Wednesday, August 22, 2012

July US economic reports generally came in ahead of expectations this past week helping push US and global markets higher.  Consumer sales jumped in July by 0.8% easily beating the consensus number of 0.3%.  Industrial production and consumer sentiment also beat the consensus to the upside.  Housing starts came in a little under expectations, but permits jumped significantly increasing confidence about this important sector going forward.  Consumer prices were unchanged in July, but producer prices jumped 0.3% raising concerns that price inflation is working its way into the system.  Overall, however, economic data continues to show that the US economy is slugging its way forward and not in immediate risk of slipping back into another recession.
The Dow Jones Industrial Average (DJIA) added 67 points (0.5%) last week while the S&P 500 gained 0.9%.  Both the DJIA and S&P 500 have now been positive for the past six weeks.  The Russell 2000 gained 2.3% and the tech-heavy NASDAQ added 1.8%.  I believe that when the smaller stocks of the Russell 2000 outperform the DJIA and S&P 500, this is an indicator that investors have increased their appetite for risk.  For the year, the DJIA is up 8.7%, the S&P 500 is up 12.8%, the Russell 2000 has gained 10.7%, and the NASDAQ is up a strong 18.1%.

Nine of the eleven major economic sectors were positive last week with eight of the eleven outperforming the DJIA.  The best performing sectors for the week were Information Technology, Consumer Discretionary, Industrials, Financials, and Materials.  The weakest were Utilities, Health Care, and Energy.  For the year, Information Technology has had a strong year followed by Consumer Discretionary, Telecom, Financials, Real Estate, and Health Care.  Utilities, Energy, and Materials bring up the rear, but as I have noted before, all sectors have positive returns for the year.

The MSCI (EAFE) posted a 0.8% weekly gain marking the fifth consecutive week this broad, but European-heavy, international index has been positive.  For the year, the MSCI (EAFE) is now up 5.2%.  The European markets have had what I would describe as a stealthy bull market since their recent bottom on June 4, 2012.  Since that low point, the STOXX Europe 600, a broad European-only (18 countries) index, has risen 16.7% while the S&P 500 posted a 10.6% gain over the same timeframe.  For the year, the STOXX Europe 600 trails the S&P 500 by more than 1%, so although there have been signs of life in European stocks, the region has still underperformed the US thus far in 2012. 

The Barclays US Aggregate Bond index posted its second losing week in a row dropping 0.7% for its second largest weekly loss in 2012 as US Treasury yields continued push higher.  For the week, the US 10-year Treasury rose another 0.16% to close Friday at 1.814%.  While 0.16% does not sound like much of an increase, it was the third largest weekly jump in yield so far in 2012.  The US 30-year yield increased 0.18% to close at 2.932%.  This was also the third largest weekly gain for the 30-year US Treasury yield in 2012.  I believe that interest rates have been rising primarily because bond investors are growing less certain about the Federal Reserve intervening with another round of quantitative easing. With the relatively good US economic data recently, the Federal Reserve will be less likely to intervene, especially going into the final months of the US presidential election cycle.  In Europe, the yield on Spanish 10-year bonds continues to fall and closed Friday at 6.443%.  Italian 10-year yields also fell while German and French 10-year yields rose somewhat proportionately with US yields.  For the week, longer duration bonds of all types underperformed, while high yield, preferreds, and short duration bonds fared the best. 

Currencies remain relatively stable while Europe and the most of the world are on vacation in August.  The Euro added just 0.33% closing at $1.233 compared to a week earlier close of $1.229.  The Euro has traded in a very narrow range between $1.22 and $1.25 for most of August and I suspect that this trend will continue until September when policy makers get back to work and start addressing the details of plans to get Europe back on solid financial footing.  The US Dollar index was up a very small 0.05% reflecting the muted movement among key currencies last week.

Commodities were little changed.  The broad Dow Jones UBS Commodity index fell a slight -0.06% last week.  The price of a barrel of WTI oil, however, was a notable exception and continued to rise adding $2.62 (2.8%) to close Friday at $96.01.  The price of WTI oil is up 9% so far in August following July’s 3.6% increase.  According to AAA, the average price of a gallon of regular gas is now $3.72 compared to $3.45 just one month ago (a 7.8% increase).  The Obama administration is so concerned about rising oil prices that it has floated the idea of tapping the strategic oil reserve in an effort to hold down oil prices during the fall campaign season.  The jump in oil prices this week has been attributed to an unexpected drop in existing supplies here in the US, but I believe that the ever-increasing instability in the Middle East, especially the anti-Israel rhetoric coming from Iran, is adding to concerns among oil traders.  Gold fell slightly for the week and is now up just $4.80 (0.3%) for the month.  Gold traders will be watching Federal Reserve Chairman Bernanke’s comments at the Fed’s Jackson Hole conference closely for any indications about the prospect of new quantitative easing in the future.  Coffee, sugar, and aluminum were the weakest individual commodities for the week while platinum and oil were the strongest. 


One of the biggest fears many investors have is that of volatility.  Let me put it another way.  One of the biggest fears that many investors have is losing a lot of money quickly.  This fear of volatility has kept some investors on the sidelines over the past year or two as stock markets have posted decent gains and cash has been earning virtually no interest.  That is what fear can turn itself into, no gains or even negative gains in safe haven investments while markets rise. I am not advocating risky investments for most of my clients, but I do think a better understanding of volatility and how it is measured, can be another important tool to help judge risk levels in the market.

Volatility is most commonly measured by the Chicago Board Options Exchanges Volatility Index (VIX).  In the basic terms, the VIX is a measure how much an investor must pay for protective options contracts on the S&P 500 index.  The price of these protective options contracts increase as the S&P 500 falls.  The faster the index falls the more the options cost.  Likewise, when the markets are rising, especially in an orderly way, the cost of protective options fall and with it the VIX index.

When the markets were losing massively during 2008, the VIX reached a high of 79.13 on October 24, 2008.  That day the S&P 500 lost 3.4% of its value and was down a staggering 40.3% for the year.  By the end of 2008, the S&P 500 managed to regain about 3% of its losses and the VIX fell to 40.0.  As of market close last Friday, the VIX stood at 13.45.  The VIX has not been this low since late February 2007.  During 2004 to 2007, the markets had an orderly and relatively steady climb.  The S&P 500 gained 9.0% in 2004, 3.0% in 2005, and 13.6% in 2006.  Beginning in March of 2007, the VIX started rising before peaking dramatically in 2008.  I would suggest that the markets in 2012 are similar to the markets in 2004, 2005, and 2006 where the S&P 500 posted modest gains while the VIX remained subdued.  The VIX’s moving average for the past year is just under 23 indicating that volatility in the market has been decreasing and the expectation is that the likelihood of a major market correction is diminished for now.

This does not mean you can fall asleep with your investments.  I have been pointing out frequently that there are critical issues facing investors.  The European debt crisis and our own “fiscal cliff” are just two of the biggest challenges staring us in the face today.  The Middle East is another that I am sensing is heating up again.  For now, markets are showing a bias towards slow and steady growth, but investors must keep their heads in the game.  At the same time, you cannot let your fear of volatility or what you hear in the latest news cycle diminish your judgment.  As I always say, “listen to the data.”  Do not be reckless, but prudent and informed before making investment decisions.

If the daily traffic jam at the Hampton Roads Bridge Tunnel here in southeastern Virginia is any indication of how many people are traveling to our beaches on vacation, then it must be the high vacation season for most Americans.  And so it is for many financial markets here and abroad.  According to, the average daily trading volume for the thirty stocks within the DJIA over the past year has been 736 million shares.  Last Friday the volume was 445 million shares, a decrease of nearly 40% in daily activity.  So traders are away and market activity and direction for now lacks the credibility of the majority.

The upcoming week brings few major economic reports that have the potential to move the markets, especially early in the week.  The first major report is the July Existing Home Sales on Wednesday morning.  Consensus is calling for an annual sale rate of 4.5 million homes compared to June’s number of 4.35 million homes.  Later in the afternoon the focus will be on the Federal Reserve’s Open Market Committee release of the minutes from it’s last meeting.  Investors will be parsing the minutes to determine the conviction, or lack of conviction, by the Federal Reserve regarding a new (Photo by: Ben Schumin) round of quantitative easing.  In recent years, the Federal Reserve has exerted strong influence over the stock and bond markets, and this influence remains.  If the Fed implies that quantitative easing is coming, I believe the prices of both stocks and bonds will be lifted.  The regular Initial Jobless Claims report will be out Thursday morning with no change expected from last week’s report of 365,000 new claims.  Finally, Friday wraps up with the July Durable Goods Orders report.  This important gauge of future manufacturing strength is expected to show a slight increase from 1.6% in June to 1.9%.  Modest and sustained manufacturing strength has been one of the keys that has kept the US economy from slipping back into recession.  Investors want to see this continue.

The New York Stock Exchange Bullish Percent (NYSEBP) closed at 58.96 up from 57.37 (2.8%) from the previous week.  This is the ninth positive week by this important indicator out of the past ten.  The S&P 500 index has become moderately overbought at a reading of 61% with the latest gains.  Recall that the degree of how overbought or conversely, oversold, an investment or index is, is based upon the previous ten weeks of price information.  If the overbought/oversold number is 0%, then the price is at the mean of the past ten week’s data.  If the price is 100% overbought, then it is said to be at the far right of a normal bell curve of price dispersion.  A bit wonky, but a great indicator of where the price of an investment or the value of an index lays with respect to the previous ten week’s worth of data.  With the S&P 500 overbought at 61%, this tells me that the index has been rising steadily and is about where it generally should be at this point.

The Dorsey Wright & Associates analysis of the markets indicate that US stocks and Bonds are the two favored major asset categories followed by Foreign Currencies, International stocks, and Commodities.  Middle capitalization stocks are favored, as is growth over value, and equal-weighted indexes over capitalization weighted indexes.  Equal-weighted indexes are those where each stock in the index is weighted the same, while in capitalization-weighted indexes the larger stocks have the largest weighting consistent with their size relative to the other stocks.  The relative strength sector weightings favor Consumer Discretionary, Real Estate, Information Technology, and Health Care.  US Treasuries and International Bonds are favored in the Bond category, while US and Developed Markets are favored within the International stock category.


Paul L. Merritt, MBA, AIF®, CRPC®
NTrust Wealth Management

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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.
Emerging market investments involve higher risks than investments from developed countries and 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 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.  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 CBOE Volatility Index - more commonly referred to as "VIX" - is an up-to-the-minute market estimate of expected volatility that is calculated by using real-time S&P 500® Index (SPX) option bid/ask quotes. VIX uses nearby and second nearby options with at least 8 days left to expiration and then weights them to yield a constant, 30-day measure of the expected volatility of the S&P 500 Index.
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.
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 generally are 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.

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. 

 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 and is a capitalization-weighted index meaning the larger companies have a larger weighting of the index.  The S&P 500 Equal Weighted Index is determined by giving each company in the index an equal weighting to each of the 500 companies that comprise 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 Russell 2000 Index Is comprised of the 2000 smallest companies of the Russell 3000 Index, which is comprised of the 3000 biggest companies in the US.   The NASDAQ Composite Index (NASDAQ) is an index representing the securities traded on the NASDAQ stock market and is comprised of over 3000 issues.  It has a heavy bias towards technology and growth stocks.  The STOXX® Europe 600 is derived from the STOXX Europe Total Market Index (TMI) and is a subset of the STOXX Global 1800 Index.  With a fixed number of 600 components, the STOXX Europe 600 represents large, mid, and small capitalization countries of the European region