Thursday, October 20, 2011

Amidst headlines proclaiming progress is being made in Europe's efforts to fix the Greece problem, US and global markets surged this past week. US retail sales figures released on Friday also gave investors hope that the likelihood of a double dip recession has receded for now.

The Dow Jones Industrial Average (DJIA) had its second best week of 2011 gaining 4.88% (541 points) last week while the S&P 500 gained 5.98% and the Russell 2000 rebounded with an 8.57% increase. While Thursday's initial jobless claims report remained above 400,000 giving little hope that the jobs picture would improve this year, retail sales grew by 1.1% in September marking the strongest gain in 7 months. For the year, the DJIA is now back in positive territory gaining 0.58% while the S&P 500 remains down 2.63% and the Russell 2000 is off 9.08%.

Like the markets, the major US economic sectors have failed to find any consistency. Early year leaders Energy, Information Technology, and Materials returned as the top performers for the week, while the current year's leaders Consumer Staples, Utilities, and Health Care were the bottom three performers this past week. All but the bottom three sectors outperformed the DJIA for the week and all eleven sectors were positive. For the year, Consumer Staples, Utilities, Health Care, Information Technology, and Consumer Discretionary are all positive and outperforming the DJIA. Financials, Materials, and Industrials remain firmly at the bottom.

The MSCI EAFE was positive for the third consecutive week gaining 4.49% and is now up 9.90% since the September 23rd close. Investors are clearly buoyed by developments in Europe and hope that political leaders are making progress in fixing the debt crisis. As I noted last week, I support efforts to improve European bank capitalization, but there is a long way to go before the all clear signal can be given.

Confidence in the Euro continues to gain momentum as the Euro rallied last week picking nearly 5 cents on the US dollar closing Friday at $1.387 marking its highest close against the US dollar since September 15th. The US dollar has weakened steadily against the Euro and other currencies since early this month as fears about a Lehman Brothers-esque style collapse in Europe subsides. This reversal of the US dollar has corresponded with an increasing trend in commodity prices and US Treasury yields.

Commodities in general have been in a positive trend after the Dow Jones UBS Commodity Index bottomed on October 4th rising 7.3% from that date with 4.5% of the increase coming this past week. The weakness in the US dollar has been a factor in rising commodity prices, but the corresponding expectations of improving global markets and thus increasing demand is behind the price moves. West Texas Intermediate (WTI) oil gained $3.44 (4.15%) this past week to close Friday at $86.42 per barrel. Gold gained $35.20 (2.15%) per ounce for a Friday close at $1671.00. Following the muddled trend found in the major US economic sectors area, there has been no sector other than oil, which has clearly separated itself as a leader among other commodity sectors recently. For the year, the Dow Jones UBS Commodity Index is down 8.73%. Gold and Precious Metals are the clear leaders so far in 2011 with Natural Gas and Base or Industrial Metals (i.e. Nickel, Copper, Lead) the laggards.

Bond markets pulled back for the third consecutive week as US Treasury interest rates continued to rise pushing down bond valuations. The 10-year interest rate increased from 2.08% a week earlier to close Friday at 2.25%. The 30-year rate also increased from 3.02% to 3.24%. High yield, Emerging market sovereign debt, and preferred bonds were the best performing sectors within the fixed-income asset category while extended maturity bonds (greater than 20 years) were the worst performers again. The Barclay's Aggregate US Bond Index closed down 0.19% last week but remains up 5.81% for the year. Investors are moving money away from the safe-haven of US Treasuries and into more risky bond sectors in search of better yields.

FAILURE IS NOT AN OPTION

A very guarded sense of optimism emerged from this past weekend's meeting of the G-20 Finance Ministers in Paris. The Germans and French stated that they were making progress towards their plan to deal with Greece and get the debt crisis under control. According to the Wall Street Journal, the plan has three legs: a new bailout for Greece, bank recapitalization, and an increase in the European Financial Stability Fund (EFSF). The Europeans will be meeting on October 23rd to finalize the details of the plan which is expected to be presented to the next meeting of the G-20 on November 3rd in Cannes, France. Markets have moved up sharply in response to this renewed optimism.

However, there are still many details to work out in the next week. The Financial Times reported late Friday that the representative of the largest private owners group of Greek debt, the Institute of International Finance (IIF), stated that his organization was unwilling to take a larger loss than the previously negotiated loss of 21% (German Chancellor Merkel is looking for a voluntary loss of between 50% and 60%). You may question why the IIF should have any say in how much of a loss they are willing to take, but the answer is simple and important: if the current private bond owners agree to a negotiated settlement, it would not constitute a technical default on the bonds. If a technical default were to occur it would trigger insurance policies, payouts, and a massive loss of confidence in European credit markets and immediately create problems for Spain and Italy. The markets would be dictating outcomes, not politicians and central bankers.

Another detail to be worked out is how banks are to be recapitalized. The Germans want each country to deal with their own banks. The French want to use ESFS funds because of concerns that increased French borrowing would jeopardize their highly coveted AAA debt rating.

I would fully expect negotiations to grow increasingly contentious as the pressure to meet very public deadlines approaches, and because this may very well be the last chance European leaders have to prove to the private markets that they can come up with comprehensive policies to deal with Greece. I would sum up the situation with a quote from one of my all-time favorite movies, Apollo 13, "Failure is NOT an option."

LOOKING AHEAD

The rally in markets here and abroad has caused several key indicators I follow to change to the positive. First, the New York Stock Exchange Bullish Percent (NYSEBP) reversed from a column of O's (selling in control) to a column of X's (buying in control), and the NYSEBP has increased from a low of 17.47% on October 4th to a close on Friday of 40.00% posting a weekly gain of nearly 17%. Second, the US stock and International stock asset categories now pass the Cash bogey check indicating that the relative strength of US and International stocks is improving. US stocks and International Stocks are still in third and last place among my five major asset classes, so I am not suggesting a full move back into either asset class, but I will be looking to selectively increase stock exposure this week primarily in US stocks.

Currencies and Commodities still remain as the top two major asset categories on a relative strength basis. The Chinese Yuan and Japanese Yen are favored in the Currency category while the agriculture and precious metals sectors are favored within the Commodity category.

In the US stock category, mid-capitalization growth stocks are favored. On a relative strength basis, Consumer Staples, Consumer Discretionary, and Utilities are the strongest sectors while Financials, Industrials, and Materials remain the weakest.

US bonds continue to come under pressure as interest rates continue rising from their historically low yields. The higher risk bonds (high yield, preferreds, and bank loans) have rallied along with the stock markets while longer maturity bonds have seen significant pullback. The International bond sector extended its rally last week on expectations that Europe is getting its act together on the Greece debt crisis. I do not recommend selling bond holdings and favor inflation protected bonds and international bonds at this time.

I continue to like gold. Investors see gold as an important hedge against paper currencies that may be exploited by central banks to help get their debt problems under control.

Among the key economic data being reported next week is the Industrial Production (Monday, the Producer Price Index (Tuesday), the Consumer Price Index and Housing Starts (Wednesday), and Jobless Claims and Existing Home Sales (Thursday). As has been the case over the past several months, investors are watching the data closely for signs of economic direction and strength.

Attention will continue to focus on Europe and the progress of political leaders to shape economic policy rather than losing control to the bond markets. Spanish and Italian bond yields will be an important indicator of investor views of the success or failure of politicians. Time is running out. The moment for action is now.

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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