Tuesday, November 11, 2014

November 9, 2014

The 2014 mid-term elections brought sweeping changes to the US political landscape with the Republican Party reaching levels in Washington, DC, not seen since the late 1940’s. State elections were equally profound with the Republicans winning governor races in some of the bluest states like Maryland, Illinois, and Massachusetts. Although the Republicans did not run a national campaign, it is clear from a state and local level that voters elected individuals promising to address the economic stagnation felt by many workers. It is too early to tell if Republicans will be successful in delivering on their promises, but I think we will certainly see a very different Congress in January.

Most key US equity markets posted gains over the past three weeks:

Source: The Wall Street Journal (Past Performance is Not Indicative of Future Returns)

Positive economic statistics and corporate profits contributed to recent market gains; however, I also believe investors were beginning to sense that the status quo in Congress was about to end.

International stocks continue to struggle. The broad international MSCI EAFE index was off -1.01% last week and the European-heavy STOXX 600 fell -0.46%. The European Commission cut its outlook for Euro zone growth on November 4th predicting the region will grow just 1.1% in 2015 compared to its forecast of 1.7% six months earlier. The European Union (EU) managed to stem a major confrontation when the French and Italians pledged budget adjustments to improve their 2015 debt forecasts delaying the sanction of fines for violating the Growth and Stability Pact for now; however, these countries will remain under scrutiny to insure they deliver on their pledges. All of this is putting pressure on Mario Draghi, European Central Bank President, to adopt a US-styled quantitative easing program. While the effectiveness of quantitative easing (QE) remains uncertain and will be debated for years to come, I believe two likely outcomes of the Europeans expanding their own QE will be a continued weakening of the Euro (helping exports to the US and other non-EU countries), and further delays of meaningful fiscal policy changes. Without significant fiscal policy changes in labor and tax laws, I believe the EU will struggle to create the growth necessary to overcome the current economic lethargy.

Bond yields edged slightly downward this past week after two weeks of increases. The US 10-year Treasury yield fell -3 basis points (a basis point is .01%--similar to a penny to a dollar) to close Friday at 2.30%. Despite the slight decrease in interest rates, the broad Barclays US Aggregate bond index managed to post a 0.1% gain for the week and is now up 5.5% for the year. The decline in interest rates came following the release of the October Employment Situation report that indicated a gain of private sector jobs of 214,000 compared to an expected increase of 240,000. Additionally, weekly hours worked remained unchanged at 34.6 hours, and wages increased 0.1% compared to an expected increase of 0.2%. The modest tone of this critical economic report failed to convince bond traders to change their overall outlook on economic growth or raise concerns that the Federal Reserve will act sooner than anticipated in raising interest rates, in my view.

The big story within commodities is the continued weakness in oil prices. For the year, WTI Oil has fallen $19.90 (-20.2%) per barrel to close Friday at $78.65. Energy prices have been slipping on a combination of increasing supplies, slowing global economic growth, and a stronger US dollar. The energy sector as a whole is the weakest performing major sector in 2014 with a loss of roughly 1.7%. Weaker energy prices have been beneficial to the average consumer by increasing disposable income, and especially to the airline industry whose profitability is closely correlated to oil prices. Other fuel-intensive industries such as package delivery and trucking should also begin to see a benefit from reduced fuel expenses.


I have read numerous studies over the years that discuss market performance following major elections like the one we just experienced. They are interesting and certainly have a story to tell. Bob Doll, chief equity strategist at Nuveen Asset Management, highlighted this past week that the S&P 500 has jumped 16% on average in the six months following mid-term elections since 1950. Additionally, Doll said that on average the stock market has gone up over 18% in the third year of a president’s term over that same period. His explanation for the six-month increase was the removal of uncertainty in the markets, while he believes the third year of growth is a result of presidents trying to juice the economy in the years leading up to a major presidential election. These broad conclusions are interesting, but what matters to us is tomorrow not yesterday.

I do believe there are some conclusions that can be drawn now. First, with control of the Senate turning over to the Republicans, I anticipate that pro-growth bills will start moving to the President’s desk. What the President does with those bills is anyone’s guess, but votes will be taken, bills will be passed, and positions staked out prior to the 2016 presidential election. Second, I believe that the Republican majority will follow through on their promise to address issues they believe are slowing the economy. Some of these issues include approval of the Keystone Pipeline construction project, major overhaul of the Affordable Care Act (ACA), and addressing perceived excesses of agency rule making by the EPA, Treasury (Dodd-Frank, inversion), and other organizations. Third, look for bipartisan efforts to lower corporate taxes. This could potentially give a boost to the stock market through higher profits and encourage new investment. How successful any of the Republican legislative agenda will be in spurring growth in the economy is unknown at this time due to the many political and geopolitical challenges that still lie ahead.

Looking at what economic areas might benefit by the Republican victory in the mid-terms is a very speculative proposition because while the Republican leadership and caucus may have their agenda, the Democratic Party and President Obama do not support that agenda. That being said, here are some of my thoughts about which sectors might benefit from the elections:

Energy: in addition to pushing for the Keystone Pipeline, the Republicans are supportive of carbon energy. Look for more favorable legislation to counter some of the anti-carbon rule-making coming from the EPA. The US has tremendous potential for exports of coal, liquid natural gas, and even oil if energy companies and these opportunities can be expanded by streamlining regulatory approvals for drilling permits, construction licenses, and export permits. The decline in the global economy and falling energy prices, however, may slow the realization of increased returns in this sector.

Defense: I think Republicans will likely push to increase defense spending to counter growing threats from China, Russia, and ISIS. The world is not a safe place and the US will be required to maintain a high state of readiness to counteract these threats.

Health Care: I believe the future of the Affordable Care Act (ACA) as currently written will be challenged. I do not think the Republicans will be able to “repeal and replace” the law in its entirety, but I do believe they will be able to chip away at some of the more unpopular provisions. Look for repeal of the medical device tax early on. There is bipartisan support for this move. I also expect early legislation to replace the law’s definition of fulltime employment from a 30-hour workweek and with a 40-hour workweek. I have read subsidies to insurance companies to help offset the costs of insurance premiums might be eliminated. This could be a real blow to insurance companies in the short-term. The health care sector has been one of the strongest in 2014, but I do not know if the sector will continue to outperform given the increased uncertainty facing many health care companies. However, the aging demographic within the US will continue to place heavy demands on health care companies helping offset some of the negative effects of potential legislative uncertainty.

With all the discussion about how the Republican Congress will affect the fiscal policies of the nation, do not overlook the Federal Reserve and monetary policy. Fed Chairwoman, Janet Yellen, spoke this past Friday in Paris to European central bankers. Among the many topics she discussed, she said that as our short-term rates begin to rise, “some heightened financial volatility” is likely to occur. I interpret her statement to suggest that stocks will fall when rates go up. I expect the Fed will try to give markets plenty of warning to dampen the negative impact on stocks if Ms. Yellen’s views are correct. There is no clear consensus about when the Fed will actually start raising rates; however, the financial media is reporting a range from spring of next year to early 2016.


I suspect that the dust will begin to settle this week following the intensity of last week’s elections. Time to turn our attention to the markets and what is happening in the economy.

Profits remain strong. Reuters reports that 88% of S&P 500 companies have reported 3rd quarter earnings with 74% exceeding analyst estimates. However, the same article reports these analysts keep trimming their profit forecasts, and that earnings growth for the fourth quarter is now estimated to be 7.6% compared to the 11.1% estimate on October 1st. The ability of companies to continue to grow revenues and profits has the potential, in my opinion, of becoming an increasingly important story and worth watching closely.

I continue to hold little confidence that Europe will fix itself anytime soon. If the European Central Bank launches a massive quantitative easing program, I would expect stocks to react positively; however, I do not believe real economic growth will return in any meaningful way and stock performance will likely continue to lag the US. The prospects of continued violence in Ukraine is also contributing to my decision to underweight the international asset category. I am also growing increasingly concerned with the Emerging Markets region. Addressing the same Paris conference last Friday as Ms. Yellen, New York Fed President William Dudley said rising interest rates in the US “could create significant challenges for those emerging market economies that have been the beneficiaries of large capital inflows in recent years.” A potential serious warning for investors in Argentina, Brazil, Chile, Indonesia, Russia, South Africa, and Turkey in particular.

According to DorseyWright & Associates, US stocks continue to dominate the rankings of the top six major asset categories followed by International stocks, Bonds, Foreign Currency, Cash, and Commodities. I continue to recommend over-weighting US stocks in equity allocations.

I remain positive regarding US equities. As always, there are reasons for caution and today is no different. However, do not let short term worries override longer term investment decisions. Markets never go straight up, even in the best bull markets, and this time is no different.

Tuesday is Veteran’s Day and I want to take the time to acknowledge all our veterans past and present. I was privileged to grow up the son and grandson of soldiers and I followed them into Army where I served with the most amazing and talented men and women. One very special group was my leadership team when I commanded an artillery battery in Germany. These men were the best of the best and I was honored to serve with them. Freedom has always carried a heavy price and we continue to face threats from abroad, but I am thankful that our nation is blessed to have young people yesterday and today like these guys who are willing to serve and defend this great country.
L to R: SFC Shiver (Smoke), 1SG Melvin (Top), CPT Merritt (BC), 1LT Johnson (XO), 2LT Lechowitch (FDO), and SFC Dennison (Gunny)

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.

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.

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.