Friday, February 8, 2013

A series of generally positive economic reports pushed major US and International indexes higher last week.  Monthly jobs gains, manufacturing activity, and continued strength in the housing market were all modestly positive and managed to overcome a stubbornly high unemployment rate (7.9%) and a surprise contraction in the 1st quarter real Gross Domestic Product (GDP) of -0.1%.  Helping to fuel market gains has been the strong inflow of cash back into both the stock and bond markets during the first three weeks of January according to data quoted by Bloomberg and the Investment Company Institute.  With the first major fiscal cliff crisis avoided by Congress, I believe investors have become more confident in the near-term and have begun to take more aggressive investment positions in the markets.  For now, the perceived absence of imminent recession or financial collapse has now propelled markets to highs not seen in five years.

The Dow Jones Industrial Average (DJIA) has gained 6.9% this year (January plus the first day of February) ending the week at 14,010,  The S&P 500 is up 6.1%, the mid and small capitalization-heavy Russell 2000 is up a strong 7.3%, while the technology-heavy NASDAQ Composite index is up 4.1%.  I will have more to say shortly about the old adage, “As January goes, so goes the rest of the year.”

The major US economic sectors are all positive for the year.  Energy leads the eleven economic sectors that I track with a 9.0% gain followed by Health Care, Financials and Industrials.  These top four performing sectors have all out-performed the DJIA at this point.  Information Technology (+3.4%), Real Estate (+4.4%), and Telecom (+4.8%) are the bottom three performing sectors.

International markets have continued to improve along with US markets.  The MSCI EAFE index has posted a 5.8% gain so far in 2013, and the European-based STOXX 600 is up 3.0%.  Growth has been a bit uneven around the globe with the Asia/Pacific region up 2.8% and the Americas region (which includes the US) is up 6.0%.  Developed markets are up 5.6% compared to Emerging markets that are up 3.8%.  Japan, the United Kingdom, and China are all up 7% or better leading most of the world’s countries in performance. 

Bonds overall are down year-to-date as measured by the Barclays Aggregate Bond index which has fallen 0.8%.  With investor appetite in risk apparently increasing, the safe-haven investments such as US Treasuries and Corporate bonds have sold off.  The current yield on the US 10-year Treasury closed above 2% for the first time since mid-April 2012, and the US 30-year closed at 3.223%, its highest level since the first week of April last year.  Surveying the many bond sectors that I follow, the best performing sectors so far this year have been those most closely correlated to the stock market: high-yield, convertibles, preferreds, and emerging market bonds.  The weakest performing bond sectors have been long-duration US Treasuries, corporate, and other high-quality bonds.  I do not think any of the pundits are surprised at the bond market’s performance given increasing investor appetite for risk.

The US Dollar index is down 0.9% a month into the year as investors continue to shed the US Dollar.  This move is consistent with other “risk-on” trades as fears of the European debt crisis subside.  The Euro reached $1.364 marking its highest close since November 2011.  The stronger Euro is now becoming a concern within Europe because this currency shift away from the US Dollar is making European exports more expensive and threatens an already fragile European economy.  Two reporters from the Wall Street Journal, Stephen Bernard and Vincent Cignarella, suggested in their article, “In Currency Wars, Balance Sheets Always Matter, that central banks have more influence than some have thought as currency weaknesses are becoming more and more correlated.  When central banks push massive amounts of cash into their economies as the US Federal Reserve has been doing with its latest round of quantitative easing, their currencies weaken.  For those of us who believe in the most basic economic theory of supply and demand, this makes perfect sense.  The more of anything will lower its value.  The Japanese Yen has weakened significantly against the US Dollar (-5.7% year-to-date) as the new Japanese prime minister has publicly called for new massive quantitative easing since his election last December.  While it may be too early to say if these trends will remain in place for any length of time, they certainly are worth watching.

Commodities continue to lag in 2013.  The Green Haven Continuous Commodity index, a broad commodity index, fell last week and is up just 2.8% for the year.  WTI Oil, however, continues to rise closing Friday at $97.77 per barrel.  I have no doubt that you have seen the price of gas moving steadily higher at the pump.  For the year, WTI Oil is now up 6.6%.  Gold finished Friday at $1670.60 per ounce and is now down 0.2% for the year.  I believe that gold has found a near-term equilibrium in demand and supply, and it remains to be seen if a catalyst comes along to move the price much higher or lower. 


The S&P 500’s gain of 5.0% last month is the twelfth best start to a year since January since 1950.  Naysayers can point to the recent 4th quarter GDP growth (-0.1%) and chronically high unemployment as two key statistics that suggest there is a certain irrationality in this move.  I share a degree of skepticism about the long-term strength of the US economy, but I believe investors are shaking off their most ardent fears about pending economic calamity and realizing that even with the dysfunctional state of US fiscal policy, the US economy is still plodding along in spite of ourselves. 

Now that we are past the first fiscal cliff, I believe the consensus of professional economists and money managers continues to be that Congress will come to yet another compromise after much rancor and demagoguery.  The solution will not likely address the key fundamental issues of an ever-expanding Federal appetite for spending, but I believe it will offer some relief from the uncertainty that has created so much fear in investors.  I am doubtful that we will see a robust economy in 2013, but there is no indication at this time that we will fall into another recession.  And since most investors thought another recession was just around the corner, stocks and other risky assets were abandoned and even completely avoided by many investors.  This sentiment is translating into greater risk-taking in financial markets.

Evidence of improving investor sentiment comes from the analytical service, Lipper, Inc., that just reported flows into managed stock investments grew to $34.2 billion over the past four weeks exceeding the net gain for all of 2012 and was the largest four-week inflow since 1996.  Statistics like this help explain the solid gains in major market indexes, but they are also considered a warning sign by market skeptics.  I also believe that as we approach the all-time high of the DJIA, the media will be full of stories suggesting that the markets are severely over-valued.  We are all influenced by our recent experiences of 2007 when the DJIA passed 14,000 only to see a market correction of over 50% in 2008 and 2009.  Will we hold here—that is a big unknown; however, the climate of fear has subsided and more and more investors are jumping back into stocks in a big way for the first time since the Great Recession.  In my opinion, moving through and staying above 14,000 will be an important positive signal.


At the top of this report I repeated an old investor adage, “As goes January, so goes the rest of the year.”  The most recent data published in the Stock Traders Almanac: 2013 (page 16), notes that this adage has been wrong just seven times in 62 years.  The most recent error occurred in 2009 when the S&P 500 was down 8.6% in January and ended up 23.5% for the year.  The last time January had a positive start and the S&P 500 ended down for the year was 2001.  I would never suggest that after such a great start to the year we will undoubtedly finish up at the end of the year, I do believe the odds seem to indicate we have a better chance of ending the year on a positive note.  As interesting as these types of adages are, I rely on technical indicators to guide my investment decisions, not an old adage.

As pleased as I am by the start of the (Source:  Dorsey Wright & Investments) year, I am also highly aware that markets do not move straight up or down over the course of days, weeks, or months.  I believe there will most likely be corrections during the course of this year, and how severe a correction turns out to be is ultimately determined by factors that we are completely incapable of knowing ahead of time.

The New York Stock Exchange Bullish Percent (NYSEBP) closed Friday at 74.06 marking the fourth consecutive weekly gain.  It is also an indicator of the elevated risk currently in the markets.  Any reading over 70 suggests that markets may be poised for some kind of pullback, but not necessarily tomorrow.  On average, the NYSEBP remains above 70 for 96 days.  It also reminds us of the recent strength in the market, and US Stocks continues to be the most favored of the five major asset categories I follow.  The International Stocks category just passed Bonds to assume the number two position pushing Bonds to third.  Foreign Currencies remain in fourth position and the Commodities category remains firmly in last place.

The CBOE Volatility index (VIX) decreased again last week to close at 12.9.  The VIX is an indicator of investor nervousness of future market changes, and the current reading suggests that the probability of a major market sell-off is subdued in the very near term.  I must remind readers that the VIX is also one of the most volatile indices in the markets and can change sharply in a down market.
My Dorsey Wright & Associates analysis suggest that 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 is in fourth position followed by Real Estate.  With the struggles of Apple, Information Technology has moved from sixth to ninth place.  Energy and Utilities are 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.

The coming week has relatively few major economic reports due to be released, however, the following week will see the all-important January Retail Sales announcement on February 13th and January Industrial Production due out on the 15th.  Consensus numbers have yet to be released for either of these reports, however, they will be important as an early barometer on how the first quarter GDP number may be headed.

As always, it is imperative to be vigilant and not to let the recent market strength lull you into a false sense of expectation that the markets will continue to rise at these most recent rates.

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

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

P.S.  If you think this type of analysis would be of benefit to anyone you know, please share this communication with them.

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.