Tuesday, February 19, 2013

After getting off to a strong start in January, equity markets have been flat so far this month.  No February surge to follow January’s move, but nor has a pullback occurred as many pundits have been suggesting is eminent. Economic data released over the past two weeks has offered no clues, no scintillating pieces of evidence that the economy is getting ready to break out into another great round of growth; but there is also no evidence to suggest that we are on a brink of another recession.  Economic data that has been released since the first estimate of the 4th Quarter 2012 Gross Domestic Product (GDP) (Q4 2012 GDP: -0.1%) now suggests 4th Quarter real GDP growth was positive in the 0.4% to 0.7% range.  Nothing to get excited about, but not a recession either.  Attention has now shifted to Washington (again) as worries about another budget crisis begin to build (again), and a looming deadline approaches (again).  More on this shortly.

The Dow Jones Industrial Average (DJIA) failed to close the week above 14,000 for the second week in a row since closing Friday, February 1st, at 14,010.  This past Friday, the DJIA ended the week at 13,982 giving back 11 points (-0.1%) for the week.  For the month, the DJIA is up 121 points (0.9%); however, if you strip out the 149-point gain on February 1st, the DJIA is now down 28 points (-0.2%) for the month.  Clearly a pause.

The other main US indexes I follow have also remained in positive territory in February.  The S&P 500 gained 0.1% for the week and is up 1.45% for the month.  The Russell 2000 added 1.0% for the week and is up 2.3% for the month, while the NASDAQ Composite fell -0.1% for the week but is up 1.6% for February. 

Seven trading weeks are now completed for 2013 and the DJIA is up 6.7%, the S&P 500 is up 6.6%, the Russell 2000 has gained 8.7%, and the NASDAQ is up 6.1%.  A good start to 2013.

The eleven major US economic sectors were mixed last week reflecting the general uncertainty about the overall direction of the markets.  Industrials, Financials, and Real Estate were the best performing of the eleven sectors and all easily out-performed the S&P 500.  Telecom, Energy, and Information Technology were the weakest sectors and finished in slightly negative territory for the week.  Energy, Industrials, Health Care, and Financials are the top four performing sectors and have all gained between 8% and 9.5% for the year.  Telecom, Information Technology, Materials, and Real Estate are the bottom four performers; but all have posted gains between 2% and 5.5%.  Much like last year, year-to-date spread between the best performing sector and the worst is not wide by historical averages, and every sector has positive returns.

Sounding a bit like a broken record from last year, International markets have continued to improve along with US markets, but lagged in the process.  The broad international index, the MSCI EAFE, fell 0.6% last week but is up 3.7% for the year.  The European-based STOXX 600 was unchanged over the previous week and is now up 2.7% for the year.  Europe remains under great economic pressure as growth in most countries remains very elusive.  However, much like here in the US, I believe investors’ expectations are so low that any growth or even continued survival of the European Union (EU) will be considered a victory and rewarded by investors.  The Emerging Markets were off 0.1% last week and are up 2.3% for the year, while the Developed Markets were off 0.1% last week and have gained 5.1% for the year. 

Bonds remain stuck in neutral.  The Barclays Aggregate Bond index, a broad indicator of the US bond market, was essentially unchanged last week and is now down 0.7% for the year.  US Treasury yields have continued to creep upwards at a very slow pace.  The US Treasury 10-year yield closed Friday at 2.010% compared to the previous Friday’s close of 1.949%, and is up from last year’s close of 1.758%.  The US Treasury 30-year has followed a similar pattern as the 10-year and the future direction of bond yields is generating a great deal of debate in the media about the painful end of the bond “bubble.”  This is an important topic for many investors given the size of their bond investments, but too long to address here; however, I will be focusing on this subject in the market commentary part of my Update in the very near future.  I will offer this one comment today—with the Federal Reserve committed to an accommodative monetary policy, it would be very difficult, in my opinion, to bet heavily against bonds right now.  The best performing bond sectors include Preferreds, High Yields, and International.  Extended duration bonds of all types (Treasuries, Government Agencies, and Corporates) have all underperformed.

There has been a lot of news lately about currencies going into the G-20 Summit this past weekend in Moscow.  Japan is just the most recent country to draw the ire of global finance ministers as Japan has publically embarked on a policy of currency devaluation in order to increase exports.  The Japanese Yen has fallen 7.8% compared to the US Dollar since the start of the year.  The leaders from the G-20 are expected to release a statement specifically calling for greater verbal discipline among the world’s largest economic leaders and to not use currency manipulation as a specific economic tool for growth.  Monetary policy has a major impact on currency valuations even if economic leaders like US Federal Reserve Chairman Ben Bernanke minimize its impact suggesting that a weaker US Dollar is but a side effect of this country’s efforts to grow our domestic economy.  Mr. Bernanke has very publicly stated that getting the US economy growing (with the aid of easy monetary policies) will clearly offset the negative aspects of a weaker US Dollar to our trading partners.  The US Dollar index is up a modest 1.6% in February on a weakening Japanese Yen (-1.95% to the US Dollar) and Euro (-1.62% to the US Dollar).  While I admit that currencies are not the most exciting topic I write about, currency valuations have important consequences on every aspect of US and global economic growth.  I will continue to follow topic issue closely.

Commodities continue to lag in 2013.  The Dow Jones UBS Commodity index, a broad commodity indicator, fell 1.4% last week and is now down 2.2% for the month of February.  Nearly every major commodity category fell last week led by Gold which lost $59.60 (-3.6%) an ounce to close Friday at $1607.30.  The fall in gold was attributed mostly to reports citing several large gold investors, like George Soros, who announced cuts to their gold holdings.  WTI Oil pulled back slightly for the first weekly loss of the year.  A barrel of WTI Oil closed Friday at $95.40 down $0.32 (-0.3%) from the previous Friday’s close.  For the year, the Dow Jones UBS Commodity index is up 0.1%, Gold is down 4.0%, and WTI Oil is up 4.0%. 


After much reading and analysis regarding sequestration and the impact on the US economy, I have come to the conclusion that it is all much ado about nothing.

As a proud veteran and patriot, I am not happy about the continuing real cuts to the Pentagon’s budget, and I believe that Congress must address defense spending very carefully; however, from a broad economic impact there is little to fear.  I also believe that the financial markets have come to the same conclusion, which is why I do not think markets will react negatively if sequestration goes into effect.

When I conducted a Google search using the term “true impact of sequestration,” I received 1.3 million hits, and quickly discovered that the search results were dominated by reports from special interest groups about how devastating sequestration-related cuts will impact them or the programs they strongly support.  I get it.  There will be pain, but in the total context of the economy, sequestration represents a little more than 1% of federal spending in 2013 according to the Congressional Budget Office.  Does this mean this makes any sense on how to run the government of the largest economy in the world?  Of course not, and politicians from both sides of the aisle should be embarrassed by such incompetent governance, but devastating to the economy—not so much.

On another note, I also believe that some investors hate success.  By that I mean the moment the markets began closing in on a 14,000 DJIA, the naysayers immediately began suggesting that markets were overpriced and set for a correction.  I would not discount the likelihood that a pullback could happen at some point, but I also understand that the technicals in the economy remain positive.  All of us are acutely aware of what happened the last time the markets passed 14,000 in the summer of 2007, and investors must not let a simple number detract from making sound investment decisions.

Please do not interpret my comments to mean that I am an endorsing a belief that markets are immune from the realities of many of the headwinds facing our country today.  I am not suggesting that at all, however, I am also aware that it is completely possible to become frozen by our fears today and that in turn could lead to inaction.  I am more confident in data than headlines, and coupled with your individual needs and risk tolerance; analysis of data helps guide my investment analysis and recommendations.

Investors are nervous.  They are nervous because of the impending sequester, they are concerned about the rising price of oil, they are worried about the unemployment rate, scared that Washington is completely broken, that slow economic growth in the US is here to stay, of recession in Europe, and they are afraid that Israel and Iran may go to war.  I am sure I have forgotten something, but you get my point.  There is much to be aware of and keep in mind, but I suggest that worries and fear are always part of the investment process, so let’s focus on what we know and deal with that effectively.

The New York Stock Exchange Bullish Percent (NYSEBP) closed Friday at 74.99 rising slightly from the close last Friday of 74.53.  This marks the seventh straight weekly increase in this important indicator.  The rate of growth has slowed, but that should be expected after the NYSEBP moves above 70.  Remember that risk increases in the market when the NYSEBP is greater than 70, but the demand for stocks (buying pressure) remains firmly in place and the markets have risen along with this demand.

US stocks remain firmly in first place among the five major asset categories Dorsey Wright & Associates analyzes on a relative strength basis.  The International stocks category is second, followed by Bonds, Currencies, and Commodities.  When Cash is added, it assumes the number five position just ahead of Commodities.  The International stock category continues to separate itself from Bonds as bonds stagnate and international stocks continue to provide positive gains in 2013.

The CBOE Volatility index (VIX) closed at 12.42 this past Friday falling from last Friday’s close of 13.02.  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.

The 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: Consumer Discretionary, Financials, and Health Care.  Financials and Health Care exchanged places since my previous Market Update and Commentary.  Industrials remains in fourth position followed by Real Estate.  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 next two weeks will have a number of important economic reports.  Housing will be the focus of next week, while Fed Chairman Ben Bernanke is expected to address Congress on February 26th and 27th, and the first revision of the 4th Quarter GDP report will be announced on Thursday, February 28th.  Other key reports include the January Consumer Price Index (21st) and the February ISM Manufacturing Index (March 1st).  As I noted earlier, the GDP report will be closely watched and a positive revision is expected.  Other reports are not expected to show much change from previous readings.

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.