Wednesday, May 30, 2012
Markets paused from the May decline last week and most domestic stock indices posted gains for the first time in four weeks. Worries over Greece and its possible withdrawal from the European Union (EU) and the Euro subsided briefly with Greek elections still more than a month away on June 17th. However, Spain continues to worry investors especially after the Spanish government's announcement last Friday that they were providing Spain's third-largest bank, Bankia, SA, with €19 billion ($23.8 billion) in capital to save that bank. Such a large injection of capital
has raised fears that Spain may have to make similar moves for other banks further stretching the Spanish government's balance sheet. In European trading on Memorial Day (May 28, 2012) the Spanish 10-year yield jumped to a multi-month high of 6.479%. Here in the United States, the major economic reports of the week generally came in line with consensus showing a very modest economic recovery underway-no good news but no terrible news either. Finally, a survey released over the past weekend shows the pro-bailout parties in Greece gaining strength in the polls boosting hopes that the Greeks are not supporting withdrawal from the EU and a return to the Drachma. This report helped firm the Euro that has fallen over the past four weeks.
For the week, the Dow Jones Industrial Average (DJIA) posted a gain of 86 points (0.69%) while the S&P 500 added 1.7%, the Russell 2000 was up 2.6%, and the NASDAQ jumped 2.1%. May, however has been a tough month with all the major indexes posting significant declines. The DJIA is down 5.7%, the S&P 500 is down 5.7%, the Russell 2000 is down 6.2%, and the NASDAQ is down 6.7%. For the year the DJIA is up 1.9%, the S&P 500 is up 4.8%, the Russell 2000 is up 3.4%, and the NASDAQ is up 8.9%.
All of the major economic sectors were positive last week led by Materials, Consumer Discretionary, Industrials, and Real Estate. Telecom, Utilities, and Consumer Staples were the weakest sectors for the week with only Telecom not outperforming the DJIA. Twenty-one weeks through 2012, Consumer Discretionary, Information Technology, and Real Estate are the top three performing major economic sectors while Energy, Utilities, and Telecom are the bottom three with Energy and Utilities negative for 2012.
As I have already noted, Europe is a complete mess. The EU is wracked by high unemployment, political uncertainty, and slowing economic output. The debate between austerity and Keynesian spending to stimulate growth rages on with no clear winner. Not surprisingly, the equity markets reflect these conditions. The MSCI (EAFE) index fell another 0.5% last week and is now down 10.9% for the month, and down 4.4% for the year. After a strong start, the Emerging Market sector has given back all of its gains for the year with a loss of 12.4% in May leaving this volatile sector down 2.1% for the year. The best performing region globally has been the Americas region that has lost 6.6% for the month, but remains positive by 3.6% for the year.
The Euro and other major foreign currencies continue to fall against the US dollar as investors seek safety in the US currency. The Euro closed Friday at $1.252 down over seven cents from the start of the month, and is now down 4.2 cents for the year. The US dollar is the go-to currency as worries increase abroad, so look no further than the US Dollar Index to gage fears in global markets. The US Dollar Index has gained 4.8% in May and is up 2.8% in 2012.
Commodities continue to struggle under the weight of a strengthening US dollar and a weakening global economy. The broad basket Dow Jones UBS Commodity Index fell 2.5% last week and is now down 5.8% for the year. China, which has been having a poor year by Chinese standards, has not been in the headlines ahead of Greece and Spain, but a drop in demand by the Chinese has certainly influenced global commodity prices. For the week, gold fell just over 2% to close at $1559.80 and is down 6.4% for the month, and 0.4% for the year. Oil has really pulled back losing 0.8% last week to close at $90.72. For the month, oil has fallen 13.4%, and is now down 8.2% for the year. Oil has held at the $90/barrel price, and I believe this remains an important support level.
Bond markets broke a 9-week positive run as the Barclays Aggregate Bond Index posted a drop of 0.2%. It is too early to read too much into this trend break, but it bears watching. US Treasury yields rose (prices down) with the 10-year and 30-year rates closing Friday at 1.738% and 2.842% respectively. These rates remain very low and reflect the fear most investors currently have. All but Spanish yields fell last week with the German 10-year Bund closing Friday at 1.37%. Interest rates continue to be a barometer of investor's fear levels, and the heavy hand of central banks makes it a difficult asset category to figure out. For the week, preferreds and high yield municipals were the best performing bond sectors while extended duration government and corporate bonds the weakest. For the year, preferreds and municipal high yield are the best performing bond sectors with high yield and short duration (domestic and international) the worst.
THE MARKETS ARE WASHED OUT
The media translates oversold markets into interesting headlines. For example, the Financial Times included the headline last Thursday questioning whether stocks will continue as a viable investment in the future. Wow. That is an amazing concept. The past decade's poor performance and volatility of stocks has certainly frustrated investors and may well continue to do so for the foreseeable future, however, this does not mean stocks are done being a good investment. It is also not the first time the media has taken us down this road. Look at the BusinessWeek cover from
August 13, 1979. Did this headline mark the bottom of the market? No, but it did come just a few short years ahead of one of the greatest bull markets in history.
I believe we are all influenced more by recent events rather than past historical occurrences. I remember clearly how the Great Depression affected my grandparents and their subsequent behavior in the years following those difficult times. Yet to most of us, the Depression is just another chapter in a history text. Today, however, we are all keenly aware of first the dot.com implosion in the markets early in the 2000's, and then the Great Recession in 2008 when markets dropped to levels not seen in decades. So it is perfectly natural for most of us to fear the uncertainly found in today's markets, but that fear should not prevent you from making smart investment decisions. Let us look at where we are today.
I have discussed the concept of overbought or oversold markets before, but let me quickly review. The price of an investment (or an index) is tracked on a daily basis and the most recent 10-week price history is plotted by Dorsey Wright & Associates (DWA) on a statistical bell curve. Three standard deviations, by definition, account for 99.7% of all prices above and below the mean during the 10-week period. If the investment price falls to the far left of the bell curve (three standard deviations) it is considered 100% oversold, however, if the price continues to fall (moves further left on the curve) it can reach even higher oversold percentages. The converse is true for rising prices. The DJIA and S&P 500 indexes are currently oversold by about 63%...high, but not extreme.
When looking at historical patterns, DWA has drawn several conclusions. First, prices do not remain oversold forever and typically rebound at some point. Second, when prices become oversold, especially by a wide margin, it can be a positive signal to come back into the market. Looking at major market segments the following conclusions can be taken from the current DWA data: bonds are somewhat overbought while international equity investments, especially Emerging Markets, are at very oversold levels; and US equities are moderately oversold. Remember too that summer is historically a weak time of year, and the New York Stock Exchange Bullish Percent remains in a defensive posture falling for a tenth consecutive week to close Friday at 48.52. All this information together continues to signal caution, but risk levels are falling.
As much as all of us are tired of hearing news about Europe, I am sorry to say that I expect Europe to continue to dominate the news in the coming week. While the future of Greece will garner the majority of headlines, I believe the most important story will be what happens to Spain and the recapitalization of its banks. Spain is a much, much larger economy than Greece, and the Europeans will be hard pressed to bailout Spain should it come down to that.
Interest rates will continue to be an important indicator of investor sentiment. Higher rates in Spain, I believe, will signal growing risk in that country's finances, while falling interest rates elsewhere will signal a gloomy outlook by investors. Historically low interest rates mean that investors are afraid and lack confidence in the longer-term outlook of the economy. The Euro and the US Dollar Index also will continue to signal the appetite for risk in the markets. A rising Euro and falling US Dollar Index will be signalling risk is back, while the converse is true.
Thursday and Friday of this week will offer a host of critical economic reports. Thursday will have the ususal Initial Jobless Claims report (no change expected from last week), but also the first revision of the Gross Domestic Product (GDP) for the first quarter of 2012. Consensus calls for a revision downward from 2.1% to 1.9%. Friday's reports include the Employment Situation for May and new jobs are expected to grow by 150,000 compared to last month's increase of just 115,000. The unemployment rate is expected to remain steady at 8.1%. Personal income is expected to remain steady, while the ISM Manufacturing Index is expected to contract very slightly. All are key reports and any significant departure from the consensus may well move markets either up or down.
The major analysis provided by DWA about the current status of the markets show that US stocks clearly remain the favored investment of the five major asset categories. There has been constant reshuffling of the four remaining asset categories. As of Friday, Bonds and Currencies occupy the second and third positions followed by Commodities and International stocks. Commodities and International stocks are very weak at the current time and I am avoiding for now. Within the US stock asset category, mid capitalization growth stocks are favored as are equal-weighted investments over capitalization-weighted indexes. Among the major economic sectors, relative strength analysis favors Consumer Discretionary, Information Technology, and Real Estate.
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 3:13 PM