Wednesday, September 14, 2011

The growing crisis in Europe is shaking investor confidence around the world and helped push US markets to their fourth worst weekly performance in 2011. The US dollar is benefiting from a rush to safety and has just broken a two-year downward trend.

For the week, the Dow Jones Industrial Average (DJIA) lost 248 points (-2.21%) closing at 10,992. The S&P 500 lost 20 points (-1.68%), and the Russell 2000 gave back 9 points (-1.38%). September is proving to be another tough month for the major indexes as the DJIA is now off 5.35%, the S&P 500 is down 5.30%, and the Russell 2000 is off 7.27%. Thirty-five weeks into 2011, the DJIA is off 5.06%, the S&P 500 is off 8.22%, and the Russell 2000 is now down a sharp 14.00%.

No sectors managed a positive return this past week, but Information Technology, Real Estate, Consumer Staples, Health Care, and Utilities were the top five sectors while Telecom, Industrials, and Financials were the worst. For the year, Utilities, Health Care, and Consumer Staples remain in positive territory. Financials continues to be the worst performing sector in 2011 losing more than 20% followed by Industrials (-14%) and Materials (-11%).

The growing uncertainty in Europe caused a sharp sell-off among international stocks reflected by a 5.53% drop of the MSCI EAFE Index. The unexpected departure of German J├╝rgen Stark from the Executive Committee of the European Central Bank (ECB) Friday seemed to be an exclamation point on a very disconcerting week. Mr. Stark's departure apparently stemmed from his opposition to the ECB's increasing purchases of Spanish and Italian bonds.

The Euro fell sharply against the US dollar last week losing nearly 5 ½ cents (-3.80%) to close at $1.366. The loss is the largest weekly drop in 2011 and pushes the Euro down to levels not seen since February. The sell-off of the Euro is linked directly to the problems with Greece and on speculation that problems may spread throughout the rest of Europe.

The price of gold closed down $2.30 (-0.12%) per ounce at $1867.70 in extremely volatile trading. Market indicators suggest that gold investors are growing more pessimistic as the Federal Reserve continues to remain on the sidelines without any additional quantitative easing. WTI Oil gained $0.36 (0.42%) per barrel to close Friday at $87.01. Oil prices may come under pressure this week as economic fears in Europe translate to slacking demand and a strengthening US dollar.

Bond markets, especially US Treasuries, continued to rally on fears from Europe sending bond investors searching for safety. The 10-year yield briefly dropped below 1.9% before closing Friday at 1.918%. As a result, long-term government US Treasuries continue show strong gains and is the best performing bond sector. International bonds of all types suffered and were down last week. For the year, long-term US Treasuries is the best performing bond sector while high yield is the worst. The Barclays Aggregate U.S. Bond Index closed the week up 0.19% and is now up 7.36% for the year.


At some point, the political leadership in Europe is going to have to come to terms with the flaws of the European Union (EU) and with it, the Euro. The biggest problem the Europeans face is how to have a common currency without a common fiscal authority.

When the governments of the European Union first envisioned the Euro they expected member countries to adhere strictly to a number of important economic benchmarks concerning important areas such as inflation, debt, and long-term interest rates. With the strength of the large European economies like Germany and the Netherlands backing the currency and the expected adherence to the economic benchmarks, weaker governments like Greece were able to borrow money much more cheaply than had it been a stand-alone country. By the time the private sector woke up to Greece's uncontrolled borrowing and spending along with lax enforcement by the other EU members, circumstances rapidly spiraled out of control.

Underlying all of this is the financial exposure of banks, primarily in Europe but also around the world, to not only Greek debt but also to Italian debt, Spanish debt, and other weak EU members' debt. The Germans have been trying to push for discipline within member countries as a condition to further bailouts, but it appears that patience is running out. First, you have the Greeks who seem incapable of accepting their current situation. Tens of thousands took to the streets in Greece last week to protest austerity measures the socialist government is attempting to impose leaving the Germans and others to doubt Greece's ability to deliver on promises to reduce spending and debt. Second, German Chancellor Merkel's political party has been losing local election after local election as the German populace expresses its displeasure with Merkel's efforts to help the EU. At some point, these domestic political defeats will force the German leadership to rethink its strategy. This is why an article in discussing whether the German's were preparing to throw in the towel over Greece caught my attention. Without German support, the Euro is going to come under increasing pressure and the threat to European banks (exposure to default by Greece) and the international banking system is becoming direr.

This narrative is the underlying story behind the sharp drop in the Euro this past week. Investors are growing increasingly skeptical that the EU is going to find a solution to the Greek problem (and thus the fundamental flaw in the Euro system) and are therefore seeking a safe haven in the US dollar. As I noted at the start of this Update, the US dollar has just broken a two-year downward trend. The longer a trend has been in place, the more important a reversal of that trend may be.

A strengthening US dollar brings with it another set of complications, but one important consideration is the impact on commodity prices.

Historically when the US dollar gains in strength, commodity prices at home drop. The strength of commodities in portfolios has come on the heels of a long-term trend of a weakening US dollar. While commodities may begin to suffer, historically this scenario has contributed to a stronger stock market by reducing the price of oil and other raw materials into the price of goods benefiting consumers and manufacturers alike. Inflation worries also subside. How all of this plays out remains to be seen, but we must watch very closely.


Every time it looks like the markets are going to start recovering they pullback. It feels like being trapped under a waterfall. If I can offer a sense of conciliation, it is that the markets appear to be in a classic bottoming process. By that, I mean they go up, down, up again, down again, and each time they do, they seem to rebound at a slightly higher point than the time before. While we are not out of trouble by any stretch, by

watching the technicals closely, you can at least try to discern between all of the negative headlines and general pessimism, and what is actually going on in the markets.

There have been no changes to the relationships between the five major asset classes I follow and their ranking currently remains: Commodities, US Equities, Foreign Currencies, Bonds, and International Equities. Additionally, cash is still out-performing the top two asset classes on a relative strength basis so if you have a low risk tolerance or short time horizon, I suggest you consider underweighting your allocation to stocks.

Within the Commodities asset category, the precious metals and agricultural sectors are favored. Among US equities, equal-weighted indexes rank above capitalization-weighted indexes, and mid-capitalization stocks rank above small- and large-capitalization stocks. Consumer Staples, Real Estate, and Utilities are the strongest relative strength sectors.

Within the bond asset category, International Bonds and Inflation Protected Bonds are favored.

It will be another relatively quiet week concerning economic data. The Producer Price Index and Retail Sales will be released on Wednesday; and Jobless Claims, the Consumer Price Index, the Philadelphia Fed Survey, and Empire State Manufacturing Survey on Thursday. Another point of awareness is that this Friday marks a Triple Witching Week. Triple Witching occurs when stock options, futures and futures options all expire on the same day. Friday, September 17th, will be the third such "triple witching" of 2011; the preceding events coming in March, June, and December each year. Triple Witching Week historically sees increased volatility both up and down, so keep that in the back of your mind if markets jump around this week.

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.


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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