Tuesday, November 29, 2011

Markets everywhere suffered from the unrelenting negative news coming from the Euro Zone last week. The key headline was the poor auction results of a German bond offering this past Thursday. According to the Wall Street Journal, only €3.644 billion ($4.82 billion) out of an offering of €6 billion ($7.94 billion) of new debt was purchased causing shock waves across global markets. Doubt is gathering like a storm on the horizon about whether or not global leaders can remain ahead of their debt problems before private bond investors simply stop absorbing the massive debt issuance from heavily indebted countries. The failure of the Super Committee here in the US did not add any confidence to investors.

Headlines in the financial media described the last full week of November trading as the worst Thanksgiving week for the Dow Jones Industrial Average (DJIA) and the S&P 500 since 1932 on a percentage basis. The DJIA lost 564 points (-4.78%), the S&P 500 lost 57 points (-4.69%) and the Russell 2000 gave back another 7.39%. For the month, the DJIA is now off 6.09%, the S&P 500 is off 7.55%, and the Russell 2000 has pulled back 10.10%. All major indexes are negative for 2011. The Russell 2000 leads all major indexes down 14.99%, followed by the S&P 500's loss of 7.87%, and the DJIA is now down 2.99% for the year.

Every major US economic sector was negative for the week. Consumer Discretionary, Health Care, Utilities, and Consumer Staples managed to outperform the DJIA while Energy, Materials and Financials were the bottom three performing sectors. The divergence between the best and worst performing sectors was slightly more than 4% marking a relatively tight spread. For 2011, Utilities, Consumer Discretionary, and Health Care remain positive while Financials, Materials, and Industrials are the worst performing.

European markets continue to be under significant pressure. For the week, international stocks, as measured by the MSCI EAFE index, lost 5.66%. For the month, the index is down 12.2%, and for the year, it has lost 20.33%. This index has about 72% exposure to European companies and 28% weighted to Asia, principally Japan. Emerging markets continue to suffer along with developed countries and have lost about 5% more on average than developed countries.

The Euro continued to falter losing nearly three cents to the US dollar closing last Friday at $1.324. The move away from the Euro and to the US dollar reveals the lack of confidence investors have in the Euro and is at its lowest point versus the US dollar since October 3, 2011. A close of $1.30 or lower will provide a sell signal for the Euro against the US dollar.

Commodity markets remain in a negative trend. In addition to a stronger dollar hurting commodity prices, the general global economic contraction is hurting all commodity prices. Making headlines on the second and third pages of many financial outlets is the growing fear of a general European recession. Austerity measures, and the likelihood of coming government spending cuts, is hurting economic outlooks throughout Europe and commodity demand is falling as a result. The Dow Jones UBS Commodity index, a broad basket indicator of commodity prices, fell 2.18% last week, is down 5.18% for the month, and for the year it is off 12.72%. Natural gas, livestock, and energy were the best performing commodity sectors while base metals, timber, and broad agriculture were the worst last week. For the year, gold and precious metals have significantly outperformed all other commodities with energy also doing well. Natural gas, base metals, and timber are the worst performing sectors for 2011.

European bond markets tell the story of the severe problems facing European countries. As of market close on Friday, the Italian 10-year bond surged to close at 7.26% up from the previous week's close of 6.64%. Spain's 10-year jumped about 0.32% and the French 10-year added about 0.22% to their rates. Most worrisome was the spike in the German 10-year rate, which went from 1.967% the previous Friday to close last week at 2.263% (0.296%), pushing the German rate above the US 10-year Treasury rate (1.964%). Coupled with the falling Euro, rising US dollar, and flip between the US 10-year rate to the German 10-year rate, the private bond markets are clearly telling political leadership in Europe that little time remains to effectively address their problems. Long duration and middle duration US Treasuries were the best performing bond sectors last week while high yield and preferreds were the worst.

THE EVOLUTION OF THE EUROPEAN DEBT CRISIS

The European debt crisis has been in the headlines for almost two years now. Markets have ebbed and flowed based upon investor perceptions about how effectively the Euro Zone's political class has been dealing with the issue.

In the beginning it was a concern that Greece would have some difficulty tapping into the private bond market to continue financing its debts. The European Union (EU) stepped forward to create a bailout facility to help Greece keep borrowing costs under control. Greece assured the EU that it would implement effective austerity measures to bring its spending down to a reasonable level. When it became apparent that Greece could not or would not meet spending cut targets, the EU (primarily Germany and France) stepped forward and called for limits to additional funding for Greece without definitive progress. In the meantime, Ireland and Portugal both fell under the bond market's glare and they too required funds from the EU bailout facility to keep from defaulting on its debt. At this point, investors quietly started voicing concerns about Italy and Spain. Over time, investors realized that Greece would eventually default on its debt. This prompted another round of intense negotiations and a voluntary haircut by Greek bond holders of up to 50%. The general perception during all of this was that the Germans and French would do everything in their power to keep the Euro a viable currency. Today, there are growing concerns that this might not be possible.

Headlines over this past weekend indicated that individual countries were now looking at the impact of the dissolution of the Euro. What a difference even a few months makes! Whether it is a few countries that leave the Euro and return to their former currencies or whether the entire Euro project is abandoned is uncertain at this time. The impact this would have on the markets is also uncertain and it is all this uncertainty that is hurting equity markets. There has never before been a time when countries surrendered their sovereign currencies for a common one so there is no blueprint about how to deal with a possible decoupling.

The Germans in particular are strongly suggesting that an enhanced federalist approach to EU fiscal policy is necessary. I agree. The problem is that the treaties forming the EU do not have a mechanism to do this. Nor does the European Central Bank have the authority to start buying sovereign debt on a wholesale level like our Federal Reserve did in 2008. There are calls for the International Monetary Fund (IMF) to step in and provide funds to the European Financial Stability Facility (EFSF) for the same purpose. This option has been suggested because the Chinese and others with currency reserves have been unwilling to step forward and provide additional funds. Ironically, if the IMF does this ECB end-around, the US and Chinese will be indirectly financing the EFSF-not something most Americans or Chinese would like to see.

There is no assurance that the EU's political leaders will stay ahead of the bond markets. However, I would not dismiss this possibility. They will do everything in their power to get this situation under control and if they do, expect the markets to rally after last week's sell-off. In the meantime, be prepared for more of everything for the foreseeable future.

LOOKING AHEAD

Besides the trouble in Europe, several geopolitical problems need watching. Over the weekend, the NATO bombing of several Pakistani outposts has seriously hurt US-Pakistani relations and further destabilized that part of the world. Additionally, there were reports over the weekend that an official of the Iranian government said it would attack US missile defenses in Turkey and Israeli nuclear facilities if Iran were attacked. Besides the global threat of violence that would come from any military action, the supply of oil could be severely restricted and prices could skyrocket-at least in the short term.

I will be watching the European debt crisis closely. It will be important to see how the bond markets (seen through bond rates) respond to the efforts of the EU leaders as they push for treaty adjustments and what the IMF does. I do not think anyone knows how this crisis will play out either the short-term or long-term.

The New York Stock Exchange Bullish Percent (NYSEBP) continued to retreat over the past week falling to a level of 43.85% with supply still in control. This reflects a drop in overall risk in the markets from several weeks ago. Remember the analogy I like to use to illustrate the NYSEBP is that of a tight ropewalker, as the NYSEBP falls, it is like the rope getting closer to the ground meaning that there is less risk to injury if the ropewalker falls off during his walk.

Among the major asset categories I follow, US stocks remains first. Commodities and Currencies are at a virtual tie at second and third, Bonds are fourth, Cash fifth, and International Stocks is last. US stocks now fail the cash bogey check, however, that is not surprising given the recent drop in stocks.

Within US equities, mid capitalization growth stocks are the strongest on a relative strength basis. Equal-weighted indexes are preferred over capitalization-weighted indexes. I believe that high quality; large capitalization dividend paying stocks present a compelling story and appear to be showing strength as a defensive investment. Within sectors, Utilities and Consumer Staples are showing the best relative strength. I anticipate that volatility will continue during these uncertain times.

I continue to like gold and commodities in general. Gold for uncertainty and commodities as an inflation hedge. On a relative strength basis, Agriculture and Broad Basket commodity categories are favored.

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

There are several important economic reports coming out this week. The most important is the Unemployment Situation report on Friday morning. The consensus is for the unemployment rate to remain steady at 9.0% with a slight uptick in new jobs. Other reports key reports include the Consumer Confidence index on Tuesday, and the Initial Jobless Claims and ISM Manufacturing Index on Thursday. As has been the case in prior weeks, investors are looking for signs of economic growth in the US.

It appears that volatility is here to stay for now. I understand how this stresses every investor. I remain committed to investing in securities with high technical attributes, keeping allocations between stocks, bonds, and other investments in a range that allows you to sleep at night, and remember that investing is not a moment-to-moment exercise. If you have any questions about the current environment or your portfolio, please call me.

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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