Monday, May 14, 2012
Equity markets continued to retreat last week as fears grew over Greece's political instability and its possible impact on the European Union, and news that banking stalwart, JP Morgan, has suffered some $2 billion in trading losses with the potential for another $1 billion. Less apparent was Cisco Systems' bad week after announcing relatively low growth projections for the remainder of 2012. The "risk off" trade is in control for now.
The Dow Jones Industrial Average (DJIA) posted its second consecutive worst weekly performance in 2012 losing 1.7% following the previous week's loss of 1.4%. DJIA components Cisco Systems and JP Morgan suffered losses of 13.7% and 11.5% respectively and contributed to much of the DJIA's drop, but they were not alone with 20 of the other 30 companies that comprise the index losing value last week as well. For the year, the DJIA is now up 4.9%. The S&P 500 faired a little better losing 1.2% for the week, while the broader Russell 2000 index posted a loss of just 0.2% and the NASDAQ lost 0.8%. After 19 weeks of trading in 2012 the S&P 500 is up 7.6%, the Russell 2000 is up by 6.6%, and the NASDAQ continues to lead posting a gain of 12.6%.
The European Union (EU) remains under considerable stress as the Greeks appear unable to cobble a coalition together to form a government. Investors worry that the new Greek government will be unable to or unwilling to adhere to austerity measures agreed to with the EU in order to qualify for bailout funds increasing the possibility that Greece may have to exit the EU. France appears, for now, to be transitioning smoothly to a new socialist government; however, Spain is back in the news after the rapid and unexpected nationalization of that country's fourth largest bank. Across the globe, China's economy appears to be slowing and doubts are growing that the Chinese can lift the world economy. For the week, the MSCI EAFE index lost 2.65% with the Asian/Pacific region posting a sharp 4.3% drop. For the year, the MSCI EAFE is now up 2.3% and the Americas region leads all others posting a 7% gain. The Emerging Markets region is up 5.5% as is the Developed Markets region, while the Asia/Pacific region is up 4.4%.
The Euro continued to fall as investors sold Euros and sought safety in the US dollar. The Euro fell nearly two cents (-1.3%) to close Friday at $1.291. The US Dollar Index gained another 1% and is now up 0.15% for the year. Whenever the US dollar has risen over the past year or so, it has generally been accompanied by a falling stock market, falling commodity prices, and falling US interest rates.
Commodities fell again last week over continued worries about the strength of the global recovery and fears of a major setback in the EU pushed the dollar stronger which in turn helps push commodity prices down. The Dow Jones UBS Commodity Index constructed with a broad basket of commodities fell 1.7% following last week's 2.7% drop and the index is now down 4.2% for the year. Gold prices dropped 3.7% and WIT Oil prices fell nearly 3%. Gold's pullback was due in part to the better than expected decline in the Producer Price Index released last Friday helped mostly by falling oil prices. The only bright spots in commodities last week were natural gas, coffee, and cocoa which where were all up around 1%. Metals and agriculture were the weakest commodity sectors for the week.
Bond markets gained for the eighth consecutive week with the Barclays Aggregate Bond Index up a very modest 0.09%. US Treasury yields fell (prices up) last week. The 10-year Treasury interest rate closed Friday at 1.845% to the previous Friday close of 1.876%. The 30-year closed Friday at 3.011% compared to the previous Friday close of 3.071%. Spanish 10-year interest rates pushed over the dangerous 6% level on Friday closing at 6.007%. This is clearly a warning sign that things are not good in Spain today. The French 10-year fell slightly to close Friday at 2.804% suggesting that the credit markets are still waiting to see what newly elected French president, Francois Hollande will actually do. For the week, extended duration US Treasuries and corporate bonds were the best performing bond sector. The worst performing sectors were Emerging market debt and International bonds.
TIME TO SELL?
Two weeks ago the markets looked great. The DJIA had reached a recent multi-year high of 13,360 during the day on May 1st but since then the Dow has fallen 4.0%. Not great, but not terrible or unusual either. In fact, markets do this on a regular basis. The S&P 500 has, on average, had three to four 5%+ corrections every year since 1928 (Source: Ned Davis Research/Wells Fargo). What we have seen most recently is known as a buying climax. A buying climax occurs when a stock (or in this case an index) makes a new yearly high, often early in the week (May 1st was a Tuesday) but then declines and closes down for the week as a whole (-1.44%). A "climax" does not mean that a stock or market (index) has finished a long-term move, or that a change in trend is on the horizon, it is simply an indication that a near-term top has been reached. Sometimes such a near-term top turns into something of long-term relevance, but just as often this is not the case and so we should look no further than our headlights (data) can illuminate.
I follow a series of data provided by Dorsey Wright & Associates (DWA). One of the data points I evaluate is where a stock or index is sitting compared to its ten-week trading band. A trading band is simply a statistical bell curve placed over a stock or index's past ten weeks of price history. If a stock or index is trading in the middle of the trading band it is considered to be fairly priced (the ten-week mean). A stock or index can be considered overbought if it is trading well above the middle of the band, and oversold if it is trading toward the bottom of the ten-week band. For those of you who have a background in statistics, the top and bottom of the bands are three standard deviations each. The bands are recalculated weekly. Today the DJIA is trading just below the middle of its ten-week band. In simple English, the market is just slightly oversold at this time. The S&P 500 is also oversold by about the same amount. This is not the time to panic and sell; however, this is not the time to be complacent either. Review individual positions and watch each closely.
I am not trying to sound pollyannaish about the last two weeks, I see what you see. However, I also see the markets within the context of years of market behavior. There is a lot of risk and uncertainty out there and I am not diminishing those risks. I have not liked international stocks for some time, and US stocks continue to have a very wide lead on all the other four major asset categories evaluated by DWA (Commodities, Bonds, International, and Currencies). Commodities have come under stress as global economic growth weakens and the US dollar strengthens, while Bonds have been a very steady investment so far in 2012. Currencies have done little and the US dollar is consolidating with the Euro.
So I believe that now is not the to time sell stocks, but do keep an eye on the markets to see how they continues to shape up.
The Europeans are still fighting the political and economic turmoil that has embraced that part of the world. The Greeks will attempt to form a government, but what form that government takes is completely unknown. Indications are that this new government will not be onboard with the German view of the EU. France is also expected to push back against the Germans. The Spanish government and banks will continue to face very tough choices and the Spaniards may have to continue bailing out their banks. The question that Spain must answer is, "where will the government get the money?" I believe that markets will continue to react to any news or economic data that validate any global growth or contraction.
Following a week with little economic data, there are a fairly large number of important reports due out this week. Tuesday kicks off with April Retail Sales and the April Consumer Price Index (CPI). The consensus for retail sales is to pull back from a gain in March of 0.8% to just 0.1% in April. The CPI is expected to be flat after a 0.3% increase in March. Declining energy prices are a major contributor to this consensus number. April Housing Starts and Industrial Production will be released Wednesday along with the Federal Open Market Committee (FOMC) minutes. Housing starts are expected to rise slightly from March and economists are anticipating a moderate jump in industrial production after a flat March. The FOMC minutes will be scrutinized for any indication that the Federal Reserve is considering another round of quantitative easing. Finally, Thursday brings the Initial Jobless Claims report. Consensus calls for a reduction of 2000 first time claims to a level of 365,000.
Even with the moderate sell-off over the past couple of weeks, my views about the markets developed through the DWA relative strength analysis are only slightly changed. US stocks remains the strongest asset category followed by Commodities, Bonds, International stocks, and Currencies. US stocks retain a very sizable lead over the other categories. Commodities have shown considerable weakness, and I am not adding to positions and will look to trim if oil and gold prices continue to pull back. Mid-capitalization stocks are favored, growth is favored over value, and equal-weighted indexes are favored over capitalization-weighted ones. On a relative strength basis, DWA puts Consumer Discretionary, Information Technology, and Financials as the three strongest economic sectors. The New York Stock Exchange Bullish Percent (NYSEBP) fell again last week and remains in an eight week negative trend. The current reading of 59.64 is now just over seven points above the 52.96 level at the start of 2012. Markets remain in a weakening trend with uncertainty abroad increasing.
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.
P.S. If you think this type of analysis would be of benefit to anyone you know, please share this communication with them.
Paul Merritt, MBA, AIF ®, CRPC ®
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.
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.
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Posted by Paul Merritt at 1:37 PM