Wednesday, June 22, 2011

US markets posted their first, albeit slightly, positive week in the past seven following the release of less bad economic news, an expectation that the Europeans will continue to bailout Greece, and a drop in most commodity prices.

For the week, the Dow Jones Industrial Average (DJIA) gained 52 points (0.44%) to close at 12,004 and the S&P 500 added a half point (0.04%) to close at 1272. The small capitalization stock index I follow, the Russell 2000, fell in between the DJIA and S&P 500 and gained just over 2 points (0.28%). For the month of June the DJIA is down 4.50%, the S&P 500 is down 5.48%, and the Russell 2000 is down 7.85%. Returns for the year remain positive for the DJIA (3.69%) and S&P 500 (1.10%), and slightly down for the Russell 2000 (-0.24%). The bellwether technical indicator I follow, the New York Stock Exchange Bullish Percent (NYSEBP), continued to fall and ended the week at a neutral 51.03. This suggests that there continues to be a breakdown of stocks even as the largest indexes held firm.

Seven of the eleven broad economic sectors exceeded the DJIA this past week. The best performing sector was Real Estate followed by Consumer Staples, Industrials, and Utilities. Materials, Energy, and Information Technology all posted negative returns and were the worst performing sectors. For the year, Health Care, Consumer Staples, Real Estate, Utilities, Energy, and Telecom are the top performing sectors and all are out performing the DJIA at this point. Financials, Materials, and Information Technology are the bottom three and all posting negative returns.

International markets continued to struggle under the concerns surrounding the European debt crisis. The MSCI EAFE (World) Index was down 0.97% for the week and is now down nearly 5% for the month. Sweden, Peru, China, Norway, and Canada have been the worst performing countries so far in June while only a handful of small and relatively insignificant markets such as Latvia and Lithuania have been at the top. No one region dominates economic returns as each has in their own way challenges to overcome. If Europe secures a solid agreement regarding Greece, this can be expected to help all markets for the short-term.

Of the all the commodities, precious metals have been holding up under the increasingly likely global economic slowdown. For the week, gold gained $6.80 (0.44%) and is now up $116.30 (8.19%) for the year. On the flip side, WTI Oil fell $6.38 (-6.38%) to close at $92.91 its lowest Friday close since February 18th. For the month oil has fallen just over $10 per barrel (-9.76%) and is now within $2 of the 2010 ending price. The Dow Jones UBS Commodity Index (DJUBS) fell nearly 4% under the weight of oil's pullback. For the year the DJUBS is off 2.09%. The strength in precious metals is a referendum on the levels of uncertainty particularly in the ability of governments to deal with their high levels of debt. The other commodities are more economically sensitive and so far in June we are seeing the onset of "demand destruction" which occurs when commodity prices reach such lofty levels that they reduce demand under the weight of those prices.

The Barclays Aggregate Bond Index posted its first down week after eight consecutive gains easing back just 0.10%. Bond investors pushed investments towards municipal and high quality bonds while emerging market, international inflation protection, and high yield bonds were the worst performers of the week. High yield's losses in particular have been severe enough to move it into the bottom sector of the bond universe for the year as international treasuries and inflation protection remain the top sectors and have exceeded the DJIA at this point.

CLANK, CLANK, CLUNK, DO YOU HEAR THE CAN GETTING KICKED DOWN THE ROAD?

As I have said before, I believe that European leadership will not allow Greece to go into any type of default and it appears that, for now, this objective will be accomplished. The stock market was up partially because this sentiment late in the week, but the details are still being worked out and now the focus is moving towards how this problem can be resolved in the long-term. Make no mistake about it, everything the European Union (EU), the European Central Bank (ECB), and the International Monetary Fund (IMF) have done and is doing is not fixing the real problem...the increasing likelihood that some EU member countries like Greece have more debt than they can ever afford to pay back. We have all watched how the citizenry in Greece has responded to efforts to launch true spending cuts causing the world to wonder how this problem will ever be solved. I do not know what the answer is, and frankly I do not believe the EU does either.

The best analysis of the Greek debt crisis I have read recently comes from a column on the editorial page of Friday's Wall Street Journal titled, "Europe's Greek Stress Test." The key points of the column's authors are: Greece will never be able to repay, European banks are now holding the bag by owning much of Greece's debt, the ECB is building its inventory of Greek bonds, and this is problem is not about Greece but rather Ireland, Portugal, Spain, and Italy. The authors conclude that European banks must increase their capital reserves. Eventually the private bond holders who the German's have been so intent on assuming some of the losses in Greek bonds will have completely exited Greece's bond market and only banks and taxpayers will be left to clean up the mess. Sound bleak; it is especially if you are a German taxpayer. This is why European leadership is trying to find a meaningful solution and attempting to increase the size of the bailout facility now.

I agree completely with the column's conclusion but also believe that it is imperative to raise bank reserves not only in European banks but here in the United States as well. Think of this as a rainy day fund that most of us use to pay for unexpected expenses. If you are comfortable with your potential expenses like a car repair or a tooth crown, you may not need to have a large reserve; however, if you think you may have some serious medical bills or legal bills ahead you would increase the size of your savings. This is precisely what banks need to do. Had Lehman Brothers had adequate reserves it would likely still be in business today. But the problem with reserves is that you cannot make money on them. The more a bank holds back and not lend out, the less money they make and that will not please shareholders. These types of structural issues found in the financial industry today illustrates why I absolutely do not recommend owning bank stocks at this time.

LOOKING AHEAD

It was nice to get a pause in the markets this past week, but I remain cautious following the less than exciting retail sales numbers and another first time unemployment report of 414,000 which continues to indicate unemployment is not improving. As bad as 414,000 was, the pundits saw the number as positive because consensus was expecting a bigger number. The problem is that as long as the number remains above 400,000 the overall unemployment numbers will not improve. Also in the news was the release of several manufacturing data points which showed a general slowdown underway. Market performance has been consistent with this evolving economic theme of high unemployment, moderate price increases, and slowing economic activity.

I mentioned at the top of the report that the NYSEBP has continued to fall. This is an important indicator that the broader market continues to lose ground and indicates that momentum remains negative. At 51, this index is in the "middle of the field" with half of the charts on a buy signal and half on a sell signal. Momentum is clearly moving in the wrong direction.

Commodities, except precious metals, have started to show weakness and I am re-evaluting these holdings. It is going to be difficult for many of the commodity categories to show strength when the underlying demand is decreasing. Additionally, any strength in the US dollar will also accentuate a pull back in prices.

Leadership within individual sectors is narrowing and three of the eleven broad sectors are now negative for 2011: Financials, Materials, and Information Technology. Health Care, Consumer Staples, Real Estate, Utilities, Energy, and Telecom all have outperformed the DJIA and other major indexes. I continue to emphasize the top four with regards to investment.

Bonds are holding their own in this declining equity, declining growth environment the markets have been in since the end of April. This is the kind of world in which bonds are favored by many investors. I believe that corporates and international bonds (excluding European sovereign debt) should be favored. I am steering clear of government bonds and high yield for now.

Now is not the time to be complacent. Pay attention to your portfolios and be patient. I believe there will be good buying opportunities in the future and I will be on the watch for a general shift in the markets signaling this opportunity.

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 Dow Jones UBS Commodities Index is composed of futures contracts on physical commodities. This index aims to provide a broadly diversified representation of commodity markets as an asset class. The index represents 19 commodities which are weighted to account for economic significance and market liquidity. This index cannot be traded directly. 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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