SPECIAL REPORT

Note: I have been working to publish my Market Update and Commentary on a bi-weekly schedule, and considering my travel schedule, I indicated last week that my next Update would not be published until July 7th. However, I am writing this Special Report to address last week’s market actions.

“Markets are always worth listening to, but sometimes they are also hard to figure. We’ll admit to putting Thursday’s global stock-market and commodities rout in that category.”

--Wall Street Journal Editorial, June 20, 2013

I could not think of a more appropriate commentary with which to begin my Special Report. The sell-off of 560 points (3.7%) in the Dow Jones Industrial Average (DJIA) in just over a day’s worth of trading from Wednesday afternoon through close of markets on Thursday has certainly raised the nervousness level in many investors. Markets sell off all the time, but why would the editorial board of the Wall Street Journal be left to publicly scratch their heads over last week’s action?

The answer requires a look at the Federal Reserve. If you read Federal Reserve Chairman Ben Bernanke’s official statement and listened to his press briefing Wednesday afternoon, his message was very clear. He is suggesting that the economy’s strength, not weakness, is the reason why he feels that the potential exists to consider reducing the level of bond purchases the Fed is making sometime late this year or early next. He also made the strong point that he has no intention to curtail bond purchases and raise short-term interest rates at the same time. He said that he would consider raising interest rates only if the unemployment rate fell to 6.5%. The message of an improving economy by the Fed is typically not the basis for a market sell-off and hence the statement by the Wall Street Journal.

I noted in my last Market Update and Commentary that there was nearly 100% consensus that the Fed would curtail its bond purchase program (also known as Qualitative Easing III) at some point, but there was little consensus of when it would begin. The Chairman clarified his position on Wednesday and the markets sold-off. I am struck by a couple of points of in-congruence between what the markets expected and received, followed by the market sell-off. First, economists and pundits had been criticizing Mr. Bernanke for his lack of clarity regarding QE III following the May Federal Open Market Committee (FOMC) meeting. Now he is being criticized in some circles (including St. Louis Fed Chairman James Bullard) for putting a timeframe and thus clarity around his future actions. Second, many critics of Mr. Bernanke have been saying for some time that the unending bond purchases by the Fed are hurting the future economy. So now when he says that an improving economy may be setting the conditions to allow for slowing and ultimately eliminating QE III, the markets sell off. Mr. Bernanke has been telegraphing his intentions for some time now that steady economic growth—precisely what Mr. Bernanke has be saying would be grounds for curtailment and ultimately termination of QE III, actually gave the markets what they expected. In my opinion, the outcome of last week’s FOMC meeting should be viewed as a net positive.

SORTING IT ALL OUT

While I may believe that last week’s Fed action will ultimately be a good thing, the stock and bond markets are acting like a drug addict going cold turkey. I am using this rather unpleasant analogy because that is the most common analogy I saw used this past weekend in the financial press, and it is a powerful way to try to explain what is going on. The story goes something like this. The economy has become addicted to the easy money that has been provided by the Fed. The economy got a temporary rush of euphoria that has felt great, but the euphoria is false and cannot last. Cold sweats set in when the easy money drug is reduced and ultimately stopped. The addicted economy goes through a somewhat unpleasant withdrawal, but ultimately finds peace and balance without the need of the artificial stimulus. This is a rather simplistic way to look at the markets today, but so far it appears to be accurate.

The rapid rise in interest rates is, in my opinion, the most disruptive aspect of last week. The US 10-year
Treasury yield has now jumped nearly 1% (88 basis points) since the end of April when the 10-year yield closed at 1.666%. Friday it closed at 2.542%. The size and speed of this jump is something we have not

seen in years and is certainly putting pressure on bond prices everywhere (bond prices fall when interest rates go up). I have learned long ago that predicting interest rates is without a doubt the hardest and most inexact endeavor economists undertake, however, as you can see by the chart below, the recent move upwards is barely a blip. This does not diminish the loss of principal bond holders have felt, but it is important that many economists see the 10-year Treasury yield as barometer of future economic growth and inflation, and given the lackluster growth of the economy, interest rates are probably closer to the top than the bottom. That said, I still believe that investors must pay a great deal of attention to their bond portfolios today.

From an equity stand point, I believe that a pause or moderate correction has started. Stocks markets are now off about 5% from the peak towards the end of May. When I look at my key technical indicators, I see the pressure of equity prices easing, but I also see that the momentum has turned enough to suggest that there could be more weakness ahead for the near future. This market is potentially setting up a buying opportunity for investors.

Going into what may again prove to be a volatile week, the prudent investor should check their portfolios security by security. Consider trimming positions if you are surpassing your ability to sleep comfortably at night, or tighten up sell-stops and then let the market dictate which stocks will be eliminated from your portfolio for now. Finally, look at the bonds. For most investors, the goal should be to keep maturities short (less than 7 years), evaluate your bond sectors and think about reducing interest rate risk and focus more on credit risk. I suggest this because in today’s markets, the risk to your bond portfolios losing value due to interest rates rising, in my opinion, is greater than the risk of a company going bankrupt.

In summary, we are in a volatile period. Markets are reacting to the new realities that the Federal Reserve will not be buying bonds forever. However, I believe the message for the markets is a very positive one and I am glad to know that the end of QE III is a possibility. Don’t be complacent—I’m not. Review your portfolios and monitor your holdings, and call me if you have any questions.

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

Market volatility has returned to stock markets these past few weeks, but up until this point, has had minimal impact on US stock markets generally. During the first two weeks of June, the major US stock indexes

rallied in the first week and sold off in the second leaving most indexes within a half percent of where the month started. After reviewing a wide variety of financial publications, there appears to be consensus that uncertainty about when the Federal Reserve will begin to taper back its current bond purchases is causing the most recent volatility. Most investors are hoping that the when Fed Chairman Bernanke speaks this

Wednesday afternoon following the Open Market Committee meeting, he will provide greater clarity about the Fed’s intentions and relieve some of the uncertainty overhanging the market.


Two weeks of trading into June, the Dow Jones Industrial Average (DJIA) is down 0.30% closing Friday at 15,070. The S&P 500 is off 0.25%, the Russell 2000 is down 0.28%, and the NASDAQ has dropped 0.94%. Year-to-date the DJIA is up 15.0%, the S&P 500 is up 14.1%, the Russell 2000 has gained 15.5%, and the NASDAQ is up 13.4%. To put this year-to-date performance into perspective, if the year had ended Friday, the S&P 500 would have its 17th best year out of the past 39 going back to 1975, and the second best year in the past ten. One last data point to consider: since the markets generally peaked around the third week in May, the DJIA is off 2.20%, the S&P 500 is down 2.54%, the Russell 2000 is down 1.66%, and the NASDAQ is off 2.24%. So while we have seen weaker markets, at this point the correction should be considered mild so far.

The top performing sectors over the first two weeks of June were Telecom (2.3%), Consumer Staples (1.5%), Utilities (0.6%), Health Care (0.3%), and Consumer Discretionary (0.1%)—all ahead of the broad stock indexes. Information Technology (-1.6%), Financials (-1.6%), Real Estate (-1.2%), and Energy (-1.1%) were the weakest performers. For the year, Health Care is the clear performance leader with a gain of about 22%, followed by Consumer Discretionary (20%), and Consumer Staples (18%). The weakest sectors for the year are Real Estate (7%), Materials (7%), and Information Technology (10%).

International stocks continue to lag US stocks for the first two weeks of June and the year. The Dow Jones Global Ex-US index is down 2.1% so far in June and is up just 1.9% for 2013. The European-focused STOXX 600 is down 3.2% since the end of May, as is the Asia/Pacific Region. Emerging Markets have been hit hard losing 5.4% over the past two weeks. The news regarding weak economic growth and employment, I believe, is contributing to the current market performance in Europe. The Emerging Markets are struggling with weakness both in Europe and China (China’s economic growth has been slowing all through 2013), and to an extent, the currency devaluation by Japan. The Asia/Pacific region is home for many of the emerging market countries, so it makes sense that this region is under pressure.

US Treasury yields rose last week for the first time in the past seven weeks prompting a bit of a relief for bondholders. The gains were not enough, however, to push the Barclays Aggregate Bond index into the black the month of June. After two weeks, the Barclays was down 0.1% for the month. The best performing bond sectors in June are Short-Term International Treasuries (3.2%), Short-Term US Treasuries (0.6%), and Intermediate Treasuries (0.2%). The weakest bond sectors are High-Yield Municipals (-4.6%), National Insured Municipals (-3.8%), and Preferreds (-2.0%). Municipal bonds of all types have shown weakness and these investor-important bond sectors, I believe, are under selling pressure because of headlines about possible municipal bankruptcies in Stockton, CA, and Detroit, MI. In case you missed Friday’s news, the current trustee for the city of Detroit, Kevyn Orr, announced that Detroit was immediately suspending payments of $35 million on $2.5 billion of unsecured bonds prompting fears among bondholders that this is the first stage towards bankruptcy. Mr. Orr told investors that he would over them around 10 cents on the dollar for their investments or face losing everything. While it is expected that some key investors such as the city worker unions will fight any efforts to reduce payouts or benefits, the economic reality is that Detroit is broke with little hope of surviving without a major restructuring of its debts and obligations. This will be an important test case for numerous other cities that are burdened with overwhelming debt and a possible blue print to handle such situations. This is why municipal bondholders around the country are watching this situation very closely.

The commodity situation has not improved, however, the rate of decline has slowed in June helped by rising oil prices. The DJ UBS Commodity index, a broad measure of commodity prices, fell 0.3% over the past two weeks, but this is an improvement over the 2.3% decline in May. WTI Oil has risen 6.4% this month primarily on fears that the Syrian civil war could be escalating after news from the White House that it would arm the rebel forces. Oil traders are getting nervous that Russia’s and Iran’s involvement in support of Syria’s President, Bashar al-Assad, could result in a broader regional conflict. As of Friday’s close, a barrel of WTI Oil cost $97.85, its highest close since mid-February. Gold prices also rallied slightly last week, but remains down 0.4% for June closing at $1387.60 an ounce. Gold has now lost $208.10 (-17.1%) for the year. Commodities are generally a key barometer about overall global growth as demand increases with economic activity. However, the generally weak commodity prices are in keeping with the very slow pace of economic recovery here and abroad.

TRYING TO READ THE FED’S OUIJA BOARD

Ever since last month’s announcement by Fed Chairman Bernanke that the Federal Reserve could begin to taper its bond purchase program (also called Quantitative Easing III, or QE III) sooner than expected due to an improving economy, markets have been in turmoil trying to figure out just when this tapering would be. I believe I am safe to say that there is near 100% consensus among economists that bond purchases cannot go on forever; however, there is little, if any, agreement about when this latest round of quantitative easing should begin to end and by how much.

I made the case recently that the Fed is really just playing around the edges of the economy, and as much as $85 billion in monthly bond purchases sounds massive, it is actually fairly insignificant in comparison to the multi-trillion dollar bond market here in the US. However, I am also extremely sensitive that perceptions matter as much, if not more, than the actual numbers. Just look at how the European Union (EU) was given a major reprieve last summer when Mario Draghi, president of the European Central Bank (ECB), calmed markets by simply stating that he would do “whatever it takes” to protect the EU and the Euro. Interest rates there fell dramatically and yet he has not had to expand the ECB balance sheet much or make loans to some of the weaker EU countries like Spain. Mr. Bernanke’s actions over the past several years have had a similar calming effect, which is why his comments last month had a meaningful impact on interest rates and has likely contributed to the volatility in the stock markets.

Economists and investors have received little economic data to suggest the US economy is growing at a strong and sustainable rate. In fact, recent data has consistently shown that the economy is stuck in a very modest expansion. Some data sets are good, others not so much, while still others do not show much of anything. However, the economy IS expanding, and I believe that has helped pushed the stock market into decent gains so far this year. The bar of investor expectations has been set very low and any real improvement helps propel the markets forward.

A key data point to consider when trying to decipher the Federal Reserve’s statements is that inflation has remained well below the 2% standard set by the Fed as a trigger point to begin curtailing bond purchases. The most recently published data on inflation show that the current rate of inflation is just 1.2%. As economists and investors digest this number, and the May employment report which pushed the overall unemployment rate up 0.1% to 7.6%, they realize that the Fed may not have to act as soon as many were anticipating to curtail bond purchases. I believe it was this realization that helped push US Treasury yields down slightly last week.

Like it or not, Mr. Bernanke’s news conference this Wednesday afternoon will be of great importance, and how he discusses the timing and scope of curtailing bond purchases will undoubtedly affect the psyche of investors and push the markets around as it has done for the past month. I am not trying to read Mr. Bernanke’s Ouija board, but I do believe he has the obligation to provide clarity to his intentions. Let us hope he does so.

LOOKING AHEAD

Mr. Bernanke’s comments on Wednesday will be the most closely watched economic event next week.

However, there will also be a couple of other key reports that will be indicators of economic growth. Several regional Fed reports on manufacturing activity around the country are due out during the week, the May Consumer Price Index (CPI) and May Housing Starts on Tuesday, and Existing Home Sales on Thursday. Each of the reports are expected to show slight improvements in what is a very, very sluggish economy. The key is to see if the economy is contracting or expanding, and consensus is anticipating a sluggish expansion.

I continue to favor stocks over bonds, currencies and commodities. As those of you who have read my Market Updates and Commentary for some time now realize that my recommendations are based upon the trends I see in the market, not by trying to predict the future. I continue to follow this premise and thus I believe that stocks are favored for now; however, sector selection is critical because strength in this market has been more selective than in recent years. On a relative strength basis, the strongest sectors are Consumer Discretionary, Health Care, and Financials. Energy, Utilities, and Information Technology are the weakest.

Also, as I noted in my last Update and Commentary, summer is traditionally the weakest period for stocks. So far this is holding true and is following the example of recent years. While the first five months of the year were strong, we have seen a pullback in stocks and we are off our highs for the year as I noted earlier. However, I do believe that a pause or even slight correction would be in order at this time although these pauses or corrections are never pleasant when we are experiencing them—even small ones. Looking over my data, it is my opinion that based on the past ten weeks of price history, stocks are actually fairly priced while bonds have sold off significantly. I still feel that bonds remain very expensive and I am cautious about bonds today.

I have not mentioned the G8 Summit in Ireland this week because I do not believe that any meaningful action will emerge from the conference. At best investors can hope that this meeting will get the ball rolling on some meaningful cooperation and trade agreements that will foster growth around the world.

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

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