Wednesday, February 29, 2012

A chapter has closed and another opened in the two-year saga of Greece's economic crisis as European leaders agreed to provide the second round of financing for the debt-ridden country. Markets responded favorably to the
news from Europe especially the Euro, which reached a 3- month high against the US dollar this past week. The trend of modestly favorable economic data continued here in the US despite the dark clouds forming on the horizon in the form of sharply higher oil prices.

The Dow Jones Industrial Average (DJIA), the S&P 500, and the NASDAQ indexes were all higher while the Russell 2000 closed down slightly for the week. The DJIA gained 0.26%, the S&P 500 gained 0.33%, the NASDAQ added 0.41%, and the Russell 2000 lost 0.21%. Eight trading weeks into the year the DJIA is up 6.26%, the S&P 500 is up 8.60%, the NASDAQ is up 13.77%, and the Russell 2000 is up 11.61%.

The Energy and Information Technology sectors were the stand out sectors last week while Real Estate, Financials, Consumer Discretionary, and Telecom were the worst performers. For the year, Information Technology, Materials, Financials, Industrials, and Energy have all posted double-digit gains while only Utilities remains in negative territory down just over 2%.

International stocks continued their strong performance this year on relative positive news from the European Union (EU). The European-heavy MSCI EAFE index was up 1.64% for the week and is now up 11.42% for the year leading all major international indexes. Emerging markets have continued to be best performing sector in the international category with the Asia/Pacific region leading all other regions for the year.

Commodities were the best performing asset category for the week on the strength of rising oil prices. The Dow Jones UBS Commodity Index (a broad-based commodity index) gained 2.46% last week, and is now up 6.16% for the year. WTI Oil surged $6.38 (6.18%) per barrel to close Friday at $109.62. Gold added $52 (3.01%) an ounce to close the week at $1777.90. Some analysts attribute the sharp rise in oil prices over the past two weeks to the mounting geopolitical tensions between Iran and the West, and that is certainly the case. However, the US dollar has been weakening as well and is playing a major role in the rise of oil and commodity prices. When the US dollar weakens, commodities become cheaper globally pushing up demand and prices. The weakest sectors within this major asset category have been mostly agricultural-related commodities such as cotton, livestock, and coffee.

The biggest story in the currency area has been the weakening of the US dollar over the past couple of weeks. The Euro gained $0.03 (2.36%) to close Friday at $1.345 marking the largest one-week gain in 2012 and pushing the Euro to a nearly three-month high. Investors are feeling more comfortable returning to Europe as fears of a Greece-induced EU meltdown subside. Adding further pressure to the US dollar is the Federal Reserve's continuing weak US dollar policy in holding interest rates to near zero. I believe that the US dollar will not strengthen as long as the Federal Reserve continues to suppress interest rates. The one exception would be if Iran and anyone starts shooting at each other. In this scenario I would anticipate a flight to safety directly to the US dollar.

US bonds rallied last week as interest rates all fell. The US 10-year Treasury moved back below 2% to close Friday at 1.977%, and the US 30-year Treasury fell slightly more but remained just above 3% to close at 3.099%. The key European 10-year sovereign interest rates all fell sharply in response to the news that the EU was moving forward on its €130 billion ($175 billion) bailout for Greece. International bonds, long-duration US Treasuries, and high yield have been the best performing bond sectors for the week while municipal bonds of all types were the worst performing. For the year, preferreds, international, and high yield are the best performing sectors while long-duration US Treasuries and corporates have been the worst. Overall performance of the bond category has been the weakest of the five major asset categories (US stocks, International stocks, Bonds, Commodities, and Currencies) I follow with the Barclays Aggregate US Bond Index up just 0.73% for the year.


As expected, the Europeans have managed to come to an agreement that will

allow the second bailout of Greece to occur. There is still the matter of private debt holders exchanging their bonds for a 53.5% haircut and lower interest rates that must still happen to complete the entire deal. The window for the debt exchange opened last Friday and will continue for the next several weeks. The deals may be done, but challenges remain which helps explain why the markets did okay rather than terrific last week.

As most of you know, I frequently cite the on-line English version of Der Spiegel, one of Germany's leading publications, as a source of in-depth coverage of this crisis. I particularly like the German perspective this publication brings. Der Spiegel did not disappoint when this past weekend I came across an interview with esteemed Harvard economist, Dr. Kenneth Rogoff, discussing his views of where Greece and the EU stand today. Let me summarize his key comments:

• It is going to be difficult to keep Greece in the EU due to its mountain of debt and uncompetitive economy. • Greece's economy may have not reached bottom yet, and for Greece to be competitive, the country must cut wages in half. • Greece should be given a sabbatical or holiday from the Euro while remaining a full member of the EU. • Additional countries will also likely need to leave the Euro currency for now. Dr. Rogoff did not specify which countries, but he did suggest it would be the periphery countries, in my opinion, implying Portugal, Spain, and Italy. • The Euro Zone must turn into a single political entity. A "United States of Europe" with a single Finance Minister, control of banking regulations, and with sole spending and taxing authority.

Agree or disagree with Dr. Rogoff's beliefs it does give some insight into the challenges the EU will have going forward. I personally believe that he is right; however, the political will to make this happen is simply not there. This will lead to more last minute negotiations and bailouts coupled with uncertainty-induced stress on the markets in the EU during the coming months and years.

Over the next few weeks and months we will see the major international groups like the G-20 (twenty largest developed and emerging market economic leaders), the International Monetary Fund (IMF), and the EU itself debate the funding and size of the European bailout fund. The G-20 and the IMF have told the EU that they must increase the size of the bailout fund and provide a greater percentage of the funding compared to the past two years. No decisions will be made over the next month or two, but the G-20 and IMF have made it very clear that the EU must take the lead on this issue.

On another important topic, the tensions with Iran, I have had little to say. It is simply too difficult and irresponsible to speculate on what is going to happen in that region of the world. It is my opinion, however, that if Israel or the US made a military strike against the Iranian nuclear complex, there would an immediate market sell-off, a surge in oil prices, and bond rates would fall further. How long this situation would last is completely unknown. If the Iranian nuclear program is severely disrupted or destroyed and the Iranian military kept in check, then I suspect that the world would cheer and markets would then rebound sharply. If, however, Iran's nuclear capability remained or the Iranians were able to launch effective counter-strikes, then the markets would remain under pressure. Only time will tell how this will play out.

Oil prices will continue to remain under pressure for the time being because of tensions with Iran and the weak US dollar. The important question is when we will begin to see the impact of high oil prices on the overall economy. For every dollar Americans spend on gasoline, that dollar is not available to spend in the rest of the economy. I believe that we will begin to see more and more stories on this topic, and of course there will be the government statistics to help analyze what is happening in the economy.


The statistics I follow from Dorsey Wright & Associates (DWA) show the markets to be overbought but not terribly so in most cases. Emerging Market debt is currently the most overbought sector followed by high yield corporate bonds, asset allocation investments, and emerging markets. This does not mean that these sectors will correct today or tomorrow but it does suggest caution and awareness.

Additionally, those of you who have read my updates over the past couple of years know that I follow the bullish percent indicator. The bullish percent is a tally by DWA of any major index (I most closely follow the New York Stock Exchange Bullish Percent--NYSEBP) that shows the percentage of stocks that is exhibiting a "buy" signal on its point and figure chart. I do not expect everyone to go and read Tom Dorsey's book on all of this, so I will tell you that whenever a bullish percent generally gets above 70%, there is greater risk in the market. Think of it as a tight wire walker working five feet off the ground compared to 50 feet off the ground. Obviously the higher you are the greater the risk and this is what the bullish percent tells me. Today the reading for the NYSEBP is nearly 77%. This high level coupled with the overbought status, to me, of the markets means that there is simply more risk in the markets today than at the start of the year and investors should be very selective on the investments they make at this point. If you have specific questions about a particular sector or asset category's status, please give me a call.

Notably this past week, the major Asset Category-Commodities, moved back into second place behind US stocks on a relative strength basis. The previous number two, Currencies, has fallen to fourth place just behind Bonds. The International asset category remains in fifth place, but has shown the most improvement on a score basis so far in 2012. It still has a ways to go before it overtakes Currencies in the number four position. Among US stocks, mid-capitalization growth stocks remain favored from a relative strength standpoint along with equal-weighted indexes. All major economic sectors are favored with Information Technology and Real Estate posting the strongest technical scores while Consumer Discretionary and Information Technology are the strongest on a relative strength basis.

As noted, the emerging market sector has continued to perform well with emphasis on the Asia/Pacific region. Thailand and Malaysia are particularly strong countries from that region of the world. South Africa is also performing well at this time. The volatility within the emerging market space makes investing in these regions riskier than most and should only be considered by more risk-tolerant investors.

The two-week surge in oil prices has pushed commodities back into a strong position. I favor precious metals and energy within the commodity asset category. My long-term bias remains towards carbon fuels.

The bond market remains attractive and I am not changing any of my opinions for this asset category. I continue to like international bonds, inflation-protection bonds, and a mix of high-yield and high-quality bonds. I am also watching senior bank loan bonds and am considering these as part of my bond portfolio. I do believe that for most bond investors income is the number one issue and this continues to be harder and harder to achieve as interest rates remain low. Bond investing has become much more difficult in recent years and I suggest investors pay particular attention to this part of their portfolios.

The second revision of the 4th Quarter 2011 GDP report will be released on Wednesday morning and is probably the most significant report coming out next week. Consensus calls for the GDP rate to remain unchanged at 2.8%. The weekly Initial Jobless Claims report will come out on Thursday as always. This report has been trending favorably in 2012 and is expected to show an improving employment picture in the US. The ISM Manufacturing Index will also come out Thursday morning and is expected to show a slight improvement.

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 financial events and situations.

Investments in commodities may have greater volatility than investments in traditional securities, particularly if the instruments involve leverage. The value of commodity-linked derivative instruments may be affected by changes in overall market movements, commodity index volatility, changes in interest rates, or factors affecting a particular industry or commodity, including international economic, political and regulatory developments.

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.

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.


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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