MARKET UPDATE AND COMMENTARY

September 4, 2015

The summer is over and it has been anything but a quiet time.  Markets have seen volatility surge in the face of a number of different factors and the pundit class has been chattering endlessly trying to explain the first real correction in the markets since 2011.  China appears to be the primary culprit for the recent sell-off along with the continued obsession over the timing and size of a possible rate increase by the Federal Reserve.  Personally, I don’t think anyone really has a full understanding of why markets have corrected, but what I do believe is that the US economy has not fundamentally changed.

Time Period	Dow Jones Industrial Average (DJIA)	S&P 500	Russell 2000	NASDAQ
First Quarter 2015	-0.26%	0.44%	3.99%	3.48%
Second Quarter 2015	-0.88%	-0.23%	0.09%	1.75%
Third Quarter to Date	-8.61%	-6.88%	-9.39%	-6.07%
Year-to-Date	-9.66%	-6.69%	-5.69%	-1.10%

Source:  The Wall Street Journal (Past performance is not indicative of future returns).  As of market close September 4, 2015.

I am suspicious about the impact of China on the US economy because China accounts for just 0.7% of the US

Gross Domestic Product (GDP).  Furthermore, I have always been suspicious of any data coming from China because it is a centrally planned and controlled economy.  Chinese leaders have likely cooked the books, and now the government has intervened in a massive fashion to stem the recent free fall in their equity markets.  Where I do believe the Chinese economy is influencing markets is within the emerging market regions whose economies are heavily dependent on the export of commodities.  Slowing demand from China will most likely have a negative impact on these smaller, commodity export-driven economies.  Additionally, the strength of the US Dollar is also hurting the emerging market region because a stronger dollar increases the price of commodities of other countries thus reducing overall global demand.

The Federal Reserve is meeting later this month (September 16-17) and economists are uncertain whether the Fed will start raising rates following this meeting or wait until later in the year, or perhaps even 2016.  The most recent US Employment data pegged the unemployment rate at 5.1%, which would be a signal in

normal market conditions for the Fed to raise rates.  However, we are not living in normal market conditions and thus the uncertainty about the Fed’s actions.  I believe that the Fed should raise rates and a 0.25% increase would be appropriate.  Such a rate increase may even provide some relief to investors by indicating the Fed considers the US economy strong enough to withstand a small rate increase.  I further believe that by starting now, the Fed will be able to increase rates to more normal levels over an extended period of time, and that should be better for markets.  Those calling on the Fed to delay further believe the markets are too fragile to handle this modest rate hike, but I am do not support that view.  For now it is just wait and see.

One final thought on the current volatility in the markets is that the growing dependence on computer algorithms for daily trading activities has probably had a role in the increased volatility.  The easiest way to describe this phenomenon is that one action begets another action, which in turn leads to another.  Computer driven trading can lead to large swings in both directions, and I believe we are seeing this impact on the daily swings in the markets.

Energy (-19%), Utilities (-14%), and Materials (-13%) have been the weakest sectors by far this year.  Only the Health Care (+3%) and Consumer Discretionary (+2%) sectors are positive year-to-date. 

Developed international markets have traded much like markets here in the US.  The European-heavy STOXX 600 has matched the S&P 500 in losses in the third quarter but remains positive for the year based upon a strong first quarter.  As you can see below, the Emerging Markets region has suffered heavily as the demand in commodities has dropped and the US Dollar has strengthened.

Time Period	Global Dow xUS	STOXX 600	Dow Jones Devel Mkt Region Total Stock Market	Dow Jones Emerg Mkt Region Total Stock Market
First Quarter 2015	3.08%	15.99%	2.23%	1.39%
Second Quarter 2015	-0.17%	0.14%	-0.10%	0.70%
Third Quarter to Date	-11.66%	-6.95%	-8.23%	-19.32%
Year-to-Date	-8.81%	3.58%	-6.27%	-17.63%

Source:  The Wall Street Journal (Past performance is not indicative of future returns).  As of market close September 4, 2015.

US interest rates have trended slightly downward over the past couple of months.  The 10-year US Treasury yield closed last Friday at 2.13% compared to 2.18% at the end of July.  The Barclays US Aggregate Bond Index is up 0.82% for the year while the Dow Jones Corporate Bond Index is up 1.03%.  Bonds have provided some relief as stocks have fallen this quarter.  According to Morningstar^® the Bank Loan sector is the best performing bond sector with a year-to-date gain of 1.69%.  The Intermediate Corporate Bond sector, where many investor dollars place funds, is up 0.36%.  As a result of the pullback in equities, especially in the energy sector, the High Yield sector is up 0.30% so far in 2015 after falling 1.49% in the past thirty days.

THE CHALLENGE OF VOLATILITY

Volatility tests investor fortitude.  It can cause the most experienced investors to question the soundness of their investments, and for some it brings back frightening memories of 2008.  It is, however, an unpleasant fact of investing.  I am not spooked and nor should you.

Stocks, bonds, commodities, and currencies fall under the same basic economic tenet of supply and demand

found elsewhere in economics.  When more sellers are in the market compared to buyers, the market falls.  It will continue to fall until investors see attractive values and buyers step in to outpace sellers.  This also helps explain the concept of support.  A support level is that point where buyers have previously stepped in to overwhelm the sellers.  Violating a support level is significant because buyers choose to stay on the sidelines at a point where they had stepped in before indicating negative sentiment.  If that happens we then look for other lower support levels with an eye on judging current buyer sentiment.  The most significant support level for the S&P 500 this year is 1870 reached on August 26th.  Buyers stepped in the next day and pushed averages higher.  Going forward I will be watching this trend carefully, but I am not expecting volatility to diminish.

This is also a good time to revisit some of the research that I have done looking back at daily moves by the S&P 500 over the past 35 years from 1980 to the end of 2014.  Over the 8878 trading days during this period, the market moved up 53.7% of the time and down 46.3% of the time.  The average change per day was 0.75%.  Through 171 trading days so far this year, the market has been up 46.8% of the time and down 53.2%.  This is not a great trend.  Additionally, the average daily change has been just 0.69%.  The third quarter, as you would expect, has been a different story with the average daily change jumping to 0.92%.  There have been 22 up days (46.8%) compared to 25 down days (53.2%) keeping with the general average in 2015.  This should not come as a surprise given the overall decline in market averages, but it is also nowhere near the magnitude of 2008 where the average daily change was 1.7%.

Facts are facts and we remain in a bear market for now, but I do not believe we are experiencing anything more than a typical correction at this time.

LOOKING AHEAD

I believe that we have not seen the last of the volatility in the markets.  I cannot underestimate the impact computer driven trading is having on markets and this is part of trading in 2015.  The exchanges can and have put in periodic delays for some securities to try and stem the influence of computer trading, but there are limits to how effective these moves will be.  Unless you are a day trader, I do not believe this will have a long-term impact on the overall direction of the markets.

I remain committed to the concept of relative strength.  For now, US stocks are favored along with bonds.  The Money Market major asset category sits at number three followed by International stocks, Currencies, and Commodities.  For the more risk averse investors this would indicate that international stocks should be avoided for now.  As I have been saying all year, small and mid capitalization stocks are favored over large caps, and that relative strength relationship has not changed.  Looking at sectors, Health Care, Consumer Cyclical, Technology, and Consumer Discretionary are the strongest on a relative strength basis.  Again, this relationship has been in place most of the year.

As I noted earlier, the Federal Reserve is going to meet a week from now.  There are several key data points due out that are important including Jobless Claims (Thursday), the Producer Price Index (Friday), Retail Sales (next Monday), and Consumer Price Index (next Wednesday).  I highlight these particular reports because they all indicate the potential inflationary pressure building in the economy, and keeping inflation under control is a top priority of the Fed.  Should these reports suggest growing inflationary pressure, I would anticipate the Fed raising rates this month.  However, there are certainly a number of doves on the Fed’s board who are likely to favor holding rates at current levels.  As I said before, I think the Fed should raise rates now in order to space increases over an extended period.

I will conclude my comments by reiterating a point I have made over the past year or so.  The economy is locked into a below average recovery of about 2% GDP growth annually.  We need more growth, but nothing the Fed can do will stimulate growth.  The Fed has certainly done all it can to stimulate the economy since 2009 with minimal impact.  It is now time for pro-growth fiscal policies to be enacted.  For the past six years most of what has come out of Washington are neutral fiscal policies at best and negative more often.  We must incentivise risk-taking, investment, and work.  It is time for our national leaders to step up and make the necessary changes, otherwise the status quo will continue.

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.