MARKET UPDATE AND COMMENTARY

May 11, 2016

Performance in the first week of May was negative across all major indexes I follow and coupled with the last week in April, has left markets flat to negative for the year. 

Time Period	Dow Jones Industrial Average (DJIA)	S&P 500	Russell 2000	NASDAQ
January	-5.5%	-5.1%	-8.8%	-5.8%
February	0.3%	-0.4%	-0.1%	-1.2%
March	7.1%	6.6%	7.8%	6.8%
April	0.5%	0.3%	1.5%	-1.9%
Year-to-Date	1.8%	0.6%	-1.9%	-5.4%

Source:  The Wall Street Journal (Past performance is not indicative of future returns).  May 6, 2016

US Dollar weakness has boosted the Energy and Emerging Markets sectors.  The tail winds of a weaker US Dollar has resulted in a resurgence in oil prices (WTI +20.3% YTD) and a rebound in Emerging Market stocks.  However, Morgan Stanley published a white paper recently cautioning investors from getting too excited due to the volatility of currency markets and dependency on central bank monetary policies.  I share this sense of caution for now.  For the year, the US Dollar is currently 5.5% lower against the Euro and 11.6% lower against the Yen.  These are sizeable moves.

International markets continue to underperform the US.  International stocks continue to lag and the Emerging Market sector cooled in April and into May.  The 4.1% drop in the DJ Emerging Markets Region index last week simply highlights the volatility found in the emerging market sector.

Time Period	Global Dow xUS	STOXX 600	Dow Jones Devel Mkt Region Total Stock Market	Dow Jones Emerg Mkt Region Total Stock Market
January	-7.0%	-6.4%	-6.3%	-7.35
February	-1.2%	-2.4%	-0.8%	0.8%
March	7.8%	1.1%	6.8%	12.3%
April	2.3%	1.2%	1.5%	0.8%
Year-to-Date	-0.9%	-9.3%	-0.3%	0.8%

Source:  The Wall Street Journal (Past performance is not indicative of future returns).  May 6, 2016

Federal Reserve holds off raising rates.  Consensus was for the Fed to raise rates in April as part of a program to move overnight lending rates higher in 2016, however, market weakness and slowing growth in the US and abroad put any increases on hold for now.  The benchmark US 10-year Treasury closed Friday at 1.78% nearly one-half percent below its starting point this year.  The German 10-year Bund is currently yielding 0.14%.  At this point, low rates reflect continued low economic growth and inflation expectations.

The initial report of the Real US Gross Domestic Product (GDP) for the 1^st quarter was 0.5%.  Economists were not expecting much for the 1^st quarter, but 0.5% disappointed most.  Unlike last year, a slow economy could not be blamed on terrible weather or a strengthening US Dollar, raising concerns about the overall strength of the US economy. 

Earnings and sales of S&P 500 companies continue to decline in the 1^st quarter.  According to FactSet, 87% of companies within the S&P 500 have reported 1^st quarter earnings and coupled with estimates for the remaining 17%, earnings are expected to decline 7.1% compared to 1^st quarter 2015.  The sales of all companies are expected to decline on average 1.6%.  A weaker US Dollar has not appreciably improved earnings of US-based companies, yet.  FactSet reports the 12-month forward looking earnings per share (EPS) for the S&P 500 is $124.64/share providing an expected price/earnings ratio (PE) of 16.6 (based upon Friday’s close of 2059.7.  This number is slightly higher than the 10-year average PE of 14.3.

The April jobs report disappointed with a net increase of 160,000 private sectors jobs.  While this number certainly disappointed investors, it should be noted that the month over month figures are volatile.  The 12-month average is 224,000 and presents a more accurate view of the labor force in economy.  While job growth is anemic by historical standards, job growth is continuing.

THE ECONOMY IS PLODDING ALONG AND MARKETS REFLECT THIS CONTINUED REALITY

Real GDP (strips out inflation) grew in the 1^st quarter by 0.5%.  This figure remains frustratingly low for a post World War II economy that has grown on average by 3.23% per year.  Looking back, the previous five years Real GDP has averaged just 1.9%.   From 2011 until the end of 2014, the S&P 500’s average annual return was 13.6% boosted by a 29.6% return in 2013.  In 2015 the S&P 500 returned -0.7%, and thus far in 2016 this index

 is up just 0.6%.  From the beginning of 2015 through last Friday, the S&P 500 is up just 7 points or 0.3%.  These numbers can frustrate even the most patient investor.

A couple of questions immediately come to mind.  First, how did the S&P 500 manage a cumulative return of 63.6% since the beginning of 2011 with such meager GDP growth?  Second, why has the yield on the US 10-year Treasury fallen from 3.30% to 1.78% over the same period?  Third, why has the US Dollar appreciated 14.4% as well since the beginning of 2011?  And finally, what is the implication for investors going forward?  I will try to answer each of these questions as briefly as possible.

I believe earnings is the real engine of stock market gains.  Since the start of 2011, US companies have earned an average of 9.86% in after tax profits with respect to the GDP.  This compares very favorably to the long-term (since 1947) average of 6.53%.  There are many factors that have driven strong earnings over the years, and I believe that the surge in productivity brought about by huge technology advances is a key reason.  Just think back to an era before the personal computer and the internet.  I am old enough to remember life before word processing, spreadsheets, and cell phones.  It is not hard to fathom the positive changes all of this has brought to the workplace and productivity.  Since 2015, however, earnings have started to slide and productivity has not increased to offset drops in sales.  Profits have slipped and with it, a stagnate market.  A slowing global economy has certainly hurt, but the Federal government’s burden on businesses through greater regulation, rules, and increased taxes is also playing a role in reducing earnings.

 The yield on the US 10-year Treasury reflects bond investors’ outlook for growth and inflation.  With real growth at just 2% and inflation in check, I see no reason to expect yields to be higher today.  Additionally, the massive intervention by the Federal Reserve and other central bankers has, in my view, kept yields artificially low compared to where the free market might have pushed them.  I cannot help but feel that central bankers in their quest to boost economic outcomes have in fact hurt the economic recovery since 2008.

Simply supply and demand principals drives the valuation of currencies.  In my view, demand for the US Dollar has increased over the past couple of years because of the perception that US bonds are safe investments during periods of uncertainty.  Foreign investors have purchased our bonds as fears abroad increased over everything from the Eurozone/Greece crisis, fears of a China slowdown, to plummeting oil prices.  To buy a US bond you need US Dollars, so investors sell their home country currencies to buy US Dollars before they purchase US bonds.  Additionally, US yields remain higher than most other developed nations yields also making our bonds more attractive.  As I pointed out in the first section, the yield on the 10-year German Bund is just 0.14% while the rest of developed Europe also remains below US yields.  As weak as our economy is, many developed international economies are even weaker.  Emerging markets have seen their yields skyrocket as those governments attempt to retain capital in their own countries as investors seek safety elsewhere.

How these factors will affect you going forward is a hard call because the global markets are always changing and in this modern era, changes can be swift.  What I do believe is that until significant reforms occur in tax and labor laws here and abroad driven by fundamental changes to the government status quo, we are likely to remain mired in a below average performing economic cycle.  To use a sports analogy, the economic playing field is muddy and it will be hard to move the ball forward appreciably over the coming months.  I am always looking for the catalyst to propel economic performance and profitability forward.  The next great thing may be a new technology, new biomedical discoveries, improving technologies in fossil fuel extraction, or a new product never before seen.  Without trying to sound too philosophical, this has been the way of the world since the evolution of man, so I see no reason to think we are running out of ideas on this planet.  I believe there will be a future catalyst and the markets will advance with this new source of corporate profits.

LOOKING AHEAD

Looking at the near term, I continue to favor higher dividend paying stocks and sectors.  If the market is going sideways, you might as well take dividends.  The best performing sectors so far in 2016 are Utilities, Energy, and Telecom.  The weakest have been Health Care, Technology, and Financials.

I expect uncertainty to remain in the economy especially in this contentious presidential election cycle as two very different economic futures are debated for the country.

The Saudi’s fired their long-tenured Oil Minister over the weekend signaling a desire to keep the pumps flowing and preserving market share.  A little reported fact is that Russia has been increasing market share in the Far East at Saudi Arabia’s expense.  Russia’s proximity helps a great deal, but the Saudi’s will not sit by and do nothing.  Any hope of production caps so eagerly sought by Venezuela, Russia, and other countries is highly doubtful.  The wildfire in Canada is having an impact of Canadian shale oil production potentially taking out a million barrels per day.  Watch the price of crude in the coming weeks.

Looking at the D.A.L.I.^(R)                        provided by Dorsey Wright & Associates, there has been no change in the top three asset categories, however, all have given up some of their tallies primarily to commodities as gold and oil prices have risen pushing commodities up to the number four position (D.A.L.I.^(R) is a long-term indicator):

       

I will conclude with my normal comment and that is I encourage everyone to look at their investments wherever they are and assess your risk tolerance within the framework of what the investment objectives you have laid out and decide if you are still consistent with those objectives.  If you are great, if not, make adjustments.

I am happy to help anyone who has questions so do not hesitate to pick up your phone and give me a call.

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.