Wednesday, October 5, 2011

With the third quarter now in the books, investors are looking back over the carnage of the financial markets' performance and asking questions about what lays ahead.

The Dow Jones Industrial Average (DJIA) managed a 1.3% gain (142 points) for the last week of September, but this did little to offset the losses of the quarter. For the 3rd quarter the DJIA lost 12.1%, the S&P 500 lost 14.3%, and the Russell 2000 gave back 22.2%. Worry over the European Union's debt crisis has been the dominant concern for investors followed closely by a US economy that seems to be unable to get out of neutral. For the year, the DJIA is now down 5.7%, the S&P 500 has lost 10.0%, and the Russell 2000 is off 17.8%.

Among the major economic sectors, all eleven were down during the 3rd quarter. The top sector, Utilities, was down just under 1% and is still up over 6% for the year. Investors have turned to this traditionally defensive, and dividend paying sector more and more as interest rates paid by bonds has fallen to record lows. Consumer Staples and Health Care are the only other sectors that remain positive year-to-date. Financials, Materials, and Industrials are the worst performing sectors for both the 3rd quarter and for the year.

Europe rebounded a bit last week on the news that the German parliament had passed legislation authorizing the expansion of the European Financial Stability Facility (EFSF) from €250 billion ($335 billion) to €440 billion ($590 billion) and Germany's obligation from €123 billion to €211 billion. The successful vote was considered an important indication of the strength of Chancellor Merkel's coalition, but comes with a number of restraints designed to limit the Chancellor's discretion in further negotiations. For the week, the MSCI EAFE index gained 3.15% marking the second best weekly performance in 2011. However, this broad international index was down 19.6% for the 3rd quarter and is now down 17.2% for the year.

The Euro fell slightly against the US dollar last week losing 1 cent (-0.74%) to close at $1.340. Eurostat, the European Union's (EU) official statistical agency reported that inflation for the trailing 12-months surged to 3% in September. Given the European Central Bank's (ECB) mandate to keep inflation at 2% or less, the natural expectation would be for the ECB to raise interest rates (helping to strengthen the Euro), but currency investors believe the ECB will not do so for now because of the debt crisis and slowing markets. The Euro gave back 11 cents (-7.6%) to the US dollar during the 3rd quarter and is now up less than 1 cent for the year. The US dollar continues to gain in strength as international investors seek out the safety of US Treasuries (international investors must sell their foreign currencies to purchase US dollars to buy US Treasuries).

The pace of price decline in precious metals slowed dramatically this past week, but still fell nonetheless. Gold lost $38.40 (-2.3%) per ounce to close the week at $1622.30. Even with the turbulence of the past month (-11.3%) gold remains up 8.0% for the 3rd quarter and 14.3% for the year. There is no indication that gold has lost its importance as an uncertainty hedge, but profit taking and margin calls have contributed to the recent selloff. Oil's decline also slowed dramatically last week with the price of a barrel of West Texas Intermediate (WTI) losing $0.79 (-0.99%) to close at $79.20. For the past quarter, WTI fell 10.8% and is now down 13.8% for the year. The UBS Commodity index, a broad basket commodity index, fell 2.1% for the week under a growing consensus that the global economy is slowing to a crawl causing a reduction for the overall demand of commodities (a strengthening US dollar also hurts the price of commodities). Livestock and Sugar were the two best-performing commodity categories while Grains and Copper were the worst. For the quarter, the UBS Commodity Index was down 14.8%, and for the year, it is down 13.7%.

Bond markets were flat to down last week as US Treasuries pulled back slightly pushing up interest rates marginally. The 10-year US Treasury yield rose from the previous week's close of 1.826% to 1.912%. I believe that the markets are trying to digest the full impact of Operation Twist-the Federal Reserve's plan to sell short maturity US Treasuries (3 year maturities and less) to buy long maturity US Treasuries (6 years or longer maturities). Corporate High Yield bonds and International Emerging Market debt were the worst performing bond sectors last week while High Yield Municipals and Long Duration US Treasuries were the best. The Barclay's Aggregate U.S. Bond Index closed the week down -0.44% and is now up 7.08% for the year.

STAGNANT GROWTH WITH VOLATILITY

The common theme I continue to hear from top investment minds in the country like Bob Doll of BlackRock and PIMCO's Mohamed El-Arian, is the suggestion that most major economies will be mired in sluggish growth for the next few years. I believe these men are correct. Saying this does not make me feel good, but I was once told by an attorney, "you pay me to tell you what you need to know, not what you want to hear."

Therefore, this less than rosy reality is where we are.

I am not suggesting that the sky is falling and that there are not opportunities for investors, but I am suggesting that patience and discretion will be necessary for successful outcomes. Returns are likely to be hard earned and may come from places that have do not appear obvious now. This is why I find the research provided by Dorsey Wright & Associates so valuable, and which will continue to help guide my investment recommendations.

The recent volatility in the markets emphasizes my thesis. European markets had a strong week, but they did so within the context of the hope that European leaders were heading towards a successful solution to the problems of Greece and the associated risks to the banking system. But is the expansion of the bailout fund really a long-term solution? Or is it yet another short-term band-aid for the deeply rooted problems found in a government that has spent more than it could afford for years? We have seen markets rise on such hope before only to be disappointed a short time later as reality once again sets in.

So be patient and be smart about your investment decisions. There will be good opportunities in the future.

LOOKING AHEAD

There have been no changes in any of the major indicators I follow. The New York Stock Exchange Bullish Percent (NYSEBP) fell slightly to 23.98 with supply (selling) in control. August 8th marked the low point for the NYSEBP at 21.38, and I would like to see this important indicator remain above that August low.

US stocks and Commodities remain the top two rated major asset categories, however they fail the cash bogy check indicating that these investments should be underweighted. I have become concerned about the deteriorating trend in the Commodity category and will review these holdings very carefully. International stocks still rank last and significantly trail the other asset categories and should be significantly underweighted.

Within US equities, mid capitalization stocks are still the strongest on a relative strength basis. I believe that high quality; large capitalization dividend paying stocks present a compelling story and appear to be showing relative strength as a defensive investment. I believe some of this strength is a result of dividend yields on many of these stocks exceeding the current yields on the 10-year and 30-year US Treasury notes. However, until the relative strength of stocks in general improves, I would be cautious about adding significant positions to any stock or equity investment at this time.

I continue to like gold. The recent selloff has come more from investors seeking profits rather than a reduction in the uncertainty factor in markets. Clearly uncertainty remains firmly in place.

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

There are three significant US economic reports due out this week. On Monday, the ISM manufacturing survey will be released. Consensus is for a very slight drop to 50.5 from 50.6. Any number above 50 shows expansion while below 50 indicates contraction. Thursday will see the weekly release of the initial jobless claims data. Consensus is for an increase up to 410,000 in new unemployment applications. The September employment report will be released on Friday. Consensus is for a net increase of 65,000 jobs and a jump in the overall unemployment rate to 9.2% from the current 9.1%.

Patience is paramount for 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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