MARKET UPDATE AND COMMENTARY

June 14, 2015

If I had to characterize US markets this far in 2015, I would have to say they have been pretty lackluster. As you can see below, the Dow Jones Industrial Average (DJIA) and the S&P 500 are flat. However, small capitalization stocks (Russell 2000) and technology stocks (NASDAQ) have bucked the trend with relatively good returns. I believe market performance can be attributed to three primary factors. First, despite the political spin found in most financial reporting, the dock strike and terrible weather in the first quarter really did take a toll on economic output. Second, worries about the Greece situation and when the Federal Reserve is going to raise interest rates have cut into stock gains. US large capitalization and dividend paying stocks and sectors have been particularly hard hit by rate hike fears. And third, small capitalization stocks, which have most of their earnings in the US, benefit when concerns about global growth arise. Technology stocks have done well, in my view, because they are the most entrepreneurial part of the US economy.

Source: The Wall Street Journal (Past performance is not indicative of future returns). As of market close June 14, 2015.

The three worst performing sectors year-to-date are Utilities (-9.9%), Real Estate (-4.3%), and Energy (-2.8%). Utilities and Real Estate are particularly sensitive to interest rate movements, and I believe that stocks within these two sectors are adjusting to the expected rise in interest rates. Energy stocks continue to struggle as uncertainty surrounds global demand and continuing strong production, especially in the US. Concerns about Iraq’s ability to produce in the face of ISIS attacks, and now the possibility of Iran bringing oil online if the sanctions are lifted as a result of talks between the US and Iran are also complicating pricing decisions by oil buyers. Finally, the strong US Dollar suppresses demand globally hurting profits in most major oil producers.

The best performing sectors are Health Care (+8.9%), Consumer Discretionary (+6.2%), and Materials (+3.3%).

After a very strong first quarter, international markets have struggled to go up. The European-heavy STOXX 600 index leads the major indexes I track with a year-to-date gain of nearly 14%. June, however, has been a different story as this index has pulled back 2.6%. I believe this is primarily attributable to the uncertainty surrounding Greece’s financial situation within the context of the European Union (EU). Greece is literally standing at the financial precipice and odds of this spendthrift country leaving the EU have increased. The Greeks must come up with €1.5 billion ($1.7 billion) for debt repayment before the end of June—money Greece simply does not have without further bailouts from the EU and International Monetary Fund (IMF). As it stands today, talks are at a standstill with both sides far apart in reaching an agreement. I fully expect these negotiations to go down to the very end. As I have said in previous Updates, it is not the size of the financial debt with Greece that is troubling to markets, but rather the uncertainty surrounding Greece’s exit from the EU and how other highly indebted EU countries may react to this development.

Source: The Wall Street Journal (Past performance is not indicative of future returns). As of market close June 14, 2015.

Turning to the emerging markets, the recent pullback in these markets has come as a bit of a surprise to investors. The consensus of the research I have done on this topic places the blame for recent weakness on a stronger US Dollar and rising US interest rates. While it is difficult to assign one or two problems across a broad swath of highly divergent economies found in the emerging market regions, most are vulnerable to capital flows (investment and lending by foreigners) and currency fluctuations. When the US Dollar rises sharply as it has done in the past six months, strains develop on the cost of capital and emerging market economies must compete for investment dollars by raising their interest rates ever higher. This action generally has the net effect of slowing down an economy, even to the point of causing recessions. All things being equal, most international investors would prefer to invest in a safer economy like the US. With rising interest rates here at home, investors may be shifting investments away (capital outflows) from more risky emerging markets to safer havens.

US interest rates have been rising. Since reaching a low of 1.67% on February 2nd, the yield on the US 10-year Treasury has increased 0.69% to 2.36%. This increase, in my view, has been a reaction of bond traders to the expectation that the Federal Reserve may raise rates later this year. This move is similar to the rise in yields from May to September 2013 when rates jumped 1.32% from a similar low of 1.62%. The impact on bond prices is predictable with many bond sectors showing negative returns during these periods of rising rates. However, keep in mind that losses are relative especially when compared to stock downturns. During the sell-off of bonds during the period cited in 2013, the Barclays US Aggregate bond index was down a little more than 4%. Since February 2nd of this year, the Barclays is down about 3%. Real weakness is in the longer duration bond sectors which experienced double digit loses in both periods. As tempting as it is to do, I simply cannot predict the direction and magnitude of interest rate changes. That is a fool’s errand. However, clearly there has been a shift this year to higher rates and the impact of this increase has hurt many bond sectors along with many dividend paying stocks.

MOVING CLOSER TO RESOLUTION OF TWO OF MY BIG FOUR

It is hard to determine which is causing the markets indigestion more—Greece or the Federal Reserve.

Either way, it does appear that clarity is coming on both of these important issues. First, the EU, IMF, and European Central Bank (ECB) all appear to be growing weary of Greece’s inflexibility in meeting creditor demands to cut pension spending and do more to raise revenues. What this means with regards to the eventual outcome with Greece is anyone’s guess; however, with a debt repayment deadline fast approaching, the political leaders in Europe must arrive at some resolution soon.

Second, the Federal Reserve is meeting this Tuesday and Wednesday. While the futures markets are telling us that the prospect of a rate increase by the Fed at this June meeting is virtually zero, all eyes will be watching the meeting announcement by Fed Chair Janet Yellen at 2 PM Wednesday followed by her press conference at 2:30 PM. What little consensus that does exist among economists suggests rates may be raised following the September or December meetings at the latest. I am hopeful that Wednesday’s announcement will help offer clarity to this prospect and the markets can move on.

As markets digest the resolution of these two key issues, I believe volatility will pick up. I think that as we get closer and closer to each major decision point, volatility will spike and then settle down as markets adjust to the new environment. I say this because I personally believe that the outcomes regarding both Greece and the Fed are going to be positive developments for the US and international markets. Certainty trumps uncertainty especially when the outcome is generally viewed as a positive.

LOOKING AHEAD

I believe I have made the case to expect more volatility in markets this summer and early fall. Do not be unsettled by this volatility, just understand it is part of the markets absorbing new economic realities.

The recent declines in most major US stock indexes has me looking at levels of support. For the S&P 500, 2080 is a very important near-term support level followed by 2050, and finally 1990. What each of these support levels indicate is when buying was re-initiated by investors following previous downturns, and they are a good indicator of investor sentiment this time around. Furthermore, it appears that the S&P 500 is just slightly oversold meaning prices remain fairly priced based upon their previous 10-weeks of trading.

The US stocks category is still the strongest of the six major asset categories I follow on a relative strength basis. The other categories in order are International stocks, Fixed income, money market funds, Currency, and Commodities. The overall relationship among these six asset categories is unchanged over the past month or so when International stocks overtook Fixed income for the number two position mid-April.

Equal weight is still favored over capitalization weighted investments. Growth over value, Small and Mid Capitalization over Large, and Health Care, Consumer Discretionary, and Technology are the top rated sectors based upon relative strength.

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®
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.

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.