Tuesday, August 16, 2011

Markets were subjected to historic volatility this past week as investors reacted to every piece of news crossing the wire.

Following the historic downgrading of the US credit rating by Standard & Poor's, the Dow Jones Industrial Average (DJIA) experienced a first-ever four consecutive days of 400+ point moves leaving the DJIA down 1.53% for the week closing Friday at 11,269.02. The S&P 500 lost 21 points (-1.72%) to finish at 1178.81, and the Russell 2000 gave back another 17 points (-2.40%) closing at 697.50. For the first two weeks of August the DJIA is down 7.20%, the S&P 500 is down 8.78%, and the Russell 2000 is down 12.49%. This same order holds for the year as the DJIA is off 2.66%, the S&P 500 is down 6.27%, and the Russell 2000 is down 10.99%.

Real Estate and Materials were both positive last week while Utilities, Health Care, and Information Technology were down less than 1% and easily outperformed the major indexes. The Financials sector was clearly the worst performing sector losing over 4%. For the year, Consumer Staples, Utilities, Health Care, Real Estate, and Energy have all outperformed the DJIA, with the top three sectors holding onto positive returns for the year. With last week's performance, Financials are now down over 18% for the year and this sector has distanced itself from the next two worst performers (Industrials and Materials) by nearly 8% and 10% respectively.

The MSCI EAFE Index fell a modest 0.97% last week buoyed slightly by news that the European Central Bank (ECB) began purchasing Spanish and Italian bonds to help stabilize European bond markets. This move is akin to the US Federal Reserve buying Treasuries and helped strengthen European bonds. US investors would recognize this effort by the ECB as a variation of our own Quantitative Easing (QE). This move has drawn sharp criticism by many in Europe who see the ECB's role strictly as an inflation fighter. It also underscores how serious the problems within the European credit markets are. Compounding this worry is the general slowdown of European economies which has mirrored our slowdown here.

The Euro has continued moving incrementally up and down against the US dollar. Last week it fell just four-tenths of a cent to close at $1.424. With both the US and Europe sharing its own sets of concerns, investors are not voting one way or the other in favor of either currency.

Gold surged to a record high mid-day on Thursday (August 11th) when the price of gold briefly exceeded $1817 per ounce before pulling back to close on Friday at $1742.60 up $90.80 (5.5%) for the week. Gold is now up $322.90 (22.74%) for the year and is clearly outperforming all other assets so far in 2011. This surge in gold prices clearly signals that investors are looking for safety in an increasingly uncertain world as politicians struggle to counter the growing lack of confidence of leadership the world over (I will discuss this issue further in the next section). Oil prices continued to fall as investors worried about weakening global economies resulting in a drop of $1.50 (-1.73%) per barrel of West Texas Intermediate. WTI Oil closed Friday at $85.38 per barrel.

The Dow Jones UBS Commodity Index, which measures a broad basket of commodities, gained 0.56% last week on the back of surging gold prices. The index is now down 3.55% for the month and is down 3.30% for the year. Grains were given a boost on Friday when the US Agriculture Department cut forecasts for corn production by 4% due to the pervasive heat wave in the Midwest. Volatility is a common aspect of commodity investing and recent gyrations are more typical than not.

Bond markets generally posted gains again last week as US interest rates continued to fall. The 10-year US Treasury rate fell to 2.249% from the previous week's close of 2.798%. For the second week in a row, US Treasuries, including Treasury Inflation Protection Notes (TIPs), extended gains and was the best performing sector in the bond market. High yield bonds continued to sell-off and is now the worst performing sector in the bond market. As investors grow concerned about the economy they tend to withdraw investments in less creditworthy companies pushing down prices and increasing yields which help explains the poor performance of high yield bonds.


While most of you probably do not recall the 1961 musical from which this section takes its title, I would guess that after the past three weeks in the markets you have probably had thoughts along this line.

It is easy to be caught up in the moment because recently the moments have been more dramatic than any time since the market crash of 2008, but I want to step back and look at the bigger picture and try to assess why the markets have entered into this period of hyper-volatility.

There are many, many different factors that enter into the investment equation today: European banking problems, Greece, slowing Gross Domestic Product (GDP) growth here and abroad, political gridlock in Washington, debt ceiling debates, the housing crisis, unemployment, and on and on. I believe that many of these issues are really a byproduct of what lies at the heart of the matter and that is the US and global economies have reached their borrowing limits and they are beginning to deleverage. Deleverage is just a fancy way of saying we have too much debt and we have to start paying that debt down. Think about what happens in your household when it is time to pay off some bills. You stop or reduce your discretionary spending so you can free up cash to tackle the bills. When this scenario is repeated in other households around the country, you get economic slowdown. Besides households, governments have also reached the breaking point of too much debt and you are seeing austerity measures being implemented by many governments, especially in Europe, causing growth rates to slow dramatically.

The trouble is that even though you are doing the right thing economically and for the long-term, you are creating problems today. These are the problems that make the headlines today like high unemployment, slowing GDPs, and an unresponsive housing market. Now this is where it gets dicey. We expect our political leaders to help get us through this cycle of deleveraging with the least amount of pain possible. But are they up to the task? Do we have the confidence that these politicians and government officials, both here and abroad, will be able to create sound monetary and fiscal policies that work, which are coordinated with the rest of the major global economies, and prevent a second economic crisis from returning with potentially greater economic harm? Answering this question correctly will direct your investment decisions for now and into the months ahead.


I continue to stress the importance of paying attention to two key indicators: the yield on the 10-year US Treasury note and the price of gold to help look for answers. The 10-year yield tells you the general consensus that investors have on the strength of the US economy, while the price of gold indicates investor confidence in our political leaders to solve and evolve a restructured economic future. Right now the votes are negative in both cases.

Buyers did re-enter the markets on Thursday and Friday offering some hope that investors still have confidence in selected areas within markets, and I am certainly looking for bargains as well. But I believe you must be focused on what you are buying and recognize that risk in the market remains. Because of that risk, I will repeat last week's observation that if you are not comfortable with the volatility and uncertainty in the market, you can increase your allocation to cash and be patient. The worst aspect of holding cash in the near-term is that you may miss some of the upside if the market does rebound; but if the markets resume their downward fall, you will preserve your assets.

Among the five major asset classes I follow: US Equities, International Equities, Bonds, Foreign Currencies, and Commodities; International Equities has fallen from third to fifth place reinforcing my opinion that International Equities should be avoided or trimmed from portfolios. The rise in Foreign Currencies to third place is a noteworthy trend since this asset category has been in the fifth and last position for several years. I will be carefully evaluating this category and may offer some investment ideas next week if I find some compelling opportunities. While Commodities and US Equities still hold the first and second positions, they fail what I call the cash bogey check. When an investment fails the cash bogey check it means that cash has a stronger relative strength ranking than the asset category sending me a clear signal to increase cash in my portfolios.

With the recent market sensitivity to news stories, there are a couple of key things to watch for in the coming week:

French President Sarkozy will meet with German Chancellor Merkel in Paris on Tuesday to discuss the deepening concern that debt problems may be spreading to Italy. As the leader of the Euro Zones strongest economy, Merkel is under tremendous pressure to work out a solution without committing German taxpayers to subsidizing all of southern Europe's free-spending governments. Compounding the challenges, France's economic growth was 0% in the second quarter and industrial output is falling across Europe.

On Tuesday morning, Housing Starts and Industrial Production data will be released followed by Thursday morning's releases which will include weekly first time Jobless Claims, the Consumer Price Index, and Existing Home Sales. All eyes will be focused on indications of economic growth or further slowdowns.

The tug of war between bulls and bears will likely continue this week but it is hard to imagine that the extreme swings we observed in the market last week will be repeated. Please reach out to me if you have any questions or comments about your portfolios or the markets in general.

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.


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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