Tuesday, November 5, 2013

MARKET UPDATE AND COMMENTARY
November 3, 2013


Despite media expectations to the contrary, the sky did not fall, the sun came up, and life as we know it did not end in October.

For the month of October the Dow Jones Industrial Average (DJIA) finished up 2.8%, the S&P 500 added 4.5%, the NASDAQ gained 3.9%, and the Russell 2000 trailed with a 2.4% gain. This does not mean there were not some tense moments along the way. The cacophony of doom and gloom reporting surrounding the budget and deficit talks in Washington was deafening; however, when the dust cleared, we survived. Our political leaders have yet again kicked the can down the road until after the first of the year, when the political fighting is expected to emerge again.

President Obama has officially nominated Janet Yellen to assume the Chairmanship of the Federal Reserve, but expect some political fighting during the nomination process. Ms. Yellen is expected to continue the more accommodative monetary policies (translation: low interest rates and continuation of bond buying) of her predecessor, Mr. Bernanke. In the meantime, some positive economic data in the manufacturing sector late last week brought out a chorus of pundits suggesting that the Fed will have to start reducing (tapering) bond purchases sooner than anticipated (late 2013 vs. spring 2014). While I have argued many times that the Fed is NOT responsible for the strength of the stock market this year, I believe there remains a strong psychological crutch associated with the Fed’s policies and investors’ perception of market strength. It is unclear what impact pulling this crutch will have on the markets once some form of tapering actually begins.

I fully expect Ms. Yellen’s nomination process, taper talk, and the next round of budget/deficit negotiations on Capitol Hill to increase investor worries and with it, greater volatility over the next three or four months.

ASSESSING WHERE WE ARE TODAY

I am struck by how quickly the end of the year is approaching. My wife, Virginia, recently posted on Facebook that one of our local easy listening radio stations is already playing Christmas music 24/7. Wow. What happened to Thanksgiving?

With just eight trading weeks remaining in the year, I want to do a quick recap of where we are today.

The major US stock market indexes are all up nicely for 2013. The DJIA is up 19.2%, the S&P 500 is up 23.5%, the small and mid-capitalization heavy Russell 2000 is up 29.0%, and the tech-heavy NASDAQ has gained 29.9%.

Returns are not shared equally between the eleven major economic sectors I follow. The Consumer Discretionary sector leads all with a gain of nearly 36% for the year. Health Care and Industrials follows with gains of 35.6% and 32.3% respectively. Real Estate, Utilities, and Materials have been the weakest sectors with year-to-date returns of 5.6%, 13.3%, and 17.7% respectively.

Bonds have been very disappointing for most investors. The Barclays US Aggregate Bond index, which is a representation of a cross section of US bond sectors, is down 1.2% for the year. Much of this poor performance is attributable to the rise in interest rates (when interest rates rise, bond prices/values fall). The benchmark US 10-year Treasury yield began the year at 1.76% and closed October 31st at 2.55%--an increase of 79 basis points (one basis point is equal to 0.01%). Interest rates have tended to trend along with investor sentiment of when the Federal Reserve is likely to start tapering. Low risk of tapering, lower interest rates; greater expectations, higher interest rates. Not all bond sectors have been negative for the year, however. The High Yield and Bank Loan bond sectors have been notable exceptions with total returns of 6.0% and 4.8% respectively. Long Government, Inflation Protection, and the Emerging Market bond sectors have been the weakest losing about 9.9%, 6.4%, and 5.6% respectively (source: Morningstar).

International markets have quietly shown some strength this year, particularly in the European region where the STOXX 600 has gained 15.3%. While the Emerging Markets region has rebounded a bit in the last couple of months, it remains down 2.6% for the year. Small and mid-capitalization international stocks have led all sectors within the international category.

Commodities continue to struggle and remains the weakest of the six major asset categories I follow. The Dow Jones UBS Commodity index, a broad measure of commodities, has lost 10.9% year-to-date. Within the commodity space, gold has been a major loser posting a decline of 22.4% with WTI Oil up just 3.2%. However, WTI Oil has been particularly hard it recently posting a 10.4% drop since August 30th.


I have recently noticed that there has been an increasing sense of worry over the strength of equity markets; however, this negative sentiment has been prevalent most of the year as equity markets posted solid gains. We have just completed what historically has been the weakest six months of the market, and the S&P 500 posted a 9.95% gain. When compared to other periods (back to 1954) where the S&P 500 managed to gain 10% or more over this same time frame, the S&P 500 on average added another 14.9% over the subsequent twelve months and 24.1% over the next two years (source: DorseyWright & Associates). While past performance is not indicative of future performance, it does offer a compelling argument that momentum can continue for a while.

As I have discussed before, I watch the relative strength of the Money Market sector compared to the other 131 sectors I track, and Money Market currently ranks 116 out of 132 (bottom 12%). In simple terms, this means that 115 categories are beating Money Market on a relative strength basis. Think of cash today as the market’s equivalent of pro football’s New York Giants. If I see this relationship begin to change, I will certainly let you know.

LOOKING AHEAD

The dysfunction in Washington remains. This is not good for our country nor is it good for business. However, sound investing requires a tin ear when it comes to listening to the pundits and media. Much relevant data indicate that the economy is growing not contracting. In this environment, that is what is necessary for the markets to continue to gain or avoid a major (>10% correction) in my view. Growth could be much better, but broad, slow growth does remain. So while I am not discounting the potential impact of the political battles our nation is currently enduring, I am also not losing sight on the momentum the equity markets are currently carrying.

I will repeat what I have been saying all year. US stocks remain the favored major asset category as tracked by Dorsey Wright & Associates. US stocks continue to hold the number one position while the International stocks asset category is a solid number two. Fixed-income is in third place, Currencies is fourth, Money Market is fifth, and Commodities remain in last place where this category as been since June 21, 2012. Small and middle-capitalization stocks are preferred over large-capitalization stocks. Equal-weighted indexes are preferred over capitalization-weighted indexes. Within the Fixed-Income category, high yield and bank loan bond sectors are favored, while energy is now favored in the weak Commodities category.

I currently favor the Consumer Discretionary, Health Care, and Industrials sectors. Within the sub-sectors, I like the Technology (Internet) and Biotech sectors.

Looking at key economic reports for the coming week, the first estimate of the 3rd Quarter Gross Domestic Product will be released on Thursday morning. There is great uncertainty around the consensus of this number and the Wall Street Journal’s estimate ranges from 1.5% to 2.7%. As a matter of comparison, the first quarter and second quarter official growth rates were 1.1% and 2.5% respectively. The October Employment Situation report will be released on Friday with a slight decline in jobs over the previous month expected. There may be some discussion regarding the impact on the employment numbers due to the temporary closure of the federal government in October. All of these reports will be parsed in order to draw some indication of whether or not a strengthening economy will cause the Federal Reserve to begin tapering its bond purchases earlier than the late spring consensus.

On a personal note, you may have noticed that I missed publishing the Market Update and Commentary last week. I was in Chicago sitting for my C(k)P Certified Professional 401(k)® designation exam which I am happy to announce that I passed. This rigorous course of study is sponsored by The Retirement Advisor University in conjunction with the UCLA Anderson School of Management Executive Education.

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




Paul L. Merritt, MBA, C(k)P®, AIF®, CRPC®
Principal
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. The Dow Jones Global ex-US index represents 77 countries and covers more than 98% of the world's market capitalization. A full complement of subindices, measuring both sectors and stock-size segments, are calculated for each country and region.