Wednesday, March 14, 2012

The past week saw modest losses in US and International stocks, bonds, and commodities. The news from Greece continues to be the focus of nearly all investors, and while it appears that the Greece deal is finally done, the price paid by Greeks to secure the bailout funds may prove costly in the future. Other headlines during the past week included another positive jobs report here at home, China announcing that it had the largest monthly trade deficit since 2000, and that the US trade deficit reached its highest level in over three years with exports to China and Europe falling significantly.

For the week, the Dow Jones Industrial Average (DJIA) fell 55 points (-0.43%), the S&P 500 gave back just over a point (-0.09%), and the tech-heavy NASDAQ fell 12 points (-0.41). As has been the case recently the Russell 2000 index fell significantly more than the other major US indexes losing 1.82% for the week. The losses in the Russell 2000 were, however, about half of last week's losses. After ten weeks of trading in 2012 the DJIA is up 5.77%, the S&P 500 is up 09.01%, the Russell 2000 is up 10.27%, and the NASDAQ is up 14.71%.

Economic sector performance was led by the Telecom sector with a gain of just under 1.5% followed by the Consumer Discretionary and Utility

sectors. Only the Materials and Energy sectors failed to outperform the DJIA for the week. For the year Information Technology, Consumer Discretionary, Financials, Materials, and Industrials have all posted double-digit gains exceeding the DJIA handily. The Utilities sector remains the only negatively performing sector for the year down just over 2%.

International stock indexes, like US indexes, posted negative returns for the week with the European-heavy MSCI EAFE index losing another 1.11% following last week's loss of 0.78%. I believe that European investors are not convinced that Greece or the EU is out of harm's way with the successful (from Greece's and the EU's perspective) bond swap with private bondholders. Investors are also looking at shrinking European economies. In a story reported by the Wall Street Journal late last week, the European Central Bank (ECB) announced it was reducing the 2012 growth target for the EU from an already anemic 0.3% growth forecast to a "slight contraction." Even with this downward revision, the ECB held interest rates steady at 1% last week and did not suggest that it was likely to lower rates anytime soon. Within international sectors, the Americas Region was the best performer losing just under 0.1% for the week, and remains the best performing region in March. The emerging markets sector lost nearly 2% but remains the strongest sector for the year gaining over 16%. The MSCI EAFE index is up 9.32% for the year.

The Dow Jones UBS Commodity index fell for the second consecutive week losing 1.55% notching the worst one-week performance for this broad basket index in 2012. Gold (+0.10%), WTI oil (+0.66%), and Brent oil (1.88%) were notable exceptions. Gold has gained 9.24% for the year and some investors consider it a possible hedge against currency depreciation. Gold traders tend to focus on global economic strength and central bank actions/reactions to that economic strength or weakness. I believe gold traders would, for example, respond very favorably if the US Federal Reserve announced another round of quantitative easing (QE III) to boost the US economy. This action could push more US dollars into circulation, holding interest rates down, weaken the US dollar, and increase the specter of future inflation-possibly the ideal soup for higher gold prices. Oil traders have recently been using the jobs report as a barometer of the strength of the US economy. As the jobs situation in the US has improved oil prices have risen with the expectations of higher demand. The ever-present tension between the West and Iran has also added upward pressure on oil prices. Natural gas was again the best performing commodity sector and remains extraordinarily volatile. Coffee, sugar, and aluminum were among the worst performing commodity sectors. Coffee prices have dropped nearly 20% this year; I hope to see that savings passed on to those of us who love our java in the morning.

The US dollar continued to strengthen against most major currencies last week. The Euro fell another 0.5% to close Friday at $1.312 as the Greece debt crisis moves to the next chapter. The US Dollar Index reported by the Wall Street Journal and represents a collection of foreign currencies has risen (representing strength for the US dollar) for the month and has shown a positive trend for the US dollar in the past several weeks making up for a poor start early in the year. Ramifications of this trend are important especially in commodity prices and international trade.

There has been minimal movement in the bond market this year and the past week was no exception. The Barclays Aggregate US Bond index fell 0.24% last week and is up just 0.70% for the year. The US Treasury 10-year yield moved back above 2% last week to close Friday at 2.030%. The US Treasury 30-year yield also increased to close at 3.179%. The increasing number of media reports on improving economic conditions in the US and Federal Reserve Chairman Bernanke's broad guidance that he did not expect to need another around of quantitative easing helped reduce the demand for bonds pushing interest rates slightly higher. Interest rate changes in Europe were mixed last week. France and Spain saw rates increase while Germany and Italy saw small declines. Spain's increase follows an announcement earlier by the prime minister that he would not hold Spanish debt to recently agreed to levels. For the week, there were modest gains in high yield municipals, low/short duration bonds, emerging market debt, and Treasury Inflation Protection Notes (TIPs) while extended duration Treasuries and intermediate municipals were the worst performing bond sectors. For the year, preferreds, international TIPs, and high yield have been the best performing sectors while extended duration Treasuries and corporates have been the worst.

IS EUROPE OUT OF TROUBLE?

A great sigh of relief will take place among the political class in Europe early Monday morning after the private debt exchange appears to have been successfully completed opening the door to the next full round of lending to Greece. The immediate crisis has been resolved, so no disorderly restructuring of Greek debt, and it appears that time has been bought for further efforts to deal with Portugal, Italy, Spain, and who knows who else. But, is Europe, and the EU really out of trouble?

I believe the answer is yes in the short-term and no in the longer-term.

For now, there is not the immediate threat of a meltdown in Europe because of an out-of-control market reaction to the Greek default. The ECB has played a critical role in calming markets down with their Long Term Refinancing Option (LTRO) which has injected critical liquidity into the

markets and pushed down dangerously high interest rates in Spain and Italy, and the EU's politicians have made some efforts towards a unified fiscal union by agreeing to modifications to existing treaty obligations. However, there remains great doubt about the future.

I have said repeatedly in my Updates that the real problem with Europe is that governmental and private sectors are simply too indebted with too little growth to deal with the problem without entire populations feeling the pain of adjusting to the new fiscal realities. Greece's economy shrank 7.5% in the 4th Quarter of 2011 and with the extreme austerity measures required to receive the second bailout, growth is highly unlikely to return for the foreseeable future. Adding to the underlying stress is an unemployment rate of 21% and climbing. I would not be surprised to see social unrest return to the streets. Spain is also confronting austerity issues and unemployment around 20%. The prime minister has openly defied an agreement he just signed with other EU leaders to hold down debt and declared that the decision to exceed the agreement with the EU was a sovereign choice. So much for fiscal unity and subordination of national budgets to the EU so desired by Germany. So I remain very skeptical that the EU will get through this fundamental economic adjustment over the next decade or so without some painful spells along the way.

The consequences to the outcomes in Greece, Spain, and Portugal are important to all of us. Not just in terms of how much we export to Europe, but in watching and learning how the EU handles their debt and spending challenges. Although our situation here in the US different (we have a printing press and the US dollar is still the global reserve currency), the future of domestic growth, unemployment rates, funding of future government obligations are all at stake.

LOOKING AHEAD

Greece is off the table for now so more attention will be directed towards the slowdown in China, rising oil prices, US domestic economic growth, and the tensions in the Middle East. Attention will also be directed now at Portugal, Italy, and Spain as investors decide what will happen there. As I noted last week, there has been a bit of a pause in the markets for now. After seeing strong monthly gains in January and February, March has been flat. This is not necessarily a bad thing because markets historically do not go straight up, so pauses are to be expected. Additionally, the technical indicators that I follow are still positive, strongly so in some cases. Yet momentum has clearly slowed.

US stocks remain the strongest of the five major asset classes I follow on a relative strength basis. This has been the case since early January of this year. The technical leaders I follow and produced by Dorsey Wright & Associates (DWA) favor mid capitalization stocks, equal-weighted indexes, and growth stocks over value. This data also emphasizes most major economic sectors except for Financials and Telecom.

According to DWA, the four remaining major asset categories: Commodities, Bonds, Currencies, and International stocks are all fairly tightly clustered together but far behind US stocks on a relative strength basis. Within the Commodity asset category, Precious Metals and Energy are the two emphasized sectors within this space. International bonds and Treasuries are the top two emphasized bond sectors. I am leery of the Treasury sector because of the extraordinary low level of interest rates, and I believe a great deal of risk lies within the bond category, especially extended duration bonds, today. The top three currencies on a relative strength basis are the Australian dollar, the Brazilian Real, and the Canadian dollar. Among the last asset category, International stocks, the US sector and Developed markets are currently favored, but I continue to like the emerging market sector as well.

The February Retail Sales Report will be released Tuesday morning. Consensus is for an increase from 0.4% in January to a 1.2% increase for February with auto sales being the major factor in the increase. The Federal Reserve will release the highlights of their Federal Open Market Committee meeting Tuesday afternoon. The Fed is expected to keep interest rates at between 0% and 0.25%, and this would be consistent with previous announcements and expressed intention to leave interest rates unchanged. Investors will be watching to see if there is any language regarding any type of additional monetary easing (QE III). Thursday is the weekly Initial Jobless Claims report (consensus is calling for a slight drop in weekly claims to 355,000) along with the February Producer Price Index and Friday is the February Consumer Price Index. Both of these inflation indicators are expected to increase of about 0.5%. Rising prices will be a concern as it eats away from the purchasing power of individuals.

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.

TIPS are U.S. government securities designed to protect investors and the future value of their fixed-income investments from the adverse effects of inflation. Using the Consumer Price Index (CPI) as a guide, the value of the bond's principal is adjusted upward to keep pace with inflation. Increase in real interest rates can cause the price of inflation-protected debt securities to decrease. Interest payments on inflation-protected debt securities can be unpredictable.

As always, if you have any specific questions on your portfolio or wish to talk to me, please do not hesitate to call.

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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.

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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