Monday, August 27, 2012

Worries over Europe’s economic slowdown, Greece’s inability to meet austerity targets, slowing growth in China, and the ability of the Federal Reserve to “move the needle,” pushed markets to a weekly loss for the first time in six weeks.

The Dow Jones Industrial Average (DJIA) lost 117 points         (-0.9%) last week while the S&P 500 fell by -0.5%.  The Russell 2000 lost -1.3% and the tech-heavy NASDAQ gave back -0.2%.  For the year the DJIA is now up 7.7%, the S&P 500 is positive by 12.2%, the Russell 2000 is up by 9.2%, and the NASDAQ leads all major indexes with a 17.8% gain.

Health Care was the only positive major economic sector last week gaining 0.6% led by the biotech and health care provider subsectors.  Health Care was followed by Financials, Real Estate, and Consumer Discretionary sectors with all outperforming the S&P 500 for the week.  The worst performing sectors were Telecom, Industrials, Utilities, and Materials.  For the year, Information Technology, Consumer Discretionary, Financials, and Health Care are the best performing sectors.  Utilities, Energy, Materials, and Industrials are the worst but all have posted positive gains.

The MSCI (EAFE) managed a 0.6% weekly gain marking pushing this European-heavy, international index to its sixth consecutive weekly gain.  The STOXX Europe 600, a broad European-only (18 countries) index, however, was down 1.8% for the week.  The Emerging Market region posted a 0.4% gain, the Asia/Pacific region lost        -0.2%, and the Americas region fell by -0.6%.  European stocks suffered over concerns that Greece will have difficulty in reaching its required austerity goal for the next two years of cutting as much as 14 billion ($17.5 billion) from government spending.  Both German Chancellor Merkel and French President Hollande reiterated the need for Greece to meet its spending cuts following separate meetings with the Greek prime minister, Antonis Samaras, this past week.  Samaras had been seeking an extension to the deadlines imposed by previous agreements on austerity measures, but the key European leaders held firm.  Merkel and other European leaders are expected to wait until a joint report published by the European Central Bank (ECB), European Commission, and International Monetary Fund (IMF) due October 5th  before making any decisions.

The Barclays US Aggregate Bond index broke a two-week decline gaining 0.6% last week.  US Treasury yields pulled back with the 10-year closing Friday at 1.684% down from last week’s close of 1.814%, and the 30-year closed at 2.794% down from the previous week’s close of 2.932%.  Key European rates managed to fall slightly even in the face of negative news about Greece.  The Spanish 10-year closed the week at 6.419% and the Italy 10-year finished Friday at 5.714%.  Extended duration US Treasuries was the best performing bond sector while short duration bonds were the weakest. 

The Euro added almost two cents to close Friday at $1.251 marking this key currency’s fourth positive week out of the past five.  The US Dollar index, a measure of the US dollar strength against six major currencies, fell 1.2% snapping a two-week positive move.  US interest rates and the strength of the US dollar were impacted by the release on Wednesday of the Federal Reserve’s (Fed) Open Market Committee meeting minutes expressing support of additional monetary support for the sluggish US economy.

Commodities posted their best gain in five weeks as the broad Dow Jones UBS Commodity index added 1.6%.  After fluctuating during the week, WTI Oil closed the week virtually unchanged closing Friday at $96.03 per barrel.  Gold restored some luster adding $53.30 (3.3%) on increasing expectations that the Fed will begin another round of quantitative easing.  Orange Juice, Silver, Platinum, and Soybeans also gained. 

INVESTORS ARE WATCHING AND WAITING

As I have highlighted in previous Updates, investors face some significant events in the next few months that, depending on their outcome, could provide serious headwinds (or a boost) for the markets.  The two biggest are the European Union’s handling of its on-going debt problems, and the approaching “fiscal cliff” here in the US.  The fiscal cliff is the simultaneous increase in taxes and sharp spending cuts currently scheduled to begin January 1, 2013.  Additionally, investors are closely monitoring the moves by the ECB and the Fed regarding further monetary stimulus—quantitative easing (QE).  It appears that investors globally are very responsive, some might even say addicted, to monetary stimulus provided by central banks.

The Fed will kick things off on Friday, August 31st when Fed Chairman Bernanke speaks at the Fed’s annual retreat at Jackson Hole, Wyoming.  Speakers will also include ECB president, Mario Draghi, who will address the conference the following day.  Investors will be listening for signs of when these key central bankers will implement more QE.  Mr. Bernanke, responding to a series of questions from Rep. Darrell Issa, Chairman of the House Committee on Oversight and Government Reform, made it very clear last Thursday that the Fed was prepared to “provide additional accommodation as needed to promote a stronger economic recovery and sustained improvement in labor market conditions in a context of price stability.”  Mr. Draghi also signaled his willingness to take action in support of the Euro back on July 26th when he said that he would “do whatever it takes to preserve the Euro.”  Investors will be looking for specifics on how and when these central bankers will act and, I believe, will not be moved by just words.  They are looking for action.

As we proceed into the fall investors will begin to place bets on how the two big events will unfold.  If investors believe that the US will fall off the fiscal cliff or Europe will spin out of control, then I believe we will see US Treasury yields begin to fall (bond prices up) as traders move to safety.  Bill Gross of PIMCO said last week that he did not expect to see any rally in 10-year Treasuries that would push yields below 1.5%.  So the largest bond manager in the world just drew a line in the sand at 1.5%.  If investors believe the US will avoid the fiscal cliff and Europe is able to manage its way through its current challenges, then I would expect to see stock markets and commodities rise.  The classic “risk on” scenario will be in force.

For now, however, investors are on the sidelines and not taking strong bets either way.  They will not be able to sit there for long.  World leaders will act, investors will react, and we will all be in for an interesting ride this fall.

LOOKING AHEAD

The summer vacation season is ending and the developed world will be back to work after Labor Day.  The US election cycle will be moving into its final phase as the conventions wrap up and campaigning moves into high gear.  Some of the uncertainty will begin to removed and more and more investors will begin to stake out their positions.  The data I follow from Dorsey Wright & Associates will help me analyze their movements and I will certainly pass on that information to you.

The upcoming week brings two important economic events.  First, the second revision to the 2nd Quarter Gross Domestic Product (GDP) will be released Wednesday morning.  Recent economic reports have pushed the consensus to call for an increase of 0.2% to 1.7%.  The second big event is the speech by Mr. Bernanke at Jackson Hole on Friday.  While there is no official consensus to report about the speech, I do believe that investors are expecting Mr. Bernanke to talk about how and when he will move to provide further monetary easing.  It is clear that Mr. Bernanke favors some kind of action, however, if the GDP number comes in better than expected Wednesday, it may be more difficult for him to take action.  I further believe he is sensitive to taking strong action just two months before a national election.  We will have a better idea on Friday of just how committed Mr. Bernanke is to easing.  Other important economic reports include the weekly Initial Jobless Claims on Thursday morning.  Last week’s number came in 7000 above consensus at 372,000 and economists are expecting 370,000 this week.  Also coming in on Thursday morning is the Personal Income report for July with consensus expecting an increase of 0.3% which is down 0.2% from June’s number.

The New York Stock Exchange Bullish Percent (NYSEBP) closed Friday at 59.79 up from 58.96 the previous week.  This tenth consecutive weekly increase shows that positive momentum remains in the US stock market even in the face of a small decline in stock prices last week.  The market decline did cause the Overbought reading to drop to 45% for the S&P 500.  This means that stocks are still trading above their ten-week average, but are not especially overpriced.  Bonds are the most overbought asset class, but have pulled back markedly the past two weeks.

Another set of data I watch which is provided by Dorsey Wright & Associates is score direction.  Score direction looks back over the past six months and monitors whether the technical strength of an asset category or sub-category is rising or falling.  It allows me to see what categories are generally improving or weakening on a technical basis.  Score direction is not a primary indicator that I evaluate but does help me to identify trends over time. Emerging market bonds have shown the most positive improvement over the past six months.  Convertible bonds, cash, and small capitalization value round out the top four most improved asset classes.

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.

I would like to close this week’s Update by offering a final salute to Neil Armstrong who passed away this past Saturday.  For those of us old enough to remember, one of the most defining moments in our lives occurred on a July afternoon 43 years ago when Neil Armstrong became the first man to step on the moon’s surface.  In the years that followed we have developed a much better understanding of the risks he, Buzz Aldrin, and Michael Collins took getting to the moon and back.   We also stand in awe of the collective efforts of the thousands of American men and women it took to land Armstrong and Aldrin on the moon.  Job well done Commander Armstrong!







Paul L. Merritt, MBA, AIF®, CRPC®
Principal
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