Thursday, September 29, 2011

Global markets tumbled this week on fears that the United States may be headed for its second recession in four years. Investors threw in the towel following remarks by Fed Chairman Bernanke announcing the specifics of "Operation Twist" and his comment that the US economy was "at serious risk."

For the week, the Dow Jones Industrial Average (DJIA) lost 732 points (-6.41%) closing at 10,771. The S&P 500 lost 80 points (-6.54%), and the Russell 2000 fell 62 points (-8.66%). For the month, the DJIA is now down 7.25%, the S&P 500 is off 6.77%, and the Russell 2000 is down 10.23%. All the major indexes are now solidly down for the year. The DJIA down 6.96%, the S&P 500 is down 9.64%, and the Russell 2000 is off 16.74%.

For yet another week, all 11 of the major economic sectors were negative. Materials, Energy, Financials, and Real Estate were the worst performers significantly underperforming the major US indexes. Utilities, Information Technology, Consumer Staples, and Health Care were the best performing sectors and handily outperformed the same US indexes. For the year, Financials have lost nearly 25% to lead all sectors on the downside; and the Energy sector has severely corrected to move into second worst spot on the list of worst performing sectors. Utilities, Consumer Staples, and Health Care are the year's best performing sectors and still positive.

Europe is a mess. It has been a mess and it will likely remain a mess. The MSCI EAFE index fell 7.33% last week and is now down nearly 20% for 2011. I addressed this subject in detail in my last Weekly Update and my view remains unchanged. Greece is going bankrupt, the European Union (EU) is being pulled down because of its currency and economic ties to Greece, and the EU is too bureaucratic to respond in a timely or effective manner. They may come up with another stop-gap measure to attempt to help, but it will end up not addressing the fundamental issue of member countries buried in insurmountable debt. Overlay all of this with a global economy that is sputtering and you get the type of week we just experienced.

The Euro continued to fall against the US dollar last week losing almost 3 cents (-2.10%) to close at $1.350. I would suggest that the Euro is being propped up by the European Central Bank's (ECB) insistence to hold interest rates at current levels. A drop in interest rates by the ECB would push the Euro down further and actually help European exports.

The price of precious metals tumbled this week with gold losing $154.00 (-8.49%) per ounce to close at $1660.70. Friday's drop of 5.8% was the worst one-day loss in 5 years. The consensus of gold analysts is that the sell-off of gold is being driven by profit taking, not because of a fundamental change in their opinions about gold or a decrease in global uncertainty. Oil followed the rout in commodities last week as the price of WTI Oil fell $7.97 (-9.06%) to close Friday at $79.99. The UBS Commodity index, a broad basket commodity index, fell 9.14% as commodity markets in general reflect growing fears of a second global recession and a subsequent drop in demand for raw materials. The best performing sectors within the commodity space were livestock and grains.

The US bond market, particularly long-term US Treasuries, did well last week as investors threw money at the seemingly last safe-haven for money. The yield on the 10-year Treasury dropped to a low of 1.70% on Friday morning before prices fell pushing the yield up to a close of 1.826% by the end of the day. The 30-year Treasury yield also fell to record lows on Friday morning reaching 2.77% before prices also fell to push the closing yield Friday up to 2.89%. The Federal Reserve's decision to initiate "Operation Twist" (purchasing longer-term Treasuries) was the catalyst to drive interest rates to historical lows, but did not deliver on investor's desire for a third round of quantitative easing. International bonds continued their sell-off over European debt worries and a rising dollar has added to the fall in internationals bond prices. For the year, long-term US Treasuries is the best performing bond sector while high yield, preferreds, and international emerging markets are the worst. The Barclays Aggregate U.S. Bond Index closed the week up 0.74% and is now up 7.55% for the year.

FEAR AND DOUBT ARE IN CONTROL

All eyes will be on the meeting this weekend in Washington of the International Monetary Federation. Expectations are that world leaders will take some type of unified action to stem the loss of confidence in global financial systems and inject liquidity to prevent a repeat of 2008.

The stakes could not be higher. All around the world economic data reflect slowing economies. Here in the United States, weekly first time joblessness data remains fixed above 400,000 and there is little hope that the overall unemployment rate will fall below 9%. The Euro Zone Gross Domestic Product contracted in the 2nd Quarter to 0.7% from a 1st Quarter gain of 3.0%, and in China the preliminary HSBC manufacturing purchasing managers index fell to 49.9 in September (any number below 50 shows contraction).

The question remains whether the key economic players can come to agreement and offer policy actions that will stem this loss of confidence. I remain skeptical. Here in the United States political rifts have never been higher. In Germany, Chancellor Merkel has suffered from an unbroken series of local political defeats, and the European Union is mired in a dysfunctional bureaucratic system that requires separate country votes and potential treaty modifications to act in concert.

Yet this is precisely the environment that demands strong leadership and effective policy actions. Time will tell if the current crop of international leaders can forge sound economic policies and restore investor confidence.

LOOKING AHEAD

As I have often said in previous Weekly Updates, stay focused on what the markets are doing-not on predicting what they will do and act accordingly. So what is going on?

Within the five major asset categories I follow-US stocks, International stocks, Commodities, Currencies, and Bonds, US stocks have actually moved into the number one position of the five and Commodities slipped to the second position on a relative strength basis. Currencies are in the third, Bonds are fourth, and International stocks a very distant fifth. If you throw a cash position into the mix, cash would be fifth and International stocks sixth. Put another way, as bad as the US markets have been, everything else has been worse.

The key indicator of market supply and demand, the New York Stock Exchange Bullish Percent (NYSEBP), has reversed to a column of O's indicating supply is in control and the current reading is a very weak 24.2%. The 2011 low of the NYSEBP occurred on August 8th at 21.4%, and the previous low before that was March 5, 2009, when the NYSEBP dipped to 13.6%. I want to make two key points: first, the NYSEBP has not exceed the previous low from August which remains a positive for now; second, a reversal back up into a column of X's would confirm that the markets are in a protracted bottoming process. Both would be positive signs and an indicator that the opportunity to make a major move back into the equity markets may come sooner rather than later.

For my newer readers, the NYSEBP is calculated by evaluating each stock on the New York Stock Exchange (NYSE) and determining if the stock is in a point and figure buy signal or a sell signal. The total number of buy signal stocks is divided by the total number of stocks on the NYSE to arrive at a percentage (the NYSEBP). Below 30% is considered to be oversold and a lower risk position while a reading over 70% is considered to be overbought and a higher risk position. I will be watching the NYSEBP very closely to see if it continues to fall or in fact establishes a higher bottom than the August low.

Although US stocks are the best performing major asset category, it still fails the cash bogey check meaning that on a relative strength basis, cash has outperformed in the short-term. Therefore, US stocks should remain underweighted. Within the US stock asset category, mid-capitalization growth stocks are currently favored. Among the eleven major sectors, Utilities, Consumer Staples, and Health Care are favored.

Within the other major asset categories, Commodities continues to fail the cash bogey check. Precious metals and agriculture remain the strongest sectors within the Commodity space. A further sell-off of precious metals will undoubtedly place this ranking at jeopardy.

Within the bond asset category, International Bonds and Inflation Protected Bonds continue to be favored.

There is a series of important economic data scheduled to be released this coming week. On Monday is the August New Homes Sales data. Tuesday will be September's Consumer Confidence Index. This will be particularly important because of this index's weighting towards expectations vs. backward looking data. Consensus calls for an increase from last month's reading of 44.5 to 46.5. Wednesday will be the August Durable Goods Orders. Consensus calls for a decrease from July's robust reading of 4.0% to 0.2%. Thursday will be the second revision of the 2nd Quarter US GDP data. Economists are expecting a slight revision upward of 0.2% to 1.2%. With nerves already frayed over last week's sell-off, investors are going to be hoping for any sort of good news. What all of this means is that if you are risk averse you should be favoring cash and bonds.

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.

Currencies and futures generallyare volatile and are not suitable for all investors. Investment in foreign exchange related products is subject to many factors that contribute to or increase volatility, such as national debt levels and trade deficits, changes in domestic and foreign interest rates, and investors' expectations concerning interest rates, currency exchange rates and global or regional political, economic or fi nancial events and situations.

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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