Tuesday, April 7, 2015

April 5, 2015

As pessimism appears to have a strangle hold on market sentiment following a series of disappointing economic reports—especially the March Employment Situation report released last Friday, I ask, why would we expect anything different from the economy other than what we have seen over the past couple of years?

The answer to my question is we should not. We should not because nothing has really changed and there is little expectation that anything will in the next few years. The US economy has been stuck in a rut of 2-2.5% annualized real growth since the start of the recovery in 2009. There has been no change to fiscal policies since the Obama administration took office six years ago. The Republicans have been unable to force any of what they consider pro-growth policy changes because they lack the ability to override presidential vetoes. The passage of the Keystone Pipeline bill and subsequent veto is an example of this. The financial regulatory burden on US business has grown unchecked. The Federal Reserve has entered and exited three different cycles of quantitative easing (QE) and has kept the Fed Funds rate at near zero since mid-December 2008. While the unemployment rate has fallen to 5.5%, the actual number of people working has fallen to levels last seen in the 1970’s.

Yet, despite the ongoing mess in Washington, the S&P 500 is up 16.13% per year going back six years (April 4, 2009). This seems hardly consistent with all of the negativity surrounding the economy, but this is precisely what has happened. The explanation to this seeming inconsistency is really at the heart of what has been happening in the US over the past six years, and I would argue is what matters today looking forward.

First, consider that the S&P 500 was rising off an incredible low in 2009. The Great Recession of 2008-2009 wiped away nearly 13 years of growth in the markets. Let me say that again—13 years of growth! Stock valuations were crushed and the bar was set very low for company performance going forward. Second, companies reacted to the Great Recession by rebuilding balance sheets and squeezing out every penny of unnecessary expenses from daily operations. This in turn helped corporate profitability, and corporate profitability is, in my view, the key to rising stock valuations. Third, technology and entrepreneurship has led to a new wave of product and industrial revolution. Everything from Apple’s continued capability enhancement of their successful iPhone franchise to a multi-generational technological change in oil and natural gas production has forever altered the economic landscape in the United States. These factors and more have helped restore stock valuations to current levels even as many naysayers were predicting another great collapse in markets.

I continue to remain optimistic that the entrepreneurial drive and spirit of Americans will continue to grind the economy forward despite the many headwinds. What I also believe is that this road forward will come with inevitable pitfalls and stumbles. The past six years are a perfect example of this. I noted that the S&P 500 index has averaged a 16% gain over the past six years, however, only two of those years actually exceeded the 16% average return (2009 and 2013 with gains of 23.4% and 29.6% respectively), and included one year with no gain at all (2011). Finally, I do not expect economic growth to look much different than it has since the recovery began because the economic and fiscal policy environment today is not conducive to much more than sluggish growth. Do I think we will continue an annual pace of 16% growth in stock markets? I do not, however, I do believe that the current trend of positive long-term gains in the markets will continue for now.


The first quarter of 2015 is in the books. Below is a summary of some of the key US indexes I follow:

The DJIA and S&P 500 returns are not much different from the same period in 2014. The biggest difference has been the strong performance of smaller capitalization stocks (Russell 2000), and the solid strength of many technology stocks (NASDAQ). The best explanation I have observed for these two indexes doing markedly better than the previous year period is that smaller capitalization stocks have less exposure to export-driven earnings and thus less affected by the stronger US Dollar, and certain technology areas continue to display strong growth prospects.

For the quarter, seven of the eleven major economic sectors outperformed the S&P 500 index. The Health Care (+9%), Consumer Discretionary (+5%), and Real Estate (+5%) sectors were the best performing. The Utility sector significantly underperformed all other sectors losing just over 5% followed by Energy (-1%), Financials (0%), and Industrials (1%).

International stocks, especially European stocks, had a good first quarter:

The strength of European markets (STOXX 600) stands out among key international indexes. While European economies have struggled over the past few years, I believe the announcement of a quantitative easing policy by the European Central Bank (ECB) and a falling Euro has helped boost investor confidence in European stock markets.

The weakness of the Euro has been one of the key stories in the first quarter of the year. The Euro fell 11.3% compared to the US Dollar through March of this year and is now down just over 22% since early May 2014. This weakness has influenced everything from exports, tourism, and energy prices. The Euro rallied just over 4% in the last two weeks of March on US economic weakness and falling US Treasury yields. While a number of economists still anticipate parity between the Euro and the US Dollar by the end of the year, I believe the accuracy of this prediction will be dependent on what action the Federal Reserve takes later this year on interest rate increases. The wider the gap between US and European interest rates with US rates higher, I believe the stronger the US Dollar will become.

The trend of interest rates in March and for the first quarter of the year continues to be lower. The benchmark 10-year US Treasury yield ended March at 1.942% compared to 2.172% at the start of the year. The Barclays US Aggregate Bond index, a broad measure of bond performance, was up 1.7% for the quarter. I believe falling rates reflect the negative economic reports that have trended during the first quarter and are not a positive development. It is hard to imagine rates continuing to remain at such depressed levels, and I believe that with better economic performance later in the year coupled with the prospect of the Federal Reserve possibly raising rates this summer or fall, interest rates may move higher by the end of the year.

The Commodities category continues to be the weakest performing major asset category I follow. The Dow Jones UBS Commodity index finished the quarter down 6% following a loss of 17% in 2014. Energy was the primary contributor to this poor performance. WTI Oil lost 11.1% in the quarter after losing nearly 46% in 2014. Natural Gas fell 11.6% in the quarter after falling 29% in 2014. The impact on lower oil prices is rippling through the economy hurting oil-related stocks in particular. Lower oil prices have not translated into higher retail sales in other sectors as many were expecting, however, I do believe there will be some improvement for the consumer assuming oil prices continue at these low levels. One more point about oil prices. Over the past 40-years, the kind of political turmoil currently on display in the Middle East would have sent oil prices soaring. The resurrection of energy production in the US coupled with Saudi Arabia’s unwillingness to cut production for the benefit of the likes of Iran, Iraq, and Russia, has removed most of what I believe to be the terrorist premium in oil prices for now.


I believe that markets will continue to limp along for now. As I noted at the beginning of my report, there is a fair amount of pessimism within investors. I fully expect the first quarter earnings reporting season which kicks off this week will be unspectacular reducing the expectation of stronger markets for the near-term.

I also believe the kind of volatility we have experienced so far this year will continue. Again, the issues investors faced in the first quarter remain and this uncertainty can drive larger daily moves in the major indices. I have been watching the negotiations between Greece and the European Union (EU) and remain very concerned about the trend there. While I have said that both parties have much to lose if Greece pulls out or is expelled from the EU, their disagreements appear to be growing. Greece may simply run out of money to meet its obligations in the next 30 to 45-days. This will trigger any number of unpleasant options for both parties and possibly lead to Greece’s departure from the EU. I do not know how all of this will work out, but this issue has not gone away.

There are only a handful of key economic reports due out over the next couple of weeks. The Federal Reserve Open Market Committee (FMOC) minutes will be released this Wednesday and will provide economists with greater insight on the Fed’s most recent thinking about interest rate hikes. The question about when they will raise rates remains of great interest to most investors. However, I expect that earnings reports will be the dominant theme for the next few weeks as companies and analysts all talk about the impact of the stronger US Dollar and oil prices on earnings. Earnings are important and drive stock valuations so I will be following the news closely.

Finally, I will remind everyone that the data remains very supportive for equities. The primary data I follow provides long-term guidance and does not react to the day-to-day or even week-to-week ups and downs. The Money Market category remains ranked at 122 out of 133 sectors I follow. This means that nearly 92% of the stock, bond, commodity, and currency categories I track are doing better on a relative strength basis than your money market account. Stocks remain the dominant major asset category with Small and Mid-Capitalization stocks favored and Growth-oriented stocks are preferred over value stocks. The other Dorsey Wright & Associate indicators I follow also suggest more of the same ahead.

If you have any questions or comments, please do not hesitate to 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 sub indices, 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.