Tuesday, October 27, 2015

October 25, 2015

As the 3rd quarter wrapped up on September 30th, investors were again reminded that investing is not always comfortable journey.  As you can see in the table below, 7% and greater losses were the norm among key US indexes last quarter.  While there have been eleven other quarters since the start of 2000 (58 quarters in all) that have posted worse returns, it is the first time in four years (Q3 2011, -14.33%) that we have seen losses of this magnitude.  In fact there have only been two other quarters in the past sixteen (Q2 2015, -0.23%; Q4 2012, -1.01%) that posted any negative returns.  The lack of any significant downturns in the market for so many years has, in my view, made this past quarter more painful psychologically.

Time Period
Dow Jones
Industrial Average

S&P 500

Russell 2000

1st Quarter
2nd Quarter
3rd Quarter
October Month-to-Date
Source:  The Wall Street Journal (Past performance is not indicative of future returns).  As of market close October 23, 2015.

Just when it seemed gloomiest, markets have rallied in October posting sizeable gains and thus reducing the impact of the late summer correction.  Along with a jump in the major domestic indexes, interest rates have also risen and the US Dollar has gained strength.  I believe the increase in interest rates is a positive for markets (a sign of strength) and the stronger US Dollar is a natural reaction to both higher rates and a better outlook for growth compared to other major regions in the world.

Not all sectors have regained lost ground in October.  The best performing sectors this month have been Materials (+12.3%), Energy (+11.9%), and Information Technology (+10.8%).  The sizable gains in Materials and Energy have cut 2015 losses but these sectors remain in negative territory for the year.  Energy remains the weakest sector for 2015 with a current loss of 13.1% followed by Materials with a 7.1% decline.  Health Care, the best performing sector on a three and five-year basis lags all but the Utility sector in October with a 3.8% gain.  Looking at sector performance year-to-date, Consumer Discretionary (+8.1%), Information Technology (+7.1%), Consumer Staples (+6.1%), and Telecom (+4.0%) are the best performing sectors.

The decline in the Energy sector corresponds to a roughly 60% drop of year-over-year earnings for this sector from third quarter 2014 to the third quarter 2015.  WTI Oil prices appear to have stabilized somewhat trading within an approximate range of $45 to $50 per barrel since the end of August.  This price stability may have contributed to the nice jump in Energy sector stocks in October.  While oil and oil service companies have been hurt by this decline in energy prices over the past year or so, selective US airline stocks have significantly outperformed.  While it would be a natural expectation that all airline stocks should have performed very well as oil prices have fallen (fuel is a major cost for most airlines), the Dow Jones US Airline Index is down 2.2% YTD.

International markets have performed in concert recently with US markets.  Despite a strong October, the Emerging Markets Region is still lagging most other regions of the world.  European stocks represented by the STOXX 600 continue to perform well in 2015 riding the wave of first quarter strength when the European Central Bank (ECB) announced the beginning of quantitative easing. 

Time Period

Global Dow xUS

Dow Jones
Devel Mkt Region
Total Stock Market
Dow Jones
Emerg Mkt Region
Total Stock Market
1st Quarter
2nd Quarter
3rd Quarter
October Month-to-Date
Source:  The Wall Street Journal (Past performance is not indicative of future returns).  As of market close October 23, 2015.

With expected Eurozone GDP growth of just 1.5% this year, virtually no inflation on the horizon, and continued ECB quantitative easing, interest rates in Europe continue to remain well below US levels.  The German 10-year Bund closed Friday at a yield of 0.51%, the French 10-year has a current yield of 0.85%, and even in Italy the 10-year government bond is yielding 1.5% nearly 0.6% below the US.  This, in my view, is not a positive indicator.  I believe low interest rates in Europe signal a weak outlook for future growth.


I find it difficult to explain precisely why the markets have done what they have done so far in 2015.  Clearly
it has not been a great year for stocks, bonds, and commodities.  China has had a role, the Fed has had a role, and certainly global and domestic politics have had a role.  My previous updates have touched on each of these factors and I certainly stand by my past reviews.  However, I want to add a new factor for you to consider: investor sentiment.

Investor sentiment is the filter by which each of us process and evaluate the events that are going on around us.  If you are like me, the start of a special vacation or visit from children naturally puts us in a great mood.  The great mood we may be feeling helps minimize how we internalize setbacks like flight delays or a flat tire if we are traveling.  Likewise, investor mood or sentiment can affect how we view financial events around us.  The better we feel about things the more we are likely to see events in a positive light and vice versa.

I believe today that investor sentiment is not particularly good.  The markets reacted quite negatively to the devaluation of the Chinese Yuan and lower oil prices have certainly hurt the energy sector.  However, neither of these events alone or together justified, in my view, the correction that occurred in the markets.  I do not believe the drop in biotech stock valuations and the recent underperformance of other health care sector stocks is really justified due to the outstanding revenue growth projections for these sectors, but fall they have.

What is causing investor sentiment to be somewhat negative?  I do not believe that any one issue or event has contributed to the current pessimism found in some investors, but I do believe that collectively a number of factors have weighed on the minds many Americans.  I believe there are five issues hurting sentiment.  First, the US economy continues to grow but at a very slow pace.  If we get 2.5% GDP growth in 2015 as a number of publications are suggesting, we are still trending well below historical post-recovery averages.  A 2.5% growth rate represents just a slight increase of the 2.2% rate since mid-2009.  This rate of growth does not foster much optimism (but it does beat a declining growth rate).  Second, incomes for most Americans continue to decline.  Doug Short writing in Advisor Perspectives this September provided this chart showing how much incomes by age bracket have declined from their peak years:

                                                        Source: Advisor Perspectives, Medium Incomes by Age Bracket: 1967-2014,
                                                                                  September 17, 2015, Doug Short

The implication to the economy is straightforward—less income means less money in the economy.  This does not even factor the mindset of earners who have been losing ground most of this century, and I contend this hurts the way the average American sees events going on around them.  Third, there is very little happening in Washington, DC, that inspires confidence in Americans.  We have seen scandals and political cronyism that sours Americans’ belief that the playing field is level and we all have a chance.  The Federal government’s reach has never been greater both in terms of regulatory burdens on business and in the pocket books of most taxpayers.  Fourth, geopolitical concerns abound.  The Middle East continues to deteriorate, China continues to grab territory in the Pacific, and the Ukrainian conflict remains uncertain.  American influence is waning and I think most of us realize that a strong and influential United States helps global commerce.  Finally, the Great Recession is still present in our investment consciousness.  It is hard to shrug such recent investment pain off when markets trend down as they have in 2015.

 As sentiment deteriorates, it is possible to overlook the positives.  Scott Grannis in the Calafia Beach Pundit listed just a few of the good news stories that investors should not overlook:  housing starts have doubled in the past five years, light vehicle sales have doubled since 2009 and are up 10% year-over-year, bank lending to small and mid-sized businesses is growing strongly, consumer loan delinquency rates are at historical lows, and Federal tax revenues have grown 11.3% annually over the past five years.  All of these are very big positives for the US economy and should not be overlooked in the haze of negative news that permeates our daily lives.  The underlying data tells a different story from many of the headlines and talk shows. 

My guidance to you is not to let the relentless media negativism deter your investment goals and objectives.  Stay focused on the data, not the headlines.


There are a couple of key economic events in the upcoming week.  The Federal Reserve Open Market Committee is meeting Tuesday and Wednesday.  There is very little expectation that the Fed will raise rates following this meeting, but we will have to wait until Wednesday afternoon to confirm.  The first estimate of the third quarter GDP will be released 8:30 AM on Thursday.  Expectations are for the annualized growth rate to slip from 3.9% in the second quarter to 1.7% in the third.  A big miss of this estimate on either side could possibly push the markets.  The most important economic report the following week is the Employment Situation report due out on Friday morning (November 6th).  While it is too early for the consensus numbers to be released, this report has the potential to really move the markets one way or the other.  I watch this report closely each month.

Third quarter earnings season is under way.  To date, 173 of the 500 companies within the S&P 500 have reported earnings with 77% exceeding averaged earning estimates.  Overall, the research firm, FactSet, is expecting earnings to decline 3.5% over the same period a year ago.  Additionally, 43% of companies are exceeding average sales estimates.  To date, Telecom (100%), Utilities (100%), and Health Care (91%) have exceed earnings expectations to lead all sectors while Materials (57%) has the lowest percentage of companies exceeding earnings this quarter. 

The Daily Asset Level Indicator from DorseyWright & Associates shows little change.  With the International asset category below the Money Market asset category, I have limited my exposure to new international investment.  Commodities continue to be very weak overall.

As of October 22, 2015.  Source: DorseyWright & Associates.

I continue to favor Growth over Value, Small and Mid-Capitalization stocks over Large, and US over International.  Within the International major asset category I favor Europe and the Asia/Pacific Developed sectors while I remain cautious about Emerging Markets.

Within the Fixed Income major asset category I favor the Preferreds, Senior 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.