Tuesday, September 22, 2015

September 20, 2015

The Federal Reserve announced on Thursday afternoon that it would leave interest rates unchanged for the time being.  The Fed provided three basic reasons for holding rates: 1) lack of inflationary pressure, 2) global economic uncertainty, and 3) recent market turbulence.  Market reaction to the news was as confused as I believe many investors are about the Fed’s decisions.  The initial move to the announcement on Thursday afternoon was an immediate pullback.  The Dow Jones Industrial Average (DJIA) fell 184 points (1.1%), but quickly rallied adding 246 points (+1.5%) peaking around 2:45 PM.  By the market close at 4:00 PM, however, the DJIA had shed 259 points (-1.5%) to close the day with a net loss of 65 points (-0.4%).  The real damage came on Friday when international and US markets sold off as investors had time to digest the Feds’ less than optimistic view of a slowing global economy.  While I believe global growth worries factored into Friday’s 1.7% decline in the DJIA, I also believe that at least some of sell-off might be attributed to the recognition that by putting off a rate increase now, when the Fed does raise rates, the size and timing of those rate increases may have to be larger and faster.  Larger and faster has historically led to economic downturns (i.e. recessions).

Time Period
Dow Jones
Industrial Average

S&P 500

Russell 2000

Third Quarter to Date
September to Date
Week of September 14
Source:  The Wall Street Journal (Past performance is not indicative of future returns).  As of market close September 18, 2015.

Bond investors have been watching the Fed closely for some time now trying to anticipate interest rate moves.  In the days leading up to Thursday’s announcement, yields on the US Treasury 10-year bond inched higher as investors hedged their bets of the Fed pushing the overnight lending rate up by 0.25%.  When that did not happen, the yield on the 10-year US Treasury fell from last Wednesday’s close of 2.299% to 2.132% on Friday’s close.  Looking back over the entire year, however, the bond market has been calm compared to stocks.  Friday’s close is just 4 basis points (a basis point is .01% or like a penny to a dollar) below from where this benchmark yield began the year.  The Barclays US Aggregate bond index is up just 0.9% for the year with the preferred stock (2.0%) and bank loan (1.7%) sectors leading all other bond sectors for the year.  The emerging market bond sector is the weakest of all bond sectors with a loss of nearly 4.5%.  Weak commodity prices, a stronger US Dollar, and poor governance in general have really hurt the emerging markets in 2015 and that weakness has spilled over to the bond sector. 

Looking at international markets, concerns over lower Chinese growth estimates has put a damper on overall global growth estimates and has contributed to lower equity returns.  China, the largest contributor to the Emerging Market Region Total Stock Market index, has helped push this index down 13.9% in 2015 despite a 2.7% gain last week.  The Emerging Market Region index has shown some stability recently but massive government intervention in Chinese markets makes it hard to determine what the real story is there.  Additionally, millions of Middle Eastern refugees are entering Europe that may ultimately prove, in my view, to be a heavy burden on public treasuries in countries that cannot afford more government spending.  I also continue to remain very concerned about the overall unemployment situation in Europe and the drag that has on the Euro Zone economy.  Overall, I cannot find much to give me a lot of enthusiasm for international equities today.

Time Period

Global Dow xUS

Dow Jones
Devel Mkt Region
Total Stock Market
Dow Jones
Emerg Mkt Region
Total Stock Market
Third Quarter to Date
September to Date
Week of September 14
Source:  The Wall Street Journal (Past performance is not indicative of future returns).  As of market close September 18, 2015.

Commodities remain weak across the board.  WTI Oil is down 16% in 2015 and is down 58.3% from a high of $107.26 back in June 2014.  Metals, grains, cotton, coffee are all down in 2015.  This broad decline in commodity prices has driven the UBS Commodity index down 15.9% this year.  Global demand for commodities has weakened especially as China’s growth has slowed.  The Chinese have been one of the major commodity consumers over the past decade and a drop in demand by China is felt by all commodity producers. 

The US Dollar is now up 6.6% compared to the Euro this year and is up 18.8% since the stronger US Dollar trend began in the spring of 2014.  The stronger US Dollar has hurt US-based global corporations by increasing the price of goods sold abroad and by reducing profits when foreign currencies are converted into US Dollars for accounting purposes.  I have said in earlier Updates that a strong US Dollar also hurts commodity sales globally because more than 90% of all commodity transactions occur in US Dollars.  Foreign traders must purchase dollars before they complete their transactions, and a stronger US Dollar adds to the overall cost of a commodity to those traders.  Following one of the basic axioms of economics, when the price of something goes up, the demand generally falls.  Finally, currency traders, in my view, have pushed the value of the US Dollar up for two primary reasons: first, the prospect of the Federal Reserve raising interest rates has global bond traders buying higher-yielding Treasury bonds—transactions that obviously take place in US Dollars, and second, global uncertainty pushes traders to buy secure US Treasuries.  As long as these two factors are present, I believe the US Dollar will remain strong.


Count me as someone who is disappointed in the Fed’s decision to leave interest rates unchanged.  It is too early to see if traders will adopt that position, but Friday’s stock market pullback may be a first hint to investor sentiment.

My disappointment in the Fed stems from several points.  First, I believe that macro economic factors such as
employment and inflation data in normal times would warrant interest rates higher than where they are today.  Second, I know global growth is slowing, and there are concerns over Iran, and over Russia’s intervention in Syria and Ukraine.  The point is there are always concerns.  By Janet Yellen’s reasoning, we may never find the “perfect” time to raise rates.  Finally, and this is crucial in my view, the longer the Fed delays raising rates, the greater the likelihood that the Fed will be late to recognize when the US economy is overheating and will be late in its efforts to temper inflation.  The Fed’s tardiness may result in larger and more frequent rate hikes in the years to come.  As I noted earlier, larger and frequent rate increases has led to recessions in the past and I think we can all agree that recessions are bad for everyone.

I am not Janet Yellen, Chair of the Federal Reserve, so what I think about the decision to hike rates does not matter.  What does matter is what impact this may have on markets.  Here are some quick thoughts on each of the major asset categories I follow:

                US STOCKS:  Stocks are driven by profits.  If the Fed is right and the economy is slowing, then profits may be a little harder to come by hurting stocks.  Interest-rate sensitive sectors like Utilities and Real Estate should be helped by not raising rates.  Financials, which benefit from higher rates, may lag for a while.  What will matter in US stocks, and this applies to the other asset categories as well, is how long will the Fed hold off on raising rates.  Investors will likely factor this into their trades in the market over the next few months.

                INTERNATIONAL STOCKS:  Major exporters to the US should benefit by the Fed’s stall on rates because the US Dollar may weaken a bit as the lure of higher rates on US Treasuries decreases.  While global markets have become increasingly connected, I do believe there are a number of local Euro-area or Asian-area factors that will impact stocks of international companies beyond what happens here in the US.  Emerging markets will be the likeliest beneficiary of the Fed’s inaction by helping the price of commodities, however, if investors believe it is just a matter of time before rates do increase, any benefit to the emerging markets may be short-lived.

                BONDS:  The bond market is heavily influenced by interest rate actions taken by the Fed.  This time is no different.  We have seen bond values in many bond sectors rise last week as rates pulled back in response to the no increase decision by the Fed.  Additionally, if investors are convinced that the Fed’s more pessimistic economic outlook is correct, I believe bond investors will keep yields on bonds lower and valuations higher.  Watching the general direction of longer-duration yields like the 10-year US Treasury may give some insight into what the Fed is doing and when they might take action on raising rates.

                CURRENCIES:  Currency prices are driven by supply and demand factors.  Prices of a currency X go up when more traders want currency X over currency Y.  This is the most basic of economic concepts.  While the concept is basic, getting the timing and direction of currency moves is hard to predict just as it is with the other major asset categories.  Higher interest rates on government and corporate debt are but one of the factors that make a currency attractive to foreign investors.  They will sell other currencies to buy the US Dollar, for example, in order to invest in US debt and get the higher yields.  Although the US Dollar has strengthened this year, it has been weakening ever so slightly in the weeks leading up to the Fed’s decision on Thursday to hold US interest rates steady.  I believe you can get a sense of what many traders believe by watching the direction of currencies to the US Dollar.  Continued US Dollar weakening will signal a lower likelihood of higher rates in the future and vice versa.  Longer-term, I believe the US Dollar will remain attractive to foreign investors.

                COMMODITIES: I believe the greatest influence on commodity prices is simply supply and demand.  Therefore, a slowing global economy will likely continue to hurt the overall value of commodities more than any changes to US interest rates.  However, I have also said that a stronger US Dollar hurts the value of commodities by reducing demand through higher prices.  Therefore, the decision by the Fed to hold rates at current levels for now will help the pricing of commodities if the US Dollar weakens.  It is hard to determine at this time if the US Dollar weakens enough to change the trend of weaker commodity demand around the world.  


Not much going on this coming week compared to the previous week.  The Federal Reserve does not meet again until October 27-28.  Early indications are that the Fed is not likely to change rates at this meeting but will wait till the December meeting, if at all.  The final revision of the 2nd Quarter Gross Domestic Product will be released on Friday.  No change is expected from last month’s revision of a growth rate of 3.7%.

I wish I could say that one of the big uncertainties facing markets this year had been cleared up by the Fed last Thursday, but it was not.  I believe we will continue to debate the timing and size of the Fed’s increase for the rest of the year.  As I have said, watch the strength of the US Dollar to get some insight on what investors believe the Fed will do and when.

My guidance on stocks, bonds, etc., has not changed.  US Stocks are the favored major asset category followed by Bonds, Money Market Funds, International Stocks, Currencies, and Commodities.  With the Money Market asset category ahead of International Stocks, I am not making adding international stocks to portfolios at this time.

Source: DorseyWright & Associates, Past Performance is Not Indicative of Future Returns

Within US Stocks, I prefer Growth over Value, Small and Mid-Capitalization stocks over Large.  And within the major economic sectors, I prefer Health Care, Consumer Cyclical, and Technology over all others.

Within the Bond sectors, I prefer the Preferred, Floating Rate, and High Yield sectors.

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.