays Aggregate Bond Index posted its seventh straight week of increases gaining 0.33% for the week. This broad-based US bond index is now up 3.44% for the year. The US 10-year Treasury yield continued to fall closing at 2.99% marking the first time the 10-year yield closed below 3% this year. To put it bluntly, the bond market is saying the economy is in terrible shape and that there is little optimism going forward. International bond investments were the best performing while high yield, preferreds and inflation protection notes were the worst. While bond returns have not been flashy, the gap between equity market returns and bond returns has been merging since the end of April.

THE STEW DOES NOT TASTE VERY GOOD

The amount of negative economic news has been building for some time but Friday's unemployment report showing private sector jobs increasing by only 54,000 and the overall unemployment rate increasing to 9.1% was the final ingredient in a stew of bad economic data. In addition to the poor unemployment report, manufacturing data, consumer sentiment data, and housing data were all very pessimistic this week. As I look at the economic landscape I see the persistent unemployment rate as problem number one. The economy cannot grow if Americans are not working. Additionally, the accommodative monetary policy the Federal Reserve has embraced, and is likely to embrace for a very long time, has weakened the US dollar and created non-core inflation for consumers to deal with every day in the grocery store and at the gas pump hurting other parts of the economy. And to cap all of this summer fun off, we have Congress and the President dithering in Washington over the debt ceiling. While two weeks ago I would have also added the European debt crisis to this unpalatable economic stew, the Europeans appear to have kicked that problem down the road for a few more months. So we will be eating our own home-style recipe of economic stew for now.

Given the overwhelming sentiment, it would be very easy to pick up your ball and go home. However, now is not the time to be emotional but rather focus on the facts to make intelligent investment decisions. So what am I seeing?

The New York Stock Exchange Bullish Percent (NYSEBP) and my primary gage of risk in the market has steadily decreased from a peak of 80.13% on January 18th to its current 2011 low of 61.57%. Additionally, the NYSEBP has given its first sell signal since May of 2010. For those of you not familiar with this indicator, this tells me what percentage of stocks in the New York Stock Exchange are on a point and figure buy signal. The higher the percentage the more stocks are actually participating in an up market. This gives me a good indication of how much strength is in the market and the counter-intuitive aspect that the higher the NYSEBP goes, the greater the risk in the market to an inevitable downturn.

The DJIA and S&P 500 are all in a column of O's meaning supply (selling pressure) is in control. Near-term support for the DJIA is 12,050 with long-term support at 11,800. For the S&P 500 it is right up against a near-term support level at 1300 with the next support found at 1240 and long-term support at 1130. Looking at most of the market-based securities that I invest in I see about half in a column of X's and half in a column of O's. I also see that most are moderately over-sold and all are well above their long-term support levels.

On a relative strength basis my key market indicators currently favor the equal-weighted S&P 500 index, mid caps, small caps, and commodities. The least favored are the US dollar, cash, short-term US treasuries, and treasury inflation protection notes.

So what I am seeing is the market in a moderate correction but nowhere near the magnitude of where we finished last May. Risk remains in place but not as much as earlier in the year, and stocks remain favored over bonds for now. While I may favor raising cash or keeping current cash levels in place depending on your portfolio, I am not suggesting now is the time to sell everything. I will remain focused on keeping the strongest technical positions in the portfolio.

LOOKING AHEAD

This is a tough time in the markets right now. The last up week in any of the major indexes was the last week in April. I am reviewing every portfolio constantly and evaluating allocations and positions carefully. I am growing weary of listening to reporters and economists use the word "unexpectedly" to describe yet another set of negative economic data. The economy is not healthy right now and I do not see any catalyst to really get things turned around. I do not believe the Federal Reserve will immediately launch into a QEIII program when it concludes its $600 billion bond buying program also known as QEII. I do believe that the Fed will take a very extended time before it begins to pull cash out of the economy and will remain accommodative for the foreseeable future. This means that interest US interest rates will remain low and commodities will remain more expensive. The challenge of predicting future commodity prices is the ongoing tug-of-war between weakening global demand and a weak US dollar.

There have been no changes to my recommendations. Stocks and Commodities are the two favored asset categories. International equities remain a close third. As this market pulls back it is imperative to monitor your investments closely for any breakdowns. Small and mid capitalization stocks remain favored over large cap even though small and mid caps have seen a greater sell-off recently. Yet these categories are still outperforming large caps over a 6 and 12 month period.

Commodities remain a favored asset category and have generally strengthened recently, however, keep in mind that this is a particularly volatile asset category. Gold has held up extremely well as an uncertainty hedge, and I still believe that an investment in a well diversified basket of commodities offers investors a hedge against inflation and a weakening US dollar.

Sectors bets have been a tough call to make this year. On a relative strength basis the top sectors are Consumer Discretionary, Real Estate, Telecom, and Health Care while Financials, Materials, and Utilities are at the bottom. On an absolute return basis, Health Care, Energy and Real Estate have been the top performers in 2011 with Financials, Materials, and Information Technology at the bottom. I maintain my recommendations based upon my relative strength work but as I have said in the past the only sector I absolutely do not advocate any exposure to is the financial sector. I do not like the banking sector in particular and I feel that there is far more downside than upside to this politically charged sector.

The likely extended weakness in the US dollar will benefit non-US denominated bonds so I continue to favor exposure to the international bond sector. Preferreds and high yield bonds have struggled recently, but I continue to favor exposure to these sectors. I continue to dislike US treasuries because of their low yields and high valuations and Treasury Inflation Protection Bonds (TIPs) because core inflation data is likely to remain low for an extended period of time and I believe these bonds do not provide true inflation protection right now because food and fuel are excluded from inflation calculations.

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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