Wednesday, February 3, 2016

January 31, 2016

January 2016 will be a month to forget posting the worst monthly equity performance since January 2009.  Performance numbers like this have brought many bears out of hibernation early and they are currently speaking doom and gloom over every radio and TV financial talk show.  My advice, tune it out.  I understand the challenge to this admonition, but it is important if you are going to avoid making bad investment decisions.  However, if you are truly uncomfortable with short-term losses in your portfolio, there is nothing wrong with increasing the cash position.  For more risk adverse investors, it is better to hold on to your cash and reenter the market later then to lose more value than you are comfortable with losing.  What I am not suggesting is a wholesale liquidation of your equity positions just because we have had a tough month.  It is about having an honest conversation with yourself about just how risk tolerant you are in context with your age, needs, and time horizon.

Time Period
Dow Jones
Industrial Average

S&P 500

Russell 2000

Jan 3 -- 8, 2016
Jan 10 -- 15, 2016
Jan 17 -- 22, 2016
Jan 25 – 29, 2016
Month & Year-to-Date
Source:  The Wall Street Journal (Past performance is not indicative of future returns).  As of market close January 29, 2016.

US small capitalization stocks (Russell 2000) and technology-heavy stocks (NASDAQ) are under-performing the broader indexes to start the year.  This is not entirely unexpected because the Russell 2000 and NASDAQ Composite indexes are populated with stocks that are more sensitive to the broader market moves and thus less attractive to investors who are looking to mitigate losses during market downturns.  It is also valuable to peel back the onion a bit and look at the components of an index to get a better understanding about what is going on.  The NASDAQ Composite, for example, has been hurt in 2016 by the weak performance of two of the indexes three largest components in January: Apple (-7.52%) and Amazon (-13.15%).  These two holdings rank #1 and #3 among the 3086 holdings in the NASDAQ Composite and comprise nearly 12% of the index’s total value.

Investors appear to be pushing money into the better dividend-paying sectors for now.  The best performing (and only positively performing) sectors in January were Utilities (+4.7%) and Telecom (+1.2%) which pay about 3.6% and 3.5% respectively each year in dividends.  This compares to about 2.1% for the full S&P 500 index.    

The broad international indexes traded a little below those of the US in January.  You can see the key broad indexes below have held up pretty well, but I believe overall International stock market performance has been propped up by the European Central Bank’s (ECB) public announcement that more aggressive quantitative easing measures are coming in March, and the continued weakness of foreign currencies to the US Dollar.

Time Period

Global Dow xUS

Dow Jones
Devel Mkt Region
Total Stock Market
Dow Jones
Emerg Mkt Region
Total Stock Market
Jan 3 -- 8, 2016
Jan 10 -- 15, 2016
Jan 17 -- 22, 2016
Jan 25 – 29, 2016
Month & Year-to-Date
Source:  The Wall Street Journal (Past performance is not indicative of future returns).  As of market close January 29, 2016.

Emerging markets continue to feel added pressure due to the slowdown in China and the weakening of commodity prices. 

WTI Oil fell nearly 26% in the first three weeks of January only to rally closing the month down 11.9% with oil finishing Friday at $33.62 per barrel.  Venezuela and Russia are leading efforts to induce other oil-producing countries to cut output to help the price of oil.  Both Venezuela and Russia are heavily dependent upon oil revenues and are suffering from Saudi Arabia’s unwillingness to cut its oil production.  There appears to be little support from the Saudi’s to support any cutbacks in oil production at this time.  According to the Wall Street Journal, part of the rally in oil prices over the past two weeks has been fueled by oil traders closing out short positions (shorting is a bearish strategy that is profitable only when the value of an investment falls) just in case some agreement is made to reduce oil production.  If these efforts fail, I think it would be entirely possible for oil prices to fall again.

The US Dollar has gained strength against the Euro (+0.23%) and the Japanese Yen (+0.5%), and is up nearly a full percent against a larger basket of six major currencies (including the Euro and Yen) through the month of January.  This continued strength of the US Dollar is hurting the emerging markets by reducing demand for oil through higher oil prices non-US traders must pay, and by forcing emerging market countries to raise their interest rates ever higher to prevent US Dollars from returning to the US as risks abroad appear to be rising.  US multi-national corporation sales/earnings are hurt when sales/earnings in foreign currencies are translated into US Dollars for accounting and financial reporting purposes.


Anyone who has been following my writing for any length of time knows that I hate, hate, hate talking about the Federal Reserve or the Fed as it is affectionately known.  My dislike of this topic comes from two major sources:  first, it is complicated and the details about just how the Fed operates are not well known or understood by almost all Americans; second, this group of unelected officials wields enormous power and conducts most of it’s meetings behind closed doors.  Even with a new effort at transparency, most analysts must attempt to make sense of monetary policy by interpreting vague periodic declarations or occasional Congressional appearances by members of the Fed’s policy committee.  So here I go again talking about the Fed.  Promise me you will make an effort to get through the next couple of paragraphs without stopping!

The Federal Reserve’s origins date back to 1791 when Alexander Hamilton (the nation’s first Treasury Secretary and staunch Federalist) pushed for the establishment of a national bank to facilitate a common currency and money creation through bank lending.  Thomas Jefferson and other wealthy farmers vigorously opposed Hamilton because they thought the central bank would hinder state banks and favor the wealthy financiers at the expense of the more rural landowners.  Hamilton got his wish, but Congress did not renew the bank’s 20-year charter and closed the Fed’s doors in 1811 only to reopen five years later.  At the end of this second 20-year charter, President Andrew Jackson had the Fed closed yet again.  It was not until 1913 that the Federal Reserve reopened remaining the hub for all US banking since then.  The Fed’s importance is unequaled as the US economy has become the largest and most important in the world.  Today the Federal Reserve influences the economy here and abroad through Monetary Policy.  The Fed implements monetary policy through the money supply in order to support currency stability and to maintain interest rates at a reasonable level.  The “full employment” mandate did not officially become a part of the Fed’s official policy mandate until 2008.  The Federal Reserve now operates under a dual mandate to keep inflation under control and foster full employment.

The other side of the economic policy coin is fiscal policy.  Congress and other legislative bodies make fiscal policies including tax policy, employment laws, and government spending.  Fiscal policy can be either support or hinder economic growth within a nation or globally.  High tax rates, inflexible employment laws, and high government spending are all components to a negative fiscal policy environment.

Since the Great Recession in 2008-2009, the Federal Reserve has kept short-term interest rates at a 0% to 0.25% range raising the overnight lending rate 0.25% just this past December.  In addition to low interest rates which were intended to stimulate economic growth, the Fed purchased over $3.5 trillion in bonds pushing all the money into the private banking system.  The expectation was that banks in turn would lend that money out to businesses greatly increasing the money supply, increasing economic activity, and raising wages.  If this had happened, inflation would have spiked, but this was a risk the Fed was willing to take.  In the end, this never happened.  With all the stimulus put in place by the Fed, the real (inflation excluded) Gross Domestic Product (GDP) in the US has grown annually by an anemic 2.1% rate since mid-2009.  The by-product of all this monetary policy easing should have been a robust GDP and much higher inflation than the 1.3% rate we have been experiencing.

Central banks around the world are trying to imitate the US Fed to some degree with accommodative monetary policy.  Last Friday, Japan announced that they would implement “negative” interest rates.  Central banks implement negative rates by charging a fee for deposits held at the central bank.  The Bank of Japan will now charge banks 0.10% interest for all excess reserve deposits.  Japan joins the Eurozone, Denmark, and Sweden who all are now charging some type of interest on excess reserves held on deposit.  A negative interest rate is intended to further induce banks to start lending more money and getting that money into circulation.  However, banks are unlikely to increase lending if either the private sector does not want the loans now or because the risk to the bank to make certain loans is greater than the 0.10% interest charge. The US Fed has not resorted to negative interest rates and I believe strongly that it will avoid doing so.

This brings me to answer the question I asked at the lead of this section, can central banks save the world?  My answer is a resounding no, and moving to negative interest rates is one more example of failed economic policy around the world.  There are limits to what monetary policy can do.  Central banks have, in my view, provided cover to politicians the world over.  Remember economic policy has two components: monetary and fiscal.  Excessive taxation, spending, and regulation are all fiscal headwinds to economic growth and have severely hindered the private sector worldwide to growing at more than a snail’s pace.  The only thing that will get the world economy growing will be pro-growth fiscal policies.  How can I be so sure?  Just look at the past six years.  We have seen the most accommodative monetary policy in modern history and yet we have seen the slowest economic growth rate following any recession. 

I want to make one final point.  Since the Fed raised short-term rates in December, the benchmark US 10-year Treasury yield has fallen from 2.28% to 1.92%.  This is not a sign of confidence of growth in the private sector here or abroad, and is now calling into question whether the Fed will raise rates another 0.25% following their March meeting as had been widely expected.  So as I said in my 2016 market outlook, don’t look for Fed discussions to go quietly away—much to my dismay!


With so much uncertainty surrounding markets of all types, it is as important as ever to study unbiased data.  Below you will see the Dorsey Wright & Associates Daily Asset Level Indicator (DALI) chart below.  I have reprinted the December 20, 2015 chart so you can see the changes that have occurred in just over a month.  US equities still sit at the number one position on a relative strength basis of the six major asset categories I follow.  This asset category has given up some tallies (mostly in the small and mid-capitalization sub-sectors) and the International equities asset category has slipped from third to fourth place in the ranking.  This drop in ranking is a big hurdle for me to overcome before recommending putting new cash at work in the International asset category.  Not to go unnoticed is the sizable jump in tallies in the Commodity asset category.  I believe this has been pushed by the jump in oil prices over the past two weeks.

As of December 20, 2015.  Source: DorseyWright & Associates.

As of January 29, 2016.  Source: DorseyWright & Associates.

Overall US equity markets remain oversold even with the rally over the past two weeks.  The recent rally has driven some of the technical indicators I follow into a positive trend for the first time since last fall.

I have added a new chart that I examine each week and this is the high-level view of favored market capitalization and sector data provided by Dorsey Wright & Associates.  It is important to understand that these are relatively slow-moving indicators and may not match current performance.  However, you can see some basic trends such as the positive movement of the Utilities and the continued weakness in the Energy and Materials sector.

As of January 29, 2016.  Source: DorseyWright & Associates.

My views of the bond sector are unchanged.  There have been gains in longer duration US Treasuries and Corporate bonds as investors both here and abroad are buying US debt.  As I discussed previously, the drop in the High-yield bond sector is notable.  For the month of January the Morningstar® high yield bond sector is down 1.58% compared to a gain of 1.38% for the Barclays US Aggregate bond index.  However, it is important to note that for the last week in January, the high yield bond sector was up 0.90% while the Barclays was up 0.52%.  This is the type of volatility I think you should expect from lesser credit quality bonds when stocks rally, and I would argue that the high yield sector is a pretty good bargain here.  Again, if you have a short time horizon or do not need the income, the weakness is important and may justify some changes in your bond portfolio; however, if you are a long-term investor, I do not believe wholesale changes in your fixed income allocations are necessary at this time.  The Fed’s raising interest rates a quarter percent will not, in my view, ease the challenge for investors who require income beyond the meager interest earned on CDs or money market funds as recent interest rate declines validate.

We remain in the midst of the 4th Quarter 2015 earnings reporting season.  It is not stacking up to be a great quarter for earnings particularly for sales/revenue growth.  With the 4th Quarter 2015 GDP report coming in at a lackluster 0.7%, the earnings are simply matching this economic statistic.  I will be reporting on this topic in greater detail in my next Update.

Please reach out to me if you have any questions or comments. 

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.