Wednesday, November 11, 2015

November 8, 2015

The rally that began in October has carried through to the first week of November helping erase much of the losses from the third quarter.  The tech-heavy NASDAQ has posted a solid return of 8.7% this year while the other major indexes have hovered around little to no gains.

Time Period
Dow Jones
Industrial Average

S&P 500

Russell 2000

1st Quarter
2nd Quarter
3rd Quarter
November 2 - 6
4th Quarter-to-Date
Source:  The Wall Street Journal (Past performance is not indicative of future returns).  As of market close November 6, 2015.

Sector returns have varied.  Four of the eleven major economic sectors I track have posted returns greater than the S&P 500 thus far in 2015.  Consumer Discretionary (+10.4%), Information Technology (+9.0%), Health Care (+6.5%), and Telecom (+3.8%) have outperformed the S&P 500.  Four sectors, Real Estate (-1.0%), Materials (-6.5%), Utilities (-8.2%), and Energy (-11.3%) have been the weakest so far.  The Materials and Energy sectors have been hit hard by the decline in oil prices, while the Utility sector has been hit hardest by rising interest rates.  Overall, the US economy is delivering modest returns on modest growth.

FactSet, one of the top equity analytic companies in the US, reports that 444 of 500 companies within the S&P 500 have announced third quarter earnings as of last Friday.  Of those reporting, 74% of companies exceeded their mean estimate for earnings while 46% exceeded their mean estimate for sales.  The Health Care sector has the highest percentage of companies exceeding estimates (88%) while Utilities (57%) and Materials (63%) have the lowest percentage.  Overall earnings have declined 2.2%.  If this trend holds, it will be the first time that there have been back-to-back quarterly declines in earnings since 2009.  While this decline is troublesome, the problem is found primarily in one sector—Energy.  The Energy sector has reported a year-over-year decline of 56.6% in earnings.  If the Energy sector was stripped out of the S&P 500 earnings data, the remaining sectors would have a blended growth rate of 4.5%.

Developed international markets continue to move somewhat in concert with US markets as they have since mid-year with the exception of emerging markets. 

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
November 2 - 6
4th Quarter-to-Date
Source:  The Wall Street Journal (Past performance is not indicative of future returns).  As of market close November 6, 2015.

As I noted in my last Update and Commentary, European growth this year is projected to grow approximately 1.5% compared to 2.5% for the US.  The European Central Bank (ECB) is continuing with their version of quantitative easing (QE) and I believe this has helped European stocks during what is clearly a tough economic period.  Emerging market economies, heavily dependent on commodity sales, have suffered more than other geographic regions.  The slowdown in Chinese consumption and a stronger US Dollar have provided a perfect storm against many developing market economies.  I do not anticipate this duo of economic factors to change in the near-term leaving outlook for the emerging markets rather anemic, in my view.

Oil is not the only commodity to feel the sting of slowing global demand and unfavorable currency exchange rates.  Lean Hogs (-32.3%), Coffee (-29.3%), Copper (-21.0%), and Natural Gas (-19.4%) are just a few of the other commodities that have seen their values drop.  The broad-based Dow Jones UBS Commodities index is currently down 18.3% in 2015 following a drop of 17% in 2014.

Interest rates have continued their recent climb.  The benchmark 10-year US Treasury yield closed Friday at 2.32% an increase of 18 basis points in one week (a basis point is like a penny to a dollar, or 0.01%) and has increased 35 basis points since October 14th.  I believe the general trend in interest rates is attributable to the growing expectation that the Federal Reserve will raise interest rates as early as its December meeting.  For bond investors this means a period of sluggish returns.  The broad-based Barclays US Aggregate Bond index fell 0.9% last week—indicating that most major bond sectors were down.  For the year, this key fixed-income index is up just 0.35%.    


With Congress passing a two-year budget deal and eliminating the threat of a government shutdown, attention is now fully focused on Janet Yellen and the Federal Reserve.  Ms. Yellen has come under increasing pressure to raise the Fed’s overnight lending rate (all other rates are set by the free market) from roughly 0% to at least 0.25%.  As all of you are no doubt aware, this argument has been raging for some time now.  Following a string of weak jobs and economic data during the summer, the market consensus was that the Fed would not raise rates until spring 2016.  Following the surprisingly strong October employment report released this past Friday, the likelihood of a rate increase in December 2015 appears much more likely.

The reaction by some components of the market has been swift and certain.  Interest rates are climbing, the US Dollar is strengthening, commodity prices have continued to weaken, and utility stock valuations weakened further.  What is not so certain is the reaction of investors towards US stocks across the board.

Stocks initially sold off about 1% Friday morning on the jobs report data, but rebounded throughout the day recovering all losses from earlier in the day.

The Financial and Technology sectors were the strongest performers Friday while Utilities and Real Estate were the weakest.  In the end, the S&P 500 was flat, the Dow Jones Industrial Average gained 0.3%, the Russell 2000 added 0.8%, and the NASDAQ posted a 0.4% gain.  Nothing out of the ordinary when the day was done.

After watching the market reaction Friday coupled with other recent days when the Fed was on the top of everyone’s minds, I believe that the markets will weather a rate increase by the Fed in December.  I do not believe in the theory that low interest rates are the reason stocks are up, rather stock prices are higher because companies have made money during a very sluggish 2% to 2.5% growing economy.  If the Fed raises rates in December by 0.25%, the markets should see this as a positive signal that the US economy can actually sustain itself without 0% interest rates.  This does not mean that there will not be volatility surrounding the approaching Fed meeting December 15-16, but I do believe that the time has finally arrived for the Fed to take action.  Whether the Fed does or not will probably depend on sustaining jobs growth and an economy that continues to plod along.

Economic reporting will be somewhat subdued in the weeks leading up to Thanksgiving.  The Federal Reserve has stated that they will be very sensitive to economic data leading up to their next meeting, and I believe this will draw interest to any economic data report that might reinforce or debunk investors’ views regarding a rate hike.  Personally, I am tired of all this mystery about the Federal Reserve.  My suggestion to investors is simply to look at investing the old fashioned way—buy into good companies and trends that are growing.  

According to FactSet, Telecom, Financials, Consumer Discretionary, and Health Care have the largest expectation for earnings growth in the fourth quarter while Energy, Materials, and Information Technology have the lowest.  On a relative strength basis, I am favoring the Technology, Consumer sectors, and Health Care sectors.  The strength in Telecom earnings has not translated to above average returns for the sector which has seen an overall sector gain of roughly 3.8%--not much better than the S&P 500 overall.  I am going to keep watching this sector closely for any signs of strength.

There has been no change to how DorseyWright & Associates currently ranks the six major asset categories.

As of November 6, 2015.  Source: DorseyWright & Associates.

Growth is favored over value and Small/Mid capitalization stocks are favored over Large cap.  This relationship is a long-term indicator because recently, large cap growth stocks have been outperforming the small and middle cap stocks.  I think it is more important to stay focused on growth stocks for now and not be especially concerned about the market capitalization of your holdings.

Within the Fixed Income major asset category I favor the Preferreds, Senior Floating Rate, and High Yield sectors.  Fixed income has become an increasingly difficult asset category to get returns due to the rising interest rate trend.  Longer duration bonds in particular I believe will have the greatest challenge ahead and would recommend using any declines in interest rates to sell longer-duration bonds for shorter duration bonds.

I am continuing to watch global headlines, especially those coming from China.  While the Chinese economy has a modest impact on US growth, the Europeans and other overseas markets are more dependent.  Slowing growth from China may lead to a broader global slowdown hurting US corporations who profit substantially from overseas sales.  

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.