Wednesday, July 18, 2012

A sharp rally on Friday lifted global markets for the first time in the past seven trading sessions. JPMorgan's good 2nd Quarter earnings lifted the entire banking sector, and reports of a slowdown in China met investor's expectations further boosting confidence on Friday. Prior to JPMorgan's report, investors had little to cheer about as another financial firm (Peregrine Financial Group) was shut down due to fraud, the Federal Reserve affirmed that it had no plans for now to engage in another round of quantitative easing, and consumer sentiment remains weak.

The Dow Jones Industrial Average (DJIA) rallied 204 points (1.6%) on Friday to end the week up 5 points (.04%) closing at 12,777. The S&P 500 also finished the week positive (0.2%), but the Russell 2000 and NASDAQ each finished down -0.8% and -1.0% respectively. For the year, the DJIA is up 4.6%, the S&P 500 is up 7.9%, the Russell 2000 has gained 8.1%, and the NASDAQ leads all major US indexes with an 11.6% gain.

Sector performance was split this past week. Utilities, Health Care, Financials, Consumer Staples, Real Estate, Telecom, and Energy were all positive and each outperformed the DJIA and S&P 500 with Utilities leading all sectors (+1.6%). Consumer Discretionary, Industrials, Materials, and Information Technology were all negative with Information Technology the worst performing sector losing nearly 2%. For the year, Real Estate, Financials, and Health Care are the best performing sectors, while Energy, Utilities, and Materials have been the worst. Only the Energy sector is negative for the year on an absolute price basis.

Conditions in Europe remain challenging and markets there continue to underperform. Italian sovereign debt was downgraded by Moody's two notches and is only several notches above junk status. French automaker, Peugeot, announced it was laying off 8000 workers (8% of its French workforce) in a desperate effort to become profitable. Newly elected French President Hollande said the layoffs were unacceptable and is directing government intervention. This is a great example of the challenges facing Europe. Peugeot is losing an estimated €200 million ($245 million) each month due to years of falling demand and heavy exposure to high-priced French labor and the government is blocking the company's efforts to cut costs. For the week, the MSCI (EAFE) index fell 0.8% and is down -0.7% for the year.

The Euro fell another -0.2% for the week closing Friday at $1.225. The good news for the Euro is that it did rally a bit on Friday and closed off earlier lows in the week. The bad news is that the Euro continued to fall and the economic prospects in Europe are not improving. I will discuss the implications of currency fluctuations on markets in greater detail in the next section of my Update.

Recent concerns over a slowing global economy and rising dollar have not been enough to hold commodity prices in check. The Dow Jones UBS Commodity index gained 2.5% last week and this follows gains of 1.1% and 5.6% during the preceding two weeks. For the year, the Dow Jones UBS Commodity index is down -0.2% for the year. Coffee and Corn led all major commodity sectors while Livestock and Platinum were the worst performing last week. Oil gained 3.1% last week after the US State Department announced that it was taking steps to further enhance the oil sanctions on Iran. It is now estimated that up to 1.5 million barrels of oil per day will be removed from global supply as a result of US efforts. Gold gained 0.8% last week mostly on the news that the slowdown of economic growth in China was not worse than anticipated giving investors some cause for optimism. I believe gold prices have been hurt recently as US Treasuries have become the "go-to" safe-haven investment over gold.

US bonds, especially longer-term US Treasuries, have continued a steady generally upward course in 2012. The yield on both 10 and 30-year Treasuries fell again this past week and remain near historic lows closing Friday at 1.490% and 2.576% respectively. The US Barclays Aggregate US Bond index gained 0.4% last week and is up 3.5% for the year. After periods of high interest rates, falling rates are generally considered bullish and boost economic output. I believe in this economic environment, however, falling interest rates reflect fear and pessimism in the economy. Buyers of the US 10-year Treasury are getting a negative real return of -0.2% at the current level of inflation. Fear is a real part of bond investors' sentiments these days. Italian 10-year yields increased slightly after Moody's downgrade, and Spanish 10-year sovereign debt retreated substantially to 6.663% taking some of the immediate pressure off the European Central Bank and others as they try to fight this crisis.


As I evaluate markets on a week-to-week basis, I have made comments such as, "a strong US dollar is acting as a headwind on the price of gold," or, "oil prices fell as the US dollar gained strength." So this week I thought I would discuss the impact of a rising or falling US dollar on a variety of asset classes and sectors. Dorsey Wright & Associates in Richmond, Virginia, gathered the data I will be using in my discussion.

Let me begin by describing why currency valuations change with respect to other currencies. The "why" is based on the most fundamental concept of economic theory-supply and demand. Events and policies within a country or region like the European Union (EU) can cause investors to move money into or out of a country. For example, if the Bank of Country High is paying 5% interest on their 10-year sovereign bond and Country Low's central bank is paying just 2% for a similar bond, investors will borrow money from Country Low at 2%, convert their cash into Country High's currency and buy Country High's higher yielding bonds profiting on the spread between bond yields. This creates demand for High's currency pushing up the value of that currency and supply for Country Low's currency pushing that currency value down. The example I have just described is known as the "Carry Trade" among investors. Other factors that can influence the demand (either up or down) for a currency include civil wars, political instability, changes to gross domestic product (GDP), trade deficits/surpluses, and inflation.

Dorsey Wright analyzed the movement of fifteen asset classes/sectors from 1985 through June 7, 2012 with respect to a rising or falling US dollar. During this nearly 28-year time-frame, there have been 11 periods of a rising US dollar trend and 11 periods of a falling trend. The chart below shows how each of these fifteen asset classes/sectors performed on an absolute basis as the US dollar rose and fell. The red bars represent the average return of the asset class/sector during periods when the US dollar is falling and the green bars represent returns when the US dollar is rising. For example, the value of gold increased 24% on average when the US dollar was falling and lost 5% during rising periods. Not surprisingly, commodities and international stocks were the most affected asset classes/sectors because they have the greatest exposure to foreign currencies. Commodities in general, and gold and oil in particular have performed much better during periods of US dollar weakness. The reason for this, I believe, is because the vast majority of the 25 billion commodity contracts traded yearly are priced in US dollars. Anyone wanting to engage in the commodity business generally must do so in US dollars. Therefore, a rising US dollar makes the value of that commodity to foreign investors more expensive to buy. Rising prices typically causes demand to fall, which in turn causes the price of that commodity to fall as well. Similarly, a strengthening US dollar means that international stock investors are most likely selling their international holdings (driving prices down) and replacing them with US denominated investments.

SOURCE: Dorsey Wright & Associates

The most widely accepted index used to track the US dollar's performance is the U.S. Dollar Index (DX/Y).The DX/Y is a measure of the US dollar compared to an unequal basket of six major currencies: the Euro (€)-57.6%, the Japanese Yen (¥)-13.6%, the British Pound (£)-11.9%, Canadian Dollar ($)-9.1%, Swedish Krona (kr)-4.2%, and the Swiss Franc (Fr)-3.6%. The DX/Y has been on a positive trend since bottoming on May 2, 2011, gaining over 14% over that period. During this same timeframe, international stocks (MSCI EAFE) have fallen about 23%, WTI Oil has pulled back 25%, and Gold has held steady gaining about 1.5%. Additionally, US large capitalization stocks (S&P 500) and small/mid-capitalization stocks (Russell 2000) are down about 6%, and the Barclays Aggregate Bond Index is up just over 5%. Looking at all the data it appears that international stocks and commodities do better in a falling US dollar environment, and US stocks and bonds are, on average, less affected by US dollar fluctuations.


Stocks are in the midst of 2nd Quarter earnings season and traders will be scrutinizing reports as they are released this week. The slowing US economy and the growing global slowdown are likely to cause earnings to be less robust this quarter, but by how much? This is the question everyone will be evaluating as this week and the next few weeks pass.

The Dorsey Wright & Associates (DWA) current technical analysis shows US stocks and Bonds as the two strongest major asset classes followed by Currencies, International stocks, and Commodities. Within the US stock asset class, Middle capitalization stocks are favored, growth is favored over value, and equal-weighted indexes are favored over capitalization-weighted indexes. On a relative strength basis, Consumer Discretionary, Real Estate, Health Care, and Consumer Staples are the strongest major economic sectors. Energy, Materials, and Industrials are the weakest. Information Technology has fallen from second to seventh position in the past week. Within the Bond major asset category, US Treasuries and International bonds are favored. Other than the changes within the major economic sectors, all previous relationships remain unchanged.

The New York Stock Exchange Bullish Percent (NYSEBP) closed at 52.10 rising by just 0.04% last week and remains in a column of X's (demand is in control). Looking at valuations over the past ten weeks, the DJIA and S&P 500 are considered to be fairly valued with the DJIA very slightly oversold at -5% while the S&P 500 is overbought by just 2%. Values north of 100 and approaching 150 are considered very overbought, while values of -100 to -150 are considered very oversold. Looking across many asset classes and sectors, fixed-income is the most overbought asset class with long-duration bonds the most overbought sector within the fixed-income asset class at +153. The most oversold sector is inverse fixed-income at -66%. While I do not use the overbought/oversold numbers as a primary indicator, it does help me gauge whether or not to start new positions within certain sectors. In this case, anything reading over 100 I will generally wait for a correction before initiating new positions.

A lot of economic data will be reported next week. Retail sales will start the week off on Monday morning. This is a very important indicator given the size of the consumer relative to the US's GDP. Consensus is looking for sales to improve by 0.2% after several months of declining sales-principally on the back of falling oil prices. This is a statistic where the details truly matter and so investors will be parsing the results carefully. The Consumer Price Index (no change) and Industrial Production (+0.3%) will be released Tuesday morning. Housing starts come out on Wednesday with a slight improvement over May expected. Jobless Claims (365,000) will be Thursday morning as ususal along with Existing Home Sales (slight increase), and the Philadelphia Fed Survey of General Business Conditions. The Philadelphia survey, while contracting, is anticipated to be better than May's number. Toss in two appearances by Fed Chairman Bernanke next week and economists and reporters will have a lot to discuss in this busy week.

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

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.

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.

Securities and Advisory Services offered through Commonwealth Financial Network®,

Member FINRA/SIPC, a Registered Investment Adviser.