MARKET UPDATE AND COMMENTARY
August 17, 2014


Markets and global events collided during the past couple of weeks creating uncertainty in investors. The Ukrainian situation in particular put markets on edge and increased volatility in the markets. Bond yields, especially in Europe, fell as investors reacted to both geopolitical events and a weakening Euro Zone economy. However, after a disappointing July, many investors experienced a respite with most major equity indexes improving during the first two weeks in August.

The Dow Jones Industrial Average (DJIA) is up 0.6% for the month and has yet again turned positive for the year (0.5%). The broader S&P 500 has shown even stronger performance gaining 1.3% so far in August and 5.8% for the year. The technology-heavy NASDAQ index is the best performing of the major indexes with a gain of 2.2% for the month and 6.9% for the year. The small capitalization Russell 2000 remains the only significant index I track that is still negative for the year losing 1.9% despite gaining 1.9% so far in August. A lagging Russell 2000 index has put this index behind the S&P 500 and S&P MidCap 400 indexes on a trailing one and three year basis for the first time in quite a while.

International markets traded higher as well in August. The Developed Markets and Asia/Pacific regions are up 0.2% in August. The Emerging Market region added 1.2% and the Americas region added 1.3%. For the year, the Emerging Market region leads all other major international indexes with an 8.6% return. Much of the strength in the emerging markets is due to a very solid performance in India (+23.3%) in 2014.

I would venture to guess that the biggest surprise for most economists so far in 2014 has been the steady decline in interest rates. The US 30-year Treasury yield has fallen from 3.97% to 3.13% (84 basis points) and the US 10-year Treasury yield has dropped from 3.03% to 2.34% (69 basis points). This drop in interest rates has pushed the Barclays S Aggregate Bond index up 4.9% this year. As I have said before, I am not happy about the fall in interest rates because of the ramifications on investor behavior (pushing conservative investors into riskier investments), and because of the message it is signaling about future economic growth (not good). However, I do believe that much of the recent demand for Treasuries (and other sovereign debt) is due to investor fears over the increasingly unstable international geopolitical situation.

Commodities continue to lag across most sectors. For the year, Gold is up 8.6%; however, I would not use gold as an indicator of other commodities. I believe gold is much more of a hedge against political and monetary uncertainty. A place for fearful investors to put cash. Most other commodities reflect the more normal supply and demand relationship I expect to see in commodity prices. The Dow Jones UBS Commodity (DJUBS) index is a broad basket index that includes agriculture, energy, metals, and livestock components and gives investors some idea of how commodities in aggregate are performing. Year-to-date, the DJUBS Commodity index is virtually unchanged; however, the index has fallen nearly 8% since the end of June. Double-digit declines in hogs, soybeans, cotton, natural gas, and corn have all contributed to this broad commodity pullback. WTI Oil has fallen 1.2% for the year even in the face of tensions in the Middle East.

WILL SHE OR WON’T SHE?

The latest fear in the rarefied circle of economists (excluding the current geopolitical situation) is whether or not Fed Chairwoman Janet Yellen will wait too long to raise interest rates. A lead story in the Wall Street Journal today (August 17th) postulates that many economists are growing concerned the Fed may lose the initiative on dealing with inflation if Yellen waits too long to begin raising rates. The basis of their argument is that the unemployment rate has fallen faster than expected and that as the slack is taken out of the labor market, wages will start rising and inflation along with it. Does the Fed raising interest rates early next year, mid-year, or late next year really matter? My answer is no, not over the long-term. What matters is how strong our economy is and will be.

My views of the debate mirror those of First Trust Chief Economist Brian Wesbury. He recently described the US economy as essentially two economies—the productive/entrepreneurial economy and the destructive/governmental spend and over-regulated economy. He cites the exploding growth of technology and its positive impact on virtually every aspect of business. This is not a new story. Technology has pushed economic activity and productivity since the advent of the personal computer in the early 1980’s. Today is no different although some of the technologies are. Technology-fueled growth is here today. Unfortunately, government has been working to curtail growth through increased wealth transfer payments and regulations that holds back economic growth. The Environmental Protection Agency’s (EPA) expected ruling reducing the amount of permissible ozone in the atmosphere immediately comes to mind (see Jay Timmons’ August 13th Wall Street Journal letter for a detailed explanation). Let me be clear, I am not taking political sides nor am I advocating a return to the 1970’s when the air was brown in many cities and lakes burned. I am stating that what the government does with regards to taxation, regulation, and laws either contributes or takes away from economic growth, and in my view the government’s action can and is causing a drag on the economy. Today the productive part of the economy is winning, but just barely. I believe this is one of the key factors why the Gross Domestic Product (GDP) has limped in around 2% annually since the Great Recession ended.

You may ask what does this have to do with Janet Yellen? It matters because she is in the position of trying to support a struggling economy through monetary policy. I believe that low interest rates have helped somewhat in encouraging borrowing by businesses and individuals; however, a struggling housing sector remains hampered by factors other than high interest rates. Low interest rates have also helped the Federal government meet its debt obligations which in turn has, for now, postponed the prospect of another budget crises. Ms. Yellen’s decision to start raising interest rates will be driven by her ability to determine when the US economy has strengthened to the point that monetary stimulus is no longer needed. If Ms. Yellen gets it right, the economy will be on solid footing and that will be the real story when she starts raising interest rates and that is good news.

Because of the tremendous uncertainty surrounding the debate on raising interest rates, I hope Ms. Yellen will adequately telegraph her moves to the markets minimizing surprise. I have a couple of key thoughts for you to consider as this debate continues:

 Interest rates remain historically low
 Predicting interest rates is a very inexact science and no one does it well regularly
 At some point the Fed will raise rates, when is anybody’s guess
 The markets may suffer an initial pullback as investors revalue their investments based upon future interest rates
 Stock prices are about corporate profitability, not Fed interest rate policy

Remember that over the long-term markets adapt. Investors will adjust strategies based upon all the known information at the time. I believe investors should invest and not try to predict what the Fed will do month-to-month. There may be more clarity on this subject in the future, but for now, who knows. We will cross that proverbial bridge when we get there. What ultimately matters is the strength of the economy.


LOOKING AHEAD

It is evident that uncertainty is every where these days. Europe, the Middle East, and Ebola concerns in Africa highlight just a few of the more dominant headlines. Uncertainty breeds volatility in markets and I believe we will continue to see nervous markets react to headlines as they break. I also believe the crisis in the Ukraine currently poses the greatest near-term threat (or relief) to markets, but trading on such geopolitical concerns can be a risky one. In Europe I am more concerned about stagnate or shrinking growth.

All of my key DorseyWright & Associates key indicators strengthened over the past couple of weeks. US stocks remain solidly in favor. International stocks actually improved slightly on a relative strength basis mostly on the gains in certain emerging markets. Bond prices clearly improved as interest rates pulled back, and commodity prices continue to slide. This last point about commodity prices is important because food prices are likely to fall as lower pork and grain prices work their way through food distribution channels. A fall in energy prices should help everyone at the gas pump.

The markets are unsettled for sure. It is very tempting to run away from good investments on the basis of all the doom and gloom in the media; however, at times like this it is important to stay focused on the bigger picture. Corporate profits and a



growing economy drive markets, and that is what I care about.




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 S&P MidCap 400® provides investors with a benchmark for mid-sized companies. The index, which is distinct from the large-cap S&P 500®, measures the performance of mid-sized companies, reflecting the distinctive risk and return characteristics of this market segment. 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 sub-indices, measuring both sectors and stock-size segments, are calculated for each country and region.