Tuesday, November 25, 2014

November 23, 2014

Central bankers from the European Union (EU), China, and Japan stepped up to take the initiative in their respective countries/regions to spur growth in the face of sagging economic reports. Meanwhile markets here in the US continued to move steadily forward.

Most key US equity indexes posted gains over the past two weeks:

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

International markets, buoyed by recent central bank announcements, have also generally moved higher.

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

The efforts by central bankers to ease monetary policy abroad gave stock investors a bit of confidence and helped drive up valuations last week, however, I also believe that it fits right within the narrative that I have discussed many times. That narrative is that central bankers can only mask the symptoms but not cure what ails Europe and Japan which are fiscal policies that stifle innovation, job creation, and entrepreneurship. China is a completely different model because it is communism seeking a way to inject a private sector component (capitalism) into the economy for economic growth and to provide opportunity to the billion-plus Chinese. While many favor China as an investment theme, I remain wary due to the lack of financial transparency, state ownership, and corruption that is so prevalent throughout their economy. In the end, European and Asian stocks may rise as they have so far this year, however, I believe they will lag US returns in general for some time.
Bond yields continued to slip downward last week with the benchmark 10-year US Treasury yield closing

Friday at 2.307% and is now down 2.5 basis points (a basis point is .01%--similar to a penny to a dollar) for the month. The broad Barclays US Aggregate bond index gained 0.1% for the week and is now up 5.6% for the year. The decline in interest rates has been attributed to renewed confidence of investors that central banks are willing to buy bonds in an effort to stimulate economic growth. The US just completed the third round of bond buying (also referred to as Quantitative Easing) with little to no effect on growth. The only thing I can say is that quantitative easing gives investors a psychological lift and that can help in the short run.

Commodities received a boost with the Chinese central bank lowering interest rates on Friday causing investors to speculate that lower interest rates will spark renewed demand for primary commodities by the Chinese. Oil and gold both rose last week with WTI Oil gaining $0.69 per barrel (+0.9%) to close at $76.51. WTI Oil is still down 22.4% for the year. Gold gained $12.10 per ounce (+1.0%) to close Friday at $1197.70. Gold is almost unchanged for the year recording a drop of just 0.4%.


It is not too early to look back at the year and draw some meaningful conclusions, so let me make a few brief observations.

• The US Dollar strengthened dramatically in 2014. The Euro is down nearly 10% and the Japanese Yen is down almost 12%. These moves signal a strong demand by international investors for US bonds and stocks, and a general confidence in our economy. I share that confidence. The rise in the US Dollar makes imports from Europe and Asia cheaper and it helps drive down energy and other commodity prices. I think for the average American, this is very good news. For US investors a rising US Dollar acts as a strong headwind on returns in international investments accounting, in part, for the lag in international stock performance.

• Oil prices have fallen dramatically in 2014. This is a real boost for consumers here and has helped keep inflation in check. The transport stocks have benefited by this drop saving airlines and truckers billions in fuel savings.

• Interest rates fell in 2014 when all the pundits were predicting a rise due to the end of quantitative easing by the Federal Reserve. This was a big miss by economists and, I believe, points to the futility of central bankers’ efforts to stimulate the economy by purchasing bonds. Interest rates are comprised of economic growth and inflation expectations and bond purchases by the Fed does not change this fundamental fact. I believe we will continue to see low inflation (1.8%) and modest economic growth (2.5% to 3.5% in real terms). This forecast has been the same for several years now.

• While not reported by the financial media, we did have a 10% correction by the S&P 500 this fall. Well, technically it was 9.9%, and it was off of intra-day highs and lows, not market close to market close. Corrections do happen and so we have had a 5% correction and a 10% correction within the same year. That is quite a change from 2013 when we had none. I have no way of predicting how the next six weeks will work out, but as I have said for some time, I do not believe we are on the verge of a stock market collapse or that we are in a bubble.

• The geopolitical situation abroad remains tenuous and the political temperature here at home is rising. While the Ukraine, the Middle East, and Pacific regions have quieted somewhat, I can say that there is still plenty that can go wrong and possibly impact the markets. Closer to home, the President’s recent executive order regarding immigration has increased the likelihood, I believe, in a harsher political discourse and raise uncertainty in investors. Overall, however, markets have ridden the trials of global and domestic tensions well this year.

I will certainly have more to say in the coming weeks about 2014 and 2015, but for now, my suggestion is to get focused on the holidays and let’s see how the rest of the year plays out.


As I said at the top of my Update and Commentary, central bankers have been working overtime to use monetary policy tools to shore up flagging economies. I think these are stop-gap measures at best. They are also, if you look closely at the US over the past five years, not particularly effective. I will say that what is more instructive is to recognize that stock markets go up because of economic expectations—not last month’s news, and because companies are profitable.

While I am bearish on Europe today and cautious on Asia, I remain fully committed to the US. I believe the US remains the most vital, flexible, and dynamic economy in the world. These adjectives translate to real actions which in turn lead to more profitable companies. I read an article this past weekend in the Wall Street Journal about how international stocks were undervalued and therefore a bargain. They also talk about how international stocks have gone up, but just not as much as US stocks. Given a choice, I prefer investments that go up more than others, therefore, I will continue to underweight international stocks for now.

The trading week will be shortened by the Thanksgiving holiday this coming week. Markets are closed on Thursday and will close early at 1 PM on Friday. Most international markets will be open. Although the week is usually a quiet one with many traders off on holiday, there are a couple of key economic reports coming out. The second estimate of the 3rd quarter gross domestic product (GDP) will be published Tuesday morning at 8:30. The consensus expectation is for a slight contraction from the first estimate from 3.5% to 3.3%. I am not expecting any significant changes to the GDP. Wednesday morning will be busy. October durable goods orders, new home sales and personal income reports will all be released. I would not expect any surprises here with this economy trudging along as it has for so many months now.

Thanksgiving is one of my favorite holidays because it causes us to stop and think about what we have to be thankful for. I hope that your week is spent surrounded by those you love and cherish.

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.

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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.