Tuesday, January 22, 2013

US markets continue their positive performance and are now up the first three weeks of the New Year.  Investors appear to be taking the contentious negotiations in Washington in stride focusing more on 4th quarter earnings releases than political jawing.

The Dow Jones Industrial Average (DJIA) gained 161 points (1.2%) last week and is now up 546 points (4.2%) for 2013.  The S&P 500 added 1.0% last week, the Russell 2000 added 1.4%, and the NASDAQ managed only a 0.3% gain.  For the year, the S&P 500 is up 4.2%, the Russell 2000 is up 5.1%, and the NASDAQ is up 3.8%.

Nine of the eleven major economic sectors posted positive gains last week with only Telecom (-1.3%) and Information Technology (-0.4%) with negative returns.  The best performing sectors so far in 2013 are Energy, Industrials, and Consumer Discretionary which have all gained between 5% and 6%.

International markets were mixed with the MSCI EAFE losing 0.1% for the week pushed down by weaker European market performance.  The Euro-centric STOXX 600 index was down 0.2% for the week.  For the year, international stocks have fared well but lag the US.  The MSCI EAFE is up 3.2% and the STOXX 600 is up 2.6%.  There has been no clear delineation in market performance between Emerging and Developed Markets thus far in 2013.  I believe the theme for international markets over the next few months will be for Europe to swing its focus away from keeping the Euro Zone from imploding towards generating economic growth, and to see if China can help drive global growth through domestic demand.

Bonds have gotten off to a rather sluggish start for the year.  The Barclays Aggregate Bond index is down 0.2% for the year as US Treasury interest rates have risen.  The 10-year rate has moved from a year-ending 1.758% to 1.840% close last Friday.  The 30-year rate has moved from 2.949% to 3.024%.  High yield, preferreds, emerging market debt, and intermediate municipals are the best performing bond sectors early in 2013.

The US Dollar has shown a little weakness against the Euro falling just under 1% in 2013 and closed Friday at $1.332.  Analysts suggest that the Euro’s strength may be a bit overdone given the extreme weakness of the European economy, however, the European Central Bank (ECB) continues to maintain its short-term lending rate a 0.75% which gives the Euro a slight advantage over the US Dollar.  The Federal Reserve continues to set the overnight lending rate (also known as the Fed Funds Rate) at roughly 0.15%.  The Yen continues to weaken (-3.7% in 2013) as Japanese leaders have publicly committed to devaluating the Yen through major asset purchases (bond buying similar to the US Federal Reserve’s current monetary policies). 

The Dow Jones UBS Commodity index gained 2.1% last week posting its second positive week in a row and is now up 1.7% for the year.  Oil was up 2.1% last week and is now up 4.2% for the year.  The price of a barrel of WTI Oil closed Friday at $95.56 and this price has been steadily climbing since mid-December.  Gold added $26.40 per ounce to close Friday at $1687.00 and is now up a modest 0.75% (12.50/ounce) in 2013.  Looking at some of the other key commodities, Natural Gas was up nearly 7% during the week, Silver gained 5.0%, and Sugar fell 5.1%.


I am an avid consumer of economic and financial news.  During the course of any given week, I read dozens of articles, white papers, and blogs.  I also squeeze in a book or two each month.  Besides keeping me informed of the latest news, I have also discovered that over time I have developed a perspective that helps me feel the pulse of what is going on.  I have learned to know which economists get it right more often than wrong, what publications consistently produce thoughtful analysis, and what indicators provide insight into what people are really thinking.  Only three weeks into the New Year, I want to share with you what I am sensing this weekend.

RED FLAGS:  Each time the DJIA approaches a historical high, writers start producing articles like the one this weekend in the Wall Street Journal titled, “Is All This Stock Market Optimism a Red Flag?”  The reporter, Joe Light, highlights how investors pushed more money into managed stock investments in the one-week period ending January 9th compared to any one-week period since January 2008.  He also cites surveys of investor sentiment which indicate that investors are more bullish today than they have been in a long time (which explains the move into stocks).  Mr. Light’s conclusion is that investors should run in the opposite direction of the herd—sell when everyone is buying.  Mr. Light is not alone, but does the herd mentality found in reports at times like this serve as a credible warning sign to you?

Let’s look at where the markets stand going into this week.  The DJIA closed last Friday 630 points (4.4%) below its all-time intra-day high of 14,279.96 on October 11, 2007.  According to Dorsey Wright & Associates, the overbought/oversold reading of the DJIA is presently 70% overbought.  High, but not extraordinarily so.  The New York Stock Exchange Bullish Percent (NYSEBP) is 70.13.  Any reading over 70 is considered to be higher risk, so this important indicator is reflecting greater risk in the US stock market.  The CBOE Volatility Index (VIX) is at 12.46 substantially below its 200-day moving average of 22.48.  So from a completely technical view of the US stock markets, it looks to me like the markets have become a bit overbought, risk is increasing but not overblown, and options traders are telling us via the VIX that the likelihood of a very sharp sell-off is muted at this time.  This is not the scenario to start selling stocks just because other investors are now realizing that stocks are an attractive place to be, however, I am very aware that the risk of stalling or a small correction is building.

RUSTY CANS:  President Obama will be sworn in for his second term this weekend.  He is making some changes to his cabinet, but based upon comments I heard him make last week, I see no likelihood that he will alter his agenda regarding spending and borrowing that has been the hallmark of his first term.  The Republicans have shown no ability to sway the president or influence his policy agenda, they control the House and lost a couple of seats in the Senate.  The Federal Reserve is unchanged and committed to their accommodative monetary policy.  In short, nothing has changed in Washington and I expect more of the same in 2013 as we have seen in the past two years. 

Mohamed  El-Erian of PIMCO  wrote an excellent article published on January 15th titled, “How Game Theory Explains Washington’s Horrible Gridlock.”  In this article, he describes the brinkmanship we have all observed in Washington as predictable by understanding gaming theory.  I will not go into the details of gaming theory he discusses, but I will share with you his conclusions:  1) there will be more political drama coming over the next few weeks, and 2) “At best, we will get by March a last-minute compromise that kicks most of the issues down the road; at worse, this will materialize after disruptions that sap more energy out of the economy.  Whatever the outcome, Congress will again contribute to the persistence of sluggish growth, high unemployment, legitimating concerns that these will be further embedded in the structure of our economy for too many years to come.”  As I have said, just more of the same.

YOU:  Even with all of the doom and gloom that the media has generated regarding the economy, for now, is growing.  Dorsey Wright & Associates conducted some research and has studied the growth rate of the Gross Domestic Product (GDP) and the S&P 500 performance following the last four recessions.  Their findings in the adjacent table may surprise you.  This most recent recovery has had the smallest GDP growth but the second best market performance.  You can conclude from this data that the strength of the US economic growth has not always been a good indicator or stock market performance.  The reasons behind this seemingly incongruent correlation make for lively debate and speculation.  However, as I have said repeatedly in my Updates, it is more important to be in the market and make as much money as you can given your risk considerations than to invest strictly on red flags, money flows, or the craziness that surrounds our political class in Washington.  So using the tools like those at Dorsey Wright, I believe it is possible to stay focused on the markets and your portfolios rather than try to explain the unexplainable.


Now that the inauguration is over it will be time for our political leaders to come back to the negotiating table to hammer out an agreement regarding the debt ceiling and sequestration.  If Mohamed El-Erian is correct, we will get a lot of drama and not much progress on the fundamental issues facing the country.  We will continue in a manner similar to the preceding few years and will leave the tough decisions about spending reform to a later time.  More of the same.

Reviewing the recent economic data there has been little evidence that there is any change to economic growth either up or down.  The Initial Jobless Claims report last Thursday showed a sizable drop in first-time claims, however, the December Consumer Confidence Index fell unexpectedly reflecting a nervousness among most Americans about the future.  This coming week, December Existing (Tuesday) and New Home (Friday) Sales will be released.  These important reports are expected to show continuing strength.  The following week will have the all important first estimate of the 4th Quarter GDP (January 30th) and the January Employment Situation (February 1st).  Both reports are expected to reflect the current plow-horse economy with no major changes.

As I indicated earlier, the NYSEBP closed Friday at a very strong 70.13.  This move is significant because it broke a series of lower highs that had been in place since early 2012.  It is important to understand that the NYSEBP may remain at elevated levels for many weeks and does not indicate that a sell-off or correction is imminent, only that the risk for such a move has increased.  I remain very encouraged by the recent strength in this key indicator.

 The Dorsey Wright & Associates analysis of the markets remained unchanged last week.  Among the major asset categories, US Stocks are ranked first, followed by Bonds.  International Stocks are in the number three position and moving closer to overtaking Bonds.  Currencies remains in fourth position while Commodities is in last position.  When Cash is included, Commodities falls to sixth place and Cash is fifth.  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.  On a relative strength basis, the top three major economic sectors are unchanged: Consumer Discretionary, Health Care, and Financials.  Industrials has risen to the fourth spot pushing Real Estate to fifth position.  Information Technology has moved from sixth to eight as this sector continues its recent struggles.  Energy and Utilities remain in the bottom two sectors.  US Treasuries and International Bonds are favored in the Bond category, while US and Developed Markets are favored within the International stock category.  Energy and Precious Metals are the favored sectors within the Commodity category.

My next Market Update and Commentary will be published in two weeks. 

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.