Monday, October 13, 2014

October 12, 2014

October is off to a tough start. I have no doubt most of you are aware of last week’s volatility so I will not spend time discussing what you already know, rather I want to spend the bulk of this update discussing what led to the selloff, risks, and what my technical indicators are suggesting.

First, a quick market recap.

The Dow Jones Industrial Average (DJIA) fell 466 points (-2.7%) last week closing Friday at 16,544. The size of the daily swings were among the largest of the year. Monday was the “quiet” day with the DJIA losing -18 points. Beginning Tuesday the DJIA swings were off and running losing -273 points, followed by a 275 point gain on Wednesday (best one day gain of the year), a -335 point drop on Thursday (the worst one day loss of the year), and a -115 point drop on Friday. For the year, the DJIA is now down 33 points (-0.2%). Looking at the other major indexes I track the S&P 500 fell -3.1 % last week, the Russell 2000 gave back -4.6%, and the NASDAQ lost 4.4%. For the year the S&P 500 is up 3.1%, the Russell 2000 is down -9.5%, and the NASDAQ is up 2.4%.

Looking at the major economic sectors, Real Estate, Utilities, and Consumer Staples posted positive returns last week likely helped by falling interest rates and the defensive nature of those sectors. Energy, Industrials, Materials, and Technology were the weakest performing sectors losing over 4% each. For the year, Real Estate, Health Care, and Utilities have all posted double-digit gains to lead all sectors; while Energy, Industrials, and Consumer Discretionary are the weakest sectors losing between -2% and -4%.

International markets were all down as well. The European-based STOXX 600 index fell -4%, the worst of the major international indexes I follow. The best performing region last week was the Emerging Markets Region losing just under -0.6%. The broad MSCI EAFE international index fell -2.4% for the week. For the year, the MSCI EAFE index is down -6.6%, the STOXX 600 is off -2.0%, the Emerging Markets Region is up 1.6%, the Asia/Pacific Region is down -2.8%, and the Americas Region is up 1.3%.

The bond market rallied as stocks sold off. The Barclays US Aggregate Bond index gained 0.7% and is up 5.1% for the year. The US 10-year Treasury yield fell 14.5 basis points (a basis point is 0.01%--like a penny to a dollar) to close Friday at 2.29%. This 10-year yield is at its lowest since June 19, 2013. Long-duration bonds, the most interest rate sensitive category, performed well, while credit sensitive bonds like high yield underperformed.

The Dow Jones UBS Commodity index gained 0.2% last week on the strength of gold (+2.4%). WTI Oil continued its slide to close Friday at $85.82 (-4.4%) on weaker global demand and strength of the US Dollar. Natural Gas also fell last week losing -4.5%, while most agricultural commodities managed a slight gain. Falling oil prices are contributing to the weakness in the Energy sector, but will help the average family as gas prices fall.


The consensus within the financial media attributes the current weakness in equity markets to fears of a global slowdown. Most of the attention is on Europe which appears to be heading into another recession. Germany’s 2nd Quarter GDP contracted -0.2%. European Central Bank (ECB) head Mario Draghi’s comments in which he said he was not optimistic about future European growth without structural reform has not helped investor sentiment. Extremely low 10-year government bond rates in the Euro Zone suggest that bond investors share his sentiment. The German 10-year Bund closed Friday at 0.89% and France’s 10-year bond settled at 1.25%. Fears of deflation are resurfacing and Draghi is expected to seek significant infrastructure spending by Germany and other European nations early next week.

I am losing confidence in Europe. The Euro has tied European nations together as never before, but the politicians in the major economies have proven incapable of passing key structural reforms in labor laws and taxation policies necessary, in my view, to get Europe growing again. Draghi gave European politicians time to implement policy changes back in July 2012 when he told the world that he would do everything necessary to save the Euro. Unfortunately, nothing has changed. Time, in my opinion, is running out. I believe another European recession is inevitable and this in turn will affect global economies.

There are several immediate effects here at home. First, the US Dollar has surged relative to the Euro. This hurts US exports to Europe because goods and services now cost almost 10% more than they did three months ago. Second, the Federal Reserve has signaled that it may have to put off raising rates in the US longer than planned over fears that US growth will suffer from a global economic slowdown. Third, if Draghi implements a more aggressive quantitative easing (QE) program in Europe, the value of the Euro is likely to continue falling just as QE here led to a weakening US Dollar. This is not a recipe for global growth, however, I believe some of the negatives will be mitigated here because of cheaper imports, lower commodity prices, and a desire by foreigners to continue investing in the US.

Adding to European concerns, we’ve had confirmation of the first US transmission of the Ebola virus in Dallas. I believe that if the Ebola virus spreads here and in Europe, global economies (not to mention the human toll) will suffer. I sincerely hope the Center of Disease Control’s assurances that they can contain this virus are true, however, if they are wrong, I cannot see how such a catastrophe will not impact the global economy. I am not overreacting at this time, but I am remaining extremely vigilant on this issue.

Finally, the geopolitical situation remains tenuous. Setbacks continue in Middle East, China and Russia appear undeterred, and the absence of North Korea’s premier over the past several months is raising concerns about North Korean stability.

I realize that I have set forth a pessimistic view of the world, but that is where we are today. The markets have taken notice and I believe these are the circumstances contributing to the current short-term weakness in the markets.

While it is easy to focus on all the negative headlines, I want to remind you of the positives. First, the US economy continues to grow. Key economic indicators reflect this strength, however, investors have ignored these facts and sold stocks. Second, my important long-term technical indicators continue to favor stocks. Third, with the recent selloff, most stock categories have reached very oversold levels. In past selloffs, stocks rarely remained at such oversold levels for long before they rallied. While every situation is different, I consider this an important factor. US companies remain strong and I believe they will be able to weather the current weakness, and if the global economy weakens as some predict, I believe the Federal Reserve will have no choice but to hold off raising rates—a positive for markets in the short-term.


I will be watching small cap stocks closely. I believe stability will first appear in this sold off market segment. While I have repeatedly said that higher interest rates represent a strengthening economy, the prospect of delayed rate hikes by the Federal Reserve will be welcomed by most investors.

I also believe that higher interest rates will signal a strengthening economy. If the 10-year and 30-year US Treasury yields start climbing again, the equity markets may follow. Remember, the Federal Reserve does not set longer rates so this observation is not inconsistent with my view that the Fed may hold short rates steady for a longer time.

We will be entering earnings season soon. Corporate profitability is critical to stemming the current slide in stock prices. I will be watching earnings announcements very closely.

Among the key economic reports due out next week, the September Retail Sales report will be published on Wednesday. Consensus is expecting a slight pullback of -0.1% compared to August. I believe any upside report will be well received. Weekly Jobless Claims will be announced on Thursday and this is always a closely watched report. Consensus expects 290,000 new claims which would continue reflect an improving employment situation.

Small cap stocks (Russell 2000) have corrected over 10% from their earlier high this year. Technology stocks (NASDAQ Composite) are off 7.2% from their high in September, and large cap stocks (S&P 500) are off 5.6% from their high. A mild correction at this point.

I fully expect volatility to continue with so many uncertainties facing investors. Volatility is unpleasant, but a natural condition in stock markets. However, I will continue watching my technical indicators for any serious breakdown and I will let you know if and when that happens.

If you have any questions or comments, please reach out to me.

Paul L. Merritt, MBA, C(k)P®, 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. 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.