Tuesday, October 9, 2012

Equity markets, both here and abroad, reversed their recent losing trends and posted solid gains for the first week of October.  The big economic headline last week was the official US unemployment rate falling to a four-year low of 7.8%.  Although markets rallied strongly on the news Friday morning, they did not hold much of the day’s gains and closed well below earlier session highs.

For the week, the Dow Jones Industrial Average (DJIA) added 173 points (1.3%).  The S&P 500 gained 1.4%, the mid- and small-capitalization dominated Russell 2000 and tech-heavy NASDAQ both increased by 0.6%.  For the week, at least, larger companies were favored over smaller ones.  As we kick off the 4th quarter, the DJIA is now up 11.4% for the year.  The S&P 500 is up 16.2%, the Russell 2000 has risen 13.8%, and the NASDAQ is up a strong 20.4%.

Financials and Health Care were the best two performing major economic sectors gaining over 2.5% each.  They were followed by Consumer Discretionary, Consumer Staples, Industrials, and Telecom.  All of these top sectors out-performed the S&P 500 for the week.  Information Technology and Energy were both slightly negative on the week and the laggards among sectors.  For the year, Consumer Discretionary, Health Care, Telecom, and Financials are the leading sectors while Utilities, Energy and Real Estate are the bottom three.  All sectors, however, remain positive and only Energy and Utilities are underperforming the DJIA.

International stocks were up nicely this past week.  The MSCI (EAFE) index gained 1.2% for the week while the European-focused STOXX 600 added 2.1%.  The Asian/Pacific and Emerging Market regions lagged gaining 0.1% and 1.1% respectively.  European investors have continued to be buoyed by Mario Draghi’s (European Central Bank President) commitment to his own version of quantitative easing for European Union (EU) countries.  Most of the EU is in recession, unemployment is at record levels, and it appears that Greece is hopelessly addicted to continued bailouts.  Yet the stock market continues to go up.  I believe this reflects the power of monetary policy in today’s economic environment.  I remain uncomfortable making any significant investments in international securities, especially European securities, and have avoided this major asset category so far in 2012.  However, I do believe that European leaders will make every effort to keep Greece within the EU and to maintain the strength of the Euro.  Even if they are successful, I believe Europe will struggle to create any real economic growth and will have trouble outperforming the US and emerging markets going forward.

US Treasury yields reversed course and the 10-year gained 0.11% to close Friday at 1.737%.  The 30-year yield also added 0.14% to close the week at 2.965%.  Analysts suggested that the sell-off in US Treasuries was the result of the unexpected drop in the unemployment numbers thus increasing the chances that the Federal Reserve would delay or curtail its recently announced bond purchases (QEIII).  No one knows at this point how the Federal Reserve will act, but yields on Treasuries did jump on Thursday and Friday.  Spanish and Italian sovereign 10-year yields fell and closed Friday at 5.686% and 5.054% respectively.  I found it interesting that Bill Gross of PIMCO revealed that he purchased both Spanish and Italian debt on news that the ECB would begin buying EU sovereign debt.  Reintroducing the private sector into the mix has to be a good thing for European bond markets for now.  The question in Europe remains, however, when will the Spanish government officially request the ECB to step in and purchase Spanish debt?  Overall bonds were generally down last week with the Barclays US Aggregate bond index dropping 0.2%.  Extend duration government bonds was the worst performing sector while international sovereign debt and international inflation protected bonds were the best performing sectors..

The US Dollar index fell 0.8 % last week and the Euro gained 1.4% against the US Dollar to close Friday at $1.303.  The sell-off in the US Dollar is a result, I believe, of the Federal Reserve’s accommodative monetary policy that weakens the US Dollar, and because of the ECB’s own easy monetary policy that reduces the attractiveness of the US Dollar as a safe haven investment.  However, there remain many unknowns about Europe today.  How the EU handles Greece’s continued bailout needs, or Spain’s expected request for ECB intervention in its own bond purchases, and how effectively the EU moves in making meaningful structural changes to the way it governs financial affairs between member countries has to be resolved.  All of these, and more, are issues that will influence markets, including currency markets, over the coming months.    

Commodities pulled back last week with the UBS Dow Jones Commodity index falling 0.5%.  Oil captured most of the commodity headlines as oil prices swung widely during the trading sessions primarily on news of gasoline shortages and rationing in California.  For the week, WTI Oil closed at $89.92 per barrel (-2.4%) for the week and is now down 9% since the start of the year.  A slowing global economy and weakening US Dollar continue to weigh negatively on oil prices.  Gold added $6.30 (0.4%) per ounce to close Friday at $1780.80.  For the year, gold has 13.7% and, I believe, continues to reflect investor concerns over Federal Reserve monetary policy that weakens the US Dollar.


As I noted at the top of this week’s Update, the unemployment report made a splash when announced on Friday with the overall unemployment rate dropping from 8.1% to 7.8%.  This news, however, was accompanied with another weak monthly jobs gain of 114,000.  I am not going to spend time explaining the nuances between the household survey and the establishment survey, or to speculate whether there was political manipulation of the numbers, but I will say that the report was not nearly as robust as it appears on the surface.  I believe the markets agree with this observation because the DJIA only closed up a modest 35 points on Friday.

The household survey, which is the basis for the overall unemployment rate, indicated that 873,000 new jobs were created in September.  This is the largest monthly job gain in 30 years.  What the survey also showed was that two-thirds of every new job was a part-time job.  What prompted a jump of 582,000 part-time jobs?  I think you need to look no further than another statistic that shows 1.2 million long-term unemployed have lost their unemployment benefits so far in 2012.  So while the headline number looks like a strong move in the right direction, the surge in part-time jobs does not lead, I believe, to long-term economic growth necessary to move the Gross Domestic Product (GDP) above 2%.

Another discussion that has been part of the political dialogue this fall has been the effectiveness or lack of effectiveness of the stimulus bill passed at the beginning of President Obama’s term.  Scott Grannis who publishes the Calafia Beach Pundit blog, made an interesting observation this past week.  His breakdown of the $840 billion stimulus spending package showed that 75% of spending went in the form of transfer payments.  Some of the examples he used to illustrate the transfers included the “cash for clunker” program, the first time homebuyer tax credit, education spending, and tax subsidies.  Spending in these types of programs does not create wealth, it simply takes it from one private citizen and gives it to another.  Scott also said that spending for infrastructure and transportation, the “shovel-ready” projects, amounted to only $65.5 billion or just 8% of the overall spending plan.

I put these two observations together to emphasize that economic growth must come from a truly expanding economy where real wealth is being created which in turn supports a growing and robust private sector economy.  This has simply not occurred.  I believe our “plow horse” economy is growing because most Americans get up every day determined to be productive and work hard for themselves and their families.  This is why my faith remains firmly grounded in the American worker and economy.


Banks and bond markets will be closed Monday in observance of Columbus Day.  Stock markets will be open.

Key US economic reports are limited this week.  The International Trade report for August will be released Thursday morning.  Consensus for this report is for the trade deficit to increase by $2 billion from July’s $42 billion to $44 billion.  The larger the trade deficit, the bigger the drag on the US GDP.  Energy imports are a big part of what drives the US trade deficit, and so energy prices do matter.  Additionally, exports can be hurt by weak European and other regional economies. So if we are exporting less due to a slowing global economy and energy imports rise, you get higher deficits.  The Initial Jobless report is also scheduled for release on Thursday morning as it is every week.  Consensus calls for first time claims to reach 370,000.  The Producer Price Index for September will be released on Friday.  This report tracks prices paid by domestic producers of goods and services and gives insight to future prices consumers may end up paying.  Experts are expecting the monthly change to drop from an increase of 1.7% in August to an increase of 0.8% for September.  The year-over-year core (less food and energy) increase is expected to remain unchanged at 0.2%.  As has been the case with most economic data for the past six months or so, the mediocre results are not contributing to a dynamic and robust economy.

The New York Stock Exchange Bullish Percent (NYSEBP) rose 0.40 to close Friday at 66.36.  The recent weekly up and down movement of this critical broad market indicator reflects the uncertainty found in the markets.  However, the NYSEBP is in a column of X’s meaning that demand is in control, and with a reading of 66.36, two-thirds of US stocks on the New York Stock Exchange are in a buy signal.  These numbers favor US stock ownership at the current time.

The Dorsey Wright & Associates analysis of the markets have remained unchanged for most of the summer.  Data indicates 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, Health Care, and Information Technology.  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.