Wednesday, July 15, 2015

July 14, 2015

I had originally planned for this Update and Commentary to be a review of the first half of 2015.  I will certainly provide a brief review; however, I want to devote a little more space to the skirmish taking place between Greece and the EU due to the long-term ramifications the outcome this may have on the global economy.

Market performance in the US during the first half of the year can be summed up in one word: lackluster.  This is not the first time I have used this word, but again it fits.

Time Period
Dow Jones
Industrial Average

S&P 500

Russell 2000

First Quarter 2015
Second Quarter 2015
First Half 2015*
Source:  The Wall Street Journal (Past performance is not indicative of future returns).  As of market close July 10, 2015.
*As of market close June 30, 2015

The Morningstar®size/style chart is another way to evaluate US market performance through the first six months of the year.  Morningstar® is a third-party private company that provides a wide variety of performance data, and they are best known for their work on mutual funds and their star ranking system.  Morningstar® also developed the size/style matrix which divides returns between stocks that fall into one of nine different boxes.  The boxes are divided into market capitalization/size (a company’s market value) and the company’s style (growth, value, or blend).  The boxes below illustrate the returns by box size/style:

Upon quick observation it is clear that growth has outperformed value or blend, and Small and Mid Capitalization stocks have outperformed Large caps.  This is a change from the last year or two where the S&P 500 index (Large cap blend) handily outperformed the other size/style boxes.  The most likely reason for this change in leadership in 2015, in my view, is the result of a stronger dollar and its negative impact on the profits of large, multi-national companies that tend to dominate the Large cap space.  As the US Dollar continues to show strength relative to other currencies, I believe Small and Mid Capitalization stocks (which typically drive most of their profits from the US) will continue to outperform their larger brethren.  Additionally, large US multi-national companies may also be perceived as more vulnerable to the turmoil in Greece and China further hurting profits and/or stock prices.

Performance of the S&P 500 sectors and Real Estate is interesting as well.  As you can see by the chart below, the Health Care and Consumer Discretionary sectors have performed well above the S&P 500 index average while Utilities and Real Estate have significantly lagged all other sectors.

I believe performance in the health care sector has been greatly assisted by the biotechnology subsector.  The biotech subsector continues to advance at a stunning pace due to outstanding technological developments which are likely to be converted into strong earnings.  I also believe that the Health Care sector is going to continue to be a strong sector as the baby boom generation ages and their demands upon this sector grow.  I think the continuing rise in interest rates is the likely culprit for the underperformance of the Utilities and Real Estate sectors.  The Energy sector continues to suffer following continued supply/demand imbalances as oil production continues to grow in the face of static or declining demand.

Turning our attention to the international sector, I believe it is safe to say that the turbulence in the international sector has been dramatic.  The Greece problem continues in one form or another to make international investors nervous as has the recent sell-off of Chinese markets following huge market gains over the 12 months (+89%).

Despite all the fear and uncertainty by investors the data does not reflect such dire outcomes:

Time Period

Global Dow xUS

Dow Jones
Devel Mkt Region
Total Stock Market
Dow Jones
Emerg Mkt Region
Total Stock Market
First Quarter 2015
Second Quarter 2015
First Half 2015*
Source:  The Wall Street Journal (Past performance is not indicative of future returns).  As of market close July 10, 2015.

The losses in the Emerging Market region are primarily due to the recent and substantial drop in Chinese markets.  As I have addressed before, China makes up 29.4% of the Dow Jones Emerging Market TSM index so has a disproportionate influence on this index’s return.  Chinese markets have rallied over the past couple of days due to unprecedented government intervention into domestic markets.  I am very skeptical of Chinese markets at this time and believe that fears over a Chinese market correction hurting US and other international markets are overstated.  After a terrible 2nd quarter, the European-dominated STOXX 600 index has rallied on news that Greece has agreed to the terms of the European Union.  While I prefer US markets, I do believe that exposure to European and other developed markets is appropriate to some degree.

The trend towards higher interest rates has been in place since early February.
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I believe this rise in interest rates is in anticipation of the Federal Reserve raising rates later this year, and because growth and inflation are slowly easing back into the economy.  The impact of rising rates has been to push down the Barclays US Aggregate bond index over -1.6% since early February, and year-to-date (YTD), the Barclays is now down -0.44%. 

The bond asset class remains one of the most challenging to invest in.  According to Morningstar® as of July 10th, the best performing bond sectors YTD are Bank Loans (2.61%), High Yield Bond (2.33%), and Preferred Stock (2.09%).  At the other end of the performance spectrum, Long Government (-4.41%), Long-Term Corporate (-3.72%), and the World Bond (-2.55%) have underperformed.  I have no doubt that the challenges in the bond asset class will continue especially as investors try to navigate the prospect of higher short-term interest rates from the Federal Reserve.


I am going to fall back on some of my military experience to try and find the appropriate analogy to describe what is happening with Greece and the European Union (EU).  I believe what we are seeing is a skirmish between the vanguard of two great global economic armies.

For most, you may be asking yourself, what is a skirmisher?  A skirmisher is a soldier who goes out in front of the main army to find the opposing army.  Their job is to gather intelligence, identify the location of the main army, to find any weaknesses that may be present, harass, and deceive.  They traditionally fight the first battle of any major engagement and the success or failure of the skirmishers contributes significantly to the outcome of the main battle.  The economic fighting going on between the EU, essentially Germany, and Greece is a skirmish in front the global economic armies of Entrepreneurism and Socialism.  How the skirmish concludes will, I believe, have an important impact on the future battles between these two competing global economic armies.

The world is finding itself more and more divided between entrepreneurial/capitalistic countries and socialist countries.    I still like to think of the United States as the leading force in the entrepreneurial world, while countries like Greece are old, inefficient, welfare states where the government is the primary consumer/employer for that country.  Entrepreneurial countries have less regulation, flexible job markets, lower government deficits, and place a high value on private ownership and responsibility.  Socialist countries have consistently low growth, inefficient labor markets that are encumbered with parochial interests and protectionism, high levels of government employment, high per capita GDP spending by government, and unsustainable debt.  These are the two forces that appear to be arraying themselves for battle in the years to come across the globe.

Greece is broke and can sustain the status quo only by spending other people’s money—notably Germany’s money.  They have a society that is heavily dependent upon the government for their livelihood.  Right behind Greece is France, Italy, Spain, and Portugal.  These countries have many similarities to Greece, but for now, the governments of those countries are trying to become more entrepreneurial and grow their economies in order to sustain themselves.  Fears over the “contagion” in Europe has been that if the socialist elements of these weaker European states see Greece succeed in extracting highly favorable terms in their standoff with the EU, the other member states will demand similar concessions.  The Germans, who also happen to be the largest holders of Greek debt and the debt of the other EU socialist countries, are attempting to bring/force an entrepreneurial culture to Greece.  If Germany and the EU succeed, I believe this will play out favorably in the years ahead with other indebted countries.  If Germany fails, then it is only a matter of time, in my view, to see more years of stagnate growth and rising levels of unemployment sweep through the old socialist countries.  The agreement reached late this past weekend is a step in the right direction; however, it is too early to tell if Greece will in fact tilt more towards an entrepreneurial culture.

While I have said that I believe the US is clearly the force behind the entrepreneurial global army, we have a number of pockets at home that are beginning to look like Greece.  Detroit, Chicago, Illinois, California, New York, and New Jersey are all afflicted by some of the same characteristics found in Greece.  There are many factors that are different that mitigate much of what is going on here; however, unless significant fiscal policy changes are made (i.e. flexible labor policies, less government spending, and better education), these governments will soon find themselves facing some type of debt crisis or even bankruptcy.  This is why I believe what is happening in Europe today is so critical.  Either the entrepreneurial skirmishers will lead their army to a successful campaign for economic growth and prosperity for all, or greater economic pain will  be pushed into the future as socialism prevails.


I said about three weeks ago that volatility was likely to pick up due to the fears over Greece and rising interest rates became more pronounced.  This has certainly come true.  The good news is that the markets have rallied enough in the past week or so to put them back into positive territory for the year (as of July 14th).

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 Financials are the top rated sectors based upon relative strength.  I might note that historically, financials have tended to do well as interest rates rise due to increased earnings potential.  The fact that financials have slipped into the third position on my relative strength chart may be the first sign of renewed strength of this sector.

Earnings season for the 2nd quarter has begun.  I expect earnings to be improved but energy and multi-national companies may struggle somewhat due to a stronger US Dollar.  I further anticipate that when the government announces the first estimate of the 2nd quarter Gross Domestic Product (GDP) on July 30th we will see a an improvement over the previous quarter.  Over the next several weeks a number of key economic reports will be published that will certainly help guide investors and likely reinforce my belief that the economy will have strengthened in the 2nd quarter.

While I hate predicting the Federal Reserve and interest rates, I do believe that the Fed will raise the overnight lending rate by a quarter of a percent (25 basis points) in the fall, and rates will continue to rise very slowly.  The Fed has signaled at this time that any increase in rates will be a result of “normalizing yields,”and not due to fears of an overheated economy.

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

P.S.  If you think this type of analysis would be of benefit to anyone you know, please share this communication with them.

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.