European Central Bank (ECB) President, Mario Draghi, announced this past Thursday that he was prepared to initiate an unlimited amount of bond purchases in order to stabilize borrowing costs among European Union (EU) countries and protect the very existence of the Euro. Markets, both here and abroad, moved sharply upwards on the news. The weak August Employment Situation Report on Friday dampened investor’s spirits and greatly increased the expectations that Federal Reserve Chairman, Ben Bernanke, would undertake further monetary stimulus referred to as quantitative easing (QE).


For the week the Dow Jones Industrial Average (DJIA) added 216 points (1.6%), the S&P 500 gained 2.2%, the NASDAQ increased 2.3%, and the small and mid-capitalization dominated Russell 2000 surged 3.7%. Thursday was the key day as the DJIA jumped 245 points, and (Source: Wall Street Journal) without it, the DJIA would have been down 39 points for the week. Encouragingly, the DJIA and other indexes all managed gains on Friday in the face of the lackluster employment report. For the year the DJIA is up 8.9%, the S&P 500 is up 14.3%, the Russell 2000 is up 13.7%, and the NASDAQ is up 20.4%.

All eleven major economic sectors were positive last week led by Materials, Financials, and Consumer Discretionary. Only Consumer Staples, Utilities, and Real Estate underperformed the DJIA. For the year, the sectors ranked by performance: Consumer Discretionary, Information Technology, Financials, Health Care, Real Estate, Telecom, Materials, Consumer Staples, Energy, and Utilities. Only Utilities and Energy have underperformed the DJIA.

International stocks rallied on the ECB announcement last week with the MSCI (EAFE) posting a 2.8% gain. The European STOXX 600 index gained 2.3%. Developed markets (2.6%) led the major regions of the world followed by the Americas (2.6%), Emerging markets (2.5%), and Asia/Pacific (1.0%). The Far East continues to be hobbled by sluggish and disappointing growth numbers coming from China and Japan’s economic and political paralysis.

The Barclays US Aggregate Bond index posted its first weekly loss (-0.3%) in three weeks as US Treasury yields pushed higher for the week. The 10-year US Treasury yield closed Friday at 1.668% up from the previous Friday close of 1.543%. The 30-year yield also gained to close the week at 2.819% compared to last week’s close of 2.667%. Yields did fall slightly on Friday after the lackluster employment report and increasing expectation that the Fed will institute QE3, but uncertainty about how the Fed will implement QE3 and the move to riskier bonds following the ECB’s announcement dominated trading strategies for the week. Spanish 10-year yields fell sharply last week closing Friday at 5.36%. The yield on Spanish 10-year notes has now fallen over 1.9% from the July 20th close of 7.27%. Italian debt also pulled back. German sovereign debt yields, like the US, increased sharply as bond traders left “safe haven” debt and rushed to higher-yielding countries like Spain and Italy with the confidence that the ECB will step in and protect their bond purchases. Short duration international was the best performing bond sector last week while long duration US Treasuries and Corporates were the weakest.

The Euro jumped the past week to a four-month high against the US Dollar to close Friday at $1.281 up over two cents (1.83%) from last Friday’s close. The US Dollar weakened on investors leaving the safety of the US currency for riskier ones and because the poor employment report has increased the likelihood of another round of quantitative easing and the low interest rates this policy is expected to bring. The US Dollar index lost 1.2% for the week and is now down for the third consecutive week.

Gold and precious metals in general did very well this past week on expectations of QE3. Gold gained $52.90 (3.1%) per ounce to close Friday at $1740.50. Gold is the primary hedge against weakening currencies that are potentially devalued by easy monetary policies announced by the ECB and anticipated by the Fed. Commodities were generally higher last week with the Dow Jones UBS Commodity index gaining 0.8%. WTI Oil dropped negligibly to close the week at $96.42 per barrel. Corn was the biggest commodity loser of the seventeen I track losing over 11% for the week. Commodity prices tend to be very volatile week over week making it difficult to draw any hard conclusions about short-term fluctuations.

IS THIS A SUGAR HIGH?

Central bankers are doing their part to bail out spendthrift politicians. With Mario Draghi’s announcement on Thursday that he was prepared to enter into unlimited bond purchases in the secondary market to keep interest rates in check and preserve the Euro, he has bought politicians an undetermined amount of time to get the EU’s fiscal house in order. Since his initial comments in July supporting the Euro and his willingness to take action to preserve the Euro, interest rates have fallen sharply for the most at-risk countries in the southern sphere of the EU. Mr. Draghi’s announced policy was supported by every ECB Governing Council member except Bundesbank President, Jens Weidmann; but even German Chancellor Angela Merkel did not renounce the move. However, Germany was able to wrestle some important concessions from the ECB. First, a country will be required to formally request that the ECB begin purchasing its bonds in the secondary market. Second, there will be strict austerity requirements imposed as a condition for the ECB to buy a country’s bonds, and third, the ECB will buy only bonds with less than three-year maturities. These may prove to be important concessions wrestled by the Germans. Angela Merkel warned that the ECB’s unprecedented monetary accommodation could not take the place of political leadership (fiscal policy) to correct the imbalances between members of the EU.

Now it appears to most pundits that Mr. Bernanke will step forward and offer additional monetary policy accommodation following the weak jobs report for August. The Federal Reserve, unlike the ECB, has a dual mandate for price stability (inflation control) and full employment. It is the employment mandate of the Fed that makes most observers believe Mr. Bernanke will take action now. There is uncertainty concerning just how he will act. Will the Fed start a new round of bond purchases, will it talk down rates by promising to hold interest rates at near zero level for another year or two, or a combination of these and other measures?

Assuming Mr. Bernanke does act and Mr. Draghi begins to buy bonds, the ultimate question is will these policies be effective or will their efforts do little more than postpone the inevitable and do more harm in the long run? In other words, are we experiencing a sugar high or is the beginning of the end to the economic crisis gripping Europe?

The challenges are great—especially in Europe. Europe lacks monetary control over the countries within the EU and this issue is at the heart of a lawsuit challenging the constitutionality of German’s involvement in the permanent bailout facility known as the European Stability Mechanism (ESM). This Wednesday the German Federal Constitutional Court is expected to rule whether German leaders can give control over budgetary matters to the EU which the plaintiffs say is currently unconstitutional and precisely what would happen if Germany signs the ESM treaty. On the same day, the Dutch go to the polls for national elections. The outcome is being interpreted as a referendum in the Netherlands, for support of the Euro and of continued bailouts. If the Europeans are ever going to stem the current crisis and retain the Euro, I believe like many economists that there must be a fundamental reorganization of the EU focusing on fiscal and monetary centralization, the requisite loss of sovereignty by all countries in the EU, and approval of all these measures by the citizens of Europe. This must be done as Europe slips back into a second recession and unemployment reaches historical highs.

How much time the markets are willing to provide the political class is a critical unknown. Indicators such as European swap spreads and interest rates tell me that there is a cushion right now and that politicians have been given plenty of room to maneuver. Interest rates have plummeted in Spain and Italy, and it is expected that the private sector will step in and continue buying bonds as long as the ECB is buying as well. I believe that interest rates will remain the canary in the cave and will tell us if the private market approves or disapproves of monetary or fiscal policy initiatives, and I will continue to report that information each week. Much has yet to be done both here and abroad and the outcome is clearly in doubt.

LOOKING AHEAD

As I previously noted, the Europeans have several major events happening this week that are of real interest to investors. Here in the US, the 2012 presidential campaign is now in full swing and Congress is expected to be back in session. With vital issues facing the government, I am expecting nothing to happen in Washington until after the election. The Federal Reserve Open Market Committee (FOMC) will be meeting during the week and all eyes will be on Chairman Bernanke and whether or not QE3 will or will not begin and how it will be implemented if it is launched. The outcome of the FOMC meeting is very, very important to the markets and the economy in general.

This week has a number of important economic reports. The July International Trade figures will be released on Tuesday and consensus calls for a trade deficit of about $44 billion which is slightly higher than June’s $42.9 billion. Given the slowing global economy the export portion of this report will be viewed critically. Thursday is the weekly Initial Jobless Claims report and consensus is that 370,000 Americans will file first time jobless claims which would be up 5000 from last week. The August Producer Price Index (PPI) will also be reported Thursday morning. This report shows price increases to sellers of goods and services and thus reflects inflation momentum building within the economy. The PPI releases two sets of data, core and non-core with core stripping out food and fuel. I find the non-core most informative because food and fuel are key components to most of what the typical American buys each and everyday. Consensus expects the core rate to increase by 0.2% (0.4% in July) and the non-core rate to increase 1.4% (0.3%). If the non-core rate comes in anywhere near consensus, it could spell seriously higher prices for most goods and services in the fall. Friday has three important sets of data scheduled for release. First there is the August Consumer Price Index (CPI). The CPI measures the change in the average price level of a fixed basket of goods and services purchased by consumers. It is the measure of the rate of inflation. Consensus for a core basket is expected to increase by 0.2% (0.1% for July) while the non-core basket is expected to increase 0.6% (0.0% in July). The second report is the August Retail Sales figures. Consensus is for August to match July’s strong 0.8% increase. The last report is the August Industrial Production report. Consensus is for August to contract at a rate of -0.1% down from a good 0.6% increase in July.

The New York Stock Exchange Bullish Percent (NYSEBP) closed Friday at 62.56 up from 60.03 the previous week. This is the twelfth weekly increase of the past thirteen for this important technical indicator and has moved up from a low of 42.66 on June 4th. The overbought reading for the S&P 500 jumped last week and closed Friday at 65% up from last Friday’s reading of 35%. Still within a very acceptable range. I have consistently reported that bonds are overpriced relative to their values over the past ten weeks, but for most bond sectors, they are not extremely overbought. Except for corporate high yield which is currently overbought at 168%. This coincides with an article in the Wall Street Journal this past weekend reporting that high income bond yields are at their lowest point since this data was kept beginning in 1983. This translates to mean that investors are so starved for yield that their purchases have driven the price for high yield bonds to all-time high which in turn drives yields down (remember the inverse relationship between bond prices and yields). Exposure in this sector must be carefully watched for weakness.

The Dorsey Wright & Associates analysis of the markets indicate that US stocks and Bonds are the two favored major asset categories followed by Foreign Currencies, International stocks, and Commodities. Middle capitalization stocks are favored, as is growth over value, and equal-weighted indexes over capitalization weighted indexes. Equal-weighted indexes are those where each stock in the index is weighted the same, while in capitalization-weighted indexes the larger stocks have the largest weighting consistent with their size relative to the other stocks. The relative strength sector weightings favor Consumer Discretionary, Real Estate, Information Technology, and Health Care. US Treasuries and International Bonds are favored in the Bond category, while US and Developed Markets are favored within the International stock category.

Paul L. Merritt, MBA, AIF®, CRPC®
Principal
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.

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.

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.

Federal Reserve Chairman Ben Bernanke delivered his much-anticipated speech at the Fed’s Jackson Hole conference Friday and markets reacted as would be expected.  His remarks made it clear that the Fed has its finger on the quantitative easing (QE) trigger, but that it was not ready to pull it just yet.  After a lackluster start to the week, Mr. Bernanke’s comments were enough to rally stocks, move bonds yields lower, weaken the US dollar, and push gold prices to a five-month high.  Investor attention will now turn to the European Central Bank (ECB) meeting next week where the ECB President, Mario Draghi, will address the very serious challenges facing the European Union (EU).

Friday’s rally was insufficient to push the Dow Jones Industrial Average (DJIA) positive for the week as this key index lost 67 points (-0.5%) and has now been down two consecutive weeks.  The S&P 500 fell by -0.3%, and the NASDAQ fell -0.1%.  The small and mid-capitalization heavy Russell 2000 posted a 0.4% gain.  The DJIA (0.6%), the S&P 500 (2.0%), the Russell 2000 (3.2%), and the NASDAQ (4.3%) were all positive in the month of August.  For the year the DJIA is now up 7.2%, the S&P 500 is positive by 11.8%, the Russell 2000 is up by 9.6%, and the NASDAQ leads all major indexes with a 17.7% gain.

Performance across the major economic sectors was generally muted with only four sectors posting positive returns.  Real Estate, Consumer Discretionary, Health Care, and Financials were the best performing sectors while Energy, Industrials, and Utilities were the weakest.  For the month of August, Information Technology was the best performing sector posting just over a 5% gain followed by Consumer Discretionary, and Materials.  Utilities, Consumer Staples, Telecom, and Real Estate were the negative sectors last month.  For the year, Information Technology, Consumer Discretionary, Financials, Health Care, Real Estate, and Telecom are all outperforming the S&P 500 while Utilities and Energy remain the worst performing sectors and the only two not exceeding the DJIA.

International stocks were notably lower last week with the MSCI (EAFE) losing -1.6% breaking six weeks of consecutive gains.  The heaviest losses came from Emerging Markets (-2.8%) and Asia/Pacific (-2.0%) regions.  For the month, the MSCI (EAFE) gained 2.4% and is now up 4.2% for the year.  The Emerging Markets was the weakest region in August losing -0.5% and is now up just 2.0% for the year.  Europe remains mired in crippling unemployment with a record 18 million (11.3%) of Europeans out of work.  Other economic indicators point to continuing slowdowns in the EU putting greater pressure political leaders and European Central Bank (ECB) President Mario Draghi.  Additionally, the growing concern about China slowing down along with the rest of the worlds’ major economies was punctuated last Saturday when the Chinese National Bureau of Statistics announced that the Purchasing Managers Index fell unexpectedly to 49.2 for August.  Any reading below 50 indicates contraction rather than expansion.

The Barclays US Aggregate Bond index stretched gains into a second week after gaining 0.5% for the week.  US Treasury yields fell again with the 10-year closing Friday at 1.543%.  In the past two weeks, the 10-week yield has fallen over a quarter percent from 1.814%.  The 30-year yield has followed a similar trajectory closing last week at 2.667% after closing at 2.932% just two weeks ago.  These drops in yields stem in part from two beliefs by traders.  First, Chairman Bernanke made it clear last Friday that he was still ready to intervene anytime to further stimulate the economy.  How specifically he would do this remains uncertain, but many economists believe buying more bonds is expected to be included in whatever steps he takes.  The Fed’s demand would push the price of bonds up and thus yields down.  Secondly, economic data here in the US has been flat and not improving thereby increasing the demand for bonds.  Low yields are the bond market’s forecast of slow economic times ahead. The cliché of a perfect storm is a bit overstated, but with the problems in Europe coupled with what is happening here in the US, bond yields have remained at historically low yields.  The same cannot be said for Spain.  Spain’s 10-year yield climbed up to 6.857% and is coming very close to the 7% level that most economists believe makes funding further Spanish borrowing unaffordable.  Not surprisingly, long-duration bonds—both Treasuries and Corporates—were the best performing of the bond sectors while low-duration bonds were the weakest.

The Euro gained just under one cent this past week to close Friday at $1.258.  This is now the third consecutive week of a strengthening Euro to the US dollar.  The US Dollar index, a measure of the US dollar strength against six major currencies, fell another 0.5% marking the fifth down week out of the past eight.  Expectations that the Federal Reserve will resume quantitative easing and thus holding down interest rates, is the likely cause for the weakening US dollar I believe.  The ECB, with all of its difficulties, still pays more on debt than the US providing incentive for buyers to remain invested in ECB debt.

Commodities posted another positive week as the broad Dow Jones UBS Commodity index rose 0.5%.  WTI Oil closed the week with a 0.5% increase closing Friday at $96.47 per barrel.  Gold rebounded strongly on Friday following Fed Chairman’s remarks at Jackson Hole and finished the week up 0.9% closing at $1687.60 per ounce.  WTI Oil jumped 9.6% in August while Gold added 4.5% and contributed substantially to the Dow Jones UBS Commodity index’s 1.3% gain.   Cocoa, Silver, and Cotton were to top gainers last week while Orange Juice, Cattle, and Platinum were the weakest.  The recent rise in oil prices has moved to the pump with the national average for a gallon of regular gas at $3.83 up 8.5% in August. 

MONETARY POLICY + FISCAL POLICY = ECONOMIC POLICY

If asked what subjects were interesting and which they might like to study, I doubt economics would be high on most people’s lists.  I remember a conversation I had some years ago while studying for my MBA at the University of Cincinnati with a friend who was earning her PhD in Economics.  I told her I thought the Holy Grail of economics was to find a quantitative model that would predict human behavior and since that was an impossible task, economics was more junk science than science.  Looking back, I realize how naïve that statement was.  I still believe that economists will never find the perfect quantitative model, but I do recognize that economics is a critical field of study and that our very well-being is strongly influenced by the outcome of economic policy decisions made both here and abroad.  Economists in the form of central bankers are exerting more power over economic policy than they have in several generations.

Economic policy consists of monetary policy and fiscal policy.  Monetary policy primarily uses the supply of money in an economy to maintain economic stability.  Controlling inflation is seen a top priority for most policy makers and they do so traditionally by setting interest rates by both regulation and the purchase and sale of bonds on the open market.  Central bankers are responsible for monetary policy in most of the free world and typically fall outside the control of political leaders.  This independence allows central bankers to make unpopular decisions such as shrinking the money supply and causing interest rates to rise and economies to slow.  Obviously, politicians would not likely support a contraction of money supply especially in an election year even if it were the right thing to do at that time.

Fiscal policy consists of policies regarding government spending and taxation.  Political leaders are responsible for setting policy matters with regards to how much a government will spend and for what, and also how much it will levy in taxes.  Politicians in democratic countries are accountable to their populations and are thus strongly influenced by the will of the people.

Coupled together, monetary policy and fiscal policy work together to foster economic growth, strength and well-being for a country. When fiscal or monetary policies get out of sync imbalances and trouble can occur.  This leads my analysis of today’s mess.

The EU and the US have been operating for decades with fiscal policies that have resulted in ever increasing sovereign debt levels.  Make no mistake, spending and borrowing is a fiscal policy decision, not a monetary one.  As debt levels increase, as government spending increases, more and more of the productivity of the private sector is diverted to government and less productive uses.  Over time this becomes a drag on an economy, production slows, unemployment rises, tax revenue to governments contract, and we suddenly wake up to the prospect of a pretty bleak future…unless fiscal policies are changed.  This is precisely the challenge facing us today.  We must make very, very tough fiscal policy decisions in democratic countries where the voters must in a sense vote against their own self-interest.

I believe most politicians do not like making tough decisions, especially when those decisions are likely to upset the very people who elected them to office.  Politicians look for an easier way.  The easy way in this case is to turn to the central bankers, Mr. Bernanke in the US and Mr. Draghi in the EU, and get them to do the heavy lifting.  For the most part, the central bankers have complied and we have seen some of the most accommodative and easy monetary policies in all of our lifetimes.  But that has not been enough to stem the crisis, especially in Europe.  Mr. Draghi did not go to Jackson Hole this past weekend because he is facing enormous pressures in Europe.  The German publication, Der Spiegel, published an outstanding story on August 27^th that summarized the problem by saying, “They (politicians) are feeling desperate because, after 17 monetary summits, they still haven’t been able to stop the crisis.  And now they are pleased to see Draghi doing the work for them.” (Italics added for emphasis.)  I believe that we have a similar situation here in the US, not quite as severe, but serious all the same.

So here we are.  Our political leaders, failing to do their jobs, continue to push central bankers to use monetary policy to compensate for terrible fiscal policies.  There are voices who challenge this application of monetary policy.  One of the most important is Jens Weidmann, the president of the Bundesbank, Germany’s equivalent to Ben Bernanke.  Mr. Weidmann has opposed most calls for the ECB to begin direct bond purchases of EU sovereign debt saying that such purchases violate the 1992 Maastricht Treaty (created the EU and the Euro ) and relieves pressure on European leaders from making tough fiscal policy adjustments.  However, Mr. Weidmann has come under increasing pressure from many politicians to relent and support Draghi’s plan for an American-styled QE by the ECB.  The Der Spiegel story concluded that it was just a matter of time before Mr. Weidmann is politically overwhelmed and forced to support direct bailouts or resign.  Mr. Bernanke is also coming under political pressure from both sides here.  The Democrats want Mr. Bernanke to do everything he can possibly do to continue providing essentially free money to keep the current administration in the White House while Republicans want Mr. Bernanke to cut off bailouts and force political leaders to make tough decisions about reducing spending and borrowing. 

The debate continues.  As you know, I try hard not to make predictions because no one really can say how events will unfold.  If you were to force me to take a position I would have to say that I believe both the ECB and the Federal Reserve will continue to use monetary policy to make up for the failings of fiscal policy.  I say this because both Draghi and Bernanke have publically stated they support such actions, and I believe the only thing that has held them back for now are the few but vocal voices of opposition who seek to shift responsibility back to elected leaders.  Mr. Bernanke and Mr. Draghi can hold off the day of reckoning for just so long, however, and if sound fiscal policy is not in place soon, two percent growth is going to feel like the good ole days.

LOOKING AHEAD

Summer is officially over and I hope everyone enjoyed their Labor Day weekend holiday. Trades will get back to work and I suspect September is going to be an interesting month.

With Draghi’s absence at Jackson Hole, even more attention will be directed to his remarks following a meeting of the ECB on Wednesday.  Much has been made of his comment this past July throwing his full support behind preserving the Euro.  Traders are expecting Mr. Draghi to begin another large round of bond purchases (quantitative easing/QE) to help stabilize borrowing costs in such countries as Spain and Italy.  The news that Germany’s exports fell sharply in August (reported Monday morning, September 3^rd) will put even more pressure on Draghi to act, and European markets holding firm on Monday reinforce this conclusion.  This will be an important speech and September promises to be an important month for the EU.

This holiday-shortened week has three major economic reports due out.  Tuesday morning is the Institute for Supply Management (ISM) Manufacturing Index August report.  The consensus calls for a reading of 50 which means manufacturing is neither growing or contracting.  Whether the number is a little above 50 or below, the manufacturing sector is not doing much.  Thursday has the weekly Initial Jobless Claims report.  Consensus is for jobless claims to come in at 370,000 the same expectation of the previous week.  The actual number last week was 374,000.  Again, this number is at such a level that a move a few thousand above or below doesn’t matter.  Unemployment seems frozen between 8% and 8.5%.  Finally, Friday has the official August Employment Situation report.  Consensus is calling for new non-farm payroll jobs to grow by 125,000 compared to July’s increase of 163,000, and the unemployment rate to remain at 8.3%.  All of these numbers have one thing in common…we are mired in a plow horse economy.

The New York Stock Exchange Bullish Percent (NYSEBP) closed Friday at 60.03 up from 59.79 the previous week.  This is the eleventh consecutive weekly increase for this important technical indicator.  I have noticed also that this is the third weekly drop in the rate of improvement meaning that the pace of improvement is slowing which typically happens before we get a drop in the NYSE Bullish Percent.  For now, however, positive momentum remains in US stocks.  The overbought reading for the S&P 500 continues to fall and closed Friday at 35%.  Looking back over ten weeks, the S&P 500 is getting less expensive and is clearly not in the extreme overbought range which I believe begins at 100%.  I have reported that fixed-income, bonds, has been the most overbought and therefore expensive asset class.  Even with the recent strength of US Treasuries, bonds as an overall asset class is now 77% overbought, high, but not extreme and well below the 120%+ readings of just a few weeks ago.  Only the Corporate High Yield bond sector is overbought by more than 100% at 125%.  Emerging market stocks have shown the greatest weakness and are now overbought just 14%, the lowest of any stock sector.

The Dorsey Wright & Associates analysis of the markets indicate that US stocks and Bonds are the two favored major asset categories followed by Foreign Currencies, International stocks, and Commodities.  Middle capitalization stocks are favored, as is growth over value, and equal-weighted indexes over capitalization weighted indexes.  Equal-weighted indexes are those where each stock in the index is weighted the same, while in capitalization-weighted indexes the larger stocks have the largest weighting consistent with their size relative to the other stocks.  The relative strength sector weightings favor Consumer Discretionary, Real Estate, Information Technology, and Health Care.  US Treasuries and International Bonds are favored in the Bond category, while US and Developed Markets are favored within the International stock category.

The fiscal cliff is looming, but for now all eyes will be on Europe.

Paul L. Merritt, MBA, AIF^®, CRPC®

Principal

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.

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.

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.

Worries over Europe’s economic slowdown, Greece’s inability to meet austerity targets, slowing growth in China, and the ability of the Federal Reserve to “move the needle,” pushed markets to a weekly loss for the first time in six weeks.

The Dow Jones Industrial Average (DJIA) lost 117 points         (-0.9%) last week while the S&P 500 fell by -0.5%.  The Russell 2000 lost -1.3% and the tech-heavy NASDAQ gave back -0.2%.  For the year the DJIA is now up 7.7%, the S&P 500 is positive by 12.2%, the Russell 2000 is up by 9.2%, and the NASDAQ leads all major indexes with a 17.8% gain.

Health Care was the only positive major economic sector last week gaining 0.6% led by the biotech and health care provider subsectors.  Health Care was followed by Financials, Real Estate, and Consumer Discretionary sectors with all outperforming the S&P 500 for the week.  The worst performing sectors were Telecom, Industrials, Utilities, and Materials.  For the year, Information Technology, Consumer Discretionary, Financials, and Health Care are the best performing sectors.  Utilities, Energy, Materials, and Industrials are the worst but all have posted positive gains.

The MSCI (EAFE) managed a 0.6% weekly gain marking pushing this European-heavy, international index to its sixth consecutive weekly gain.  The STOXX Europe 600, a broad European-only (18 countries) index, however, was down 1.8% for the week.  The Emerging Market region posted a 0.4% gain, the Asia/Pacific region lost        -0.2%, and the Americas region fell by -0.6%.  European stocks suffered over concerns that Greece will have difficulty in reaching its required austerity goal for the next two years of cutting as much as €14 billion ($17.5 billion) from government spending.  Both German Chancellor Merkel and French President Hollande reiterated the need for Greece to meet its spending cuts following separate meetings with the Greek prime minister, Antonis Samaras, this past week.  Samaras had been seeking an extension to the deadlines imposed by previous agreements on austerity measures, but the key European leaders held firm.  Merkel and other European leaders are expected to wait until a joint report published by the European Central Bank (ECB), European Commission, and International Monetary Fund (IMF) due October 5^th  before making any decisions.

The Barclays US Aggregate Bond index broke a two-week decline gaining 0.6% last week.  US Treasury yields pulled back with the 10-year closing Friday at 1.684% down from last week’s close of 1.814%, and the 30-year closed at 2.794% down from the previous week’s close of 2.932%.  Key European rates managed to fall slightly even in the face of negative news about Greece.  The Spanish 10-year closed the week at 6.419% and the Italy 10-year finished Friday at 5.714%.  Extended duration US Treasuries was the best performing bond sector while short duration bonds were the weakest. 

The Euro added almost two cents to close Friday at $1.251 marking this key currency’s fourth positive week out of the past five.  The US Dollar index, a measure of the US dollar strength against six major currencies, fell 1.2% snapping a two-week positive move.  US interest rates and the strength of the US dollar were impacted by the release on Wednesday of the Federal Reserve’s (Fed) Open Market Committee meeting minutes expressing support of additional monetary support for the sluggish US economy.

Commodities posted their best gain in five weeks as the broad Dow Jones UBS Commodity index added 1.6%.  After fluctuating during the week, WTI Oil closed the week virtually unchanged closing Friday at $96.03 per barrel.  Gold restored some luster adding $53.30 (3.3%) on increasing expectations that the Fed will begin another round of quantitative easing.  Orange Juice, Silver, Platinum, and Soybeans also gained. 

INVESTORS ARE WATCHING AND WAITING

As I have highlighted in previous Updates, investors face some significant events in the next few months that, depending on their outcome, could provide serious headwinds (or a boost) for the markets.  The two biggest are the European Union’s handling of its on-going debt problems, and the approaching “fiscal cliff” here in the US.  The fiscal cliff is the simultaneous increase in taxes and sharp spending cuts currently scheduled to begin January 1, 2013.  Additionally, investors are closely monitoring the moves by the ECB and the Fed regarding further monetary stimulus—quantitative easing (QE).  It appears that investors globally are very responsive, some might even say addicted, to monetary stimulus provided by central banks.

The Fed will kick things off on Friday, August 31^st when Fed Chairman Bernanke speaks at the Fed’s annual retreat at Jackson Hole, Wyoming.  Speakers will also include ECB president, Mario Draghi, who will address the conference the following day.  Investors will be listening for signs of when these key central bankers will implement more QE.  Mr. Bernanke, responding to a series of questions from Rep. Darrell Issa, Chairman of the House Committee on Oversight and Government Reform, made it very clear last Thursday that the Fed was prepared to “provide additional accommodation as needed to promote a stronger economic recovery and sustained improvement in labor market conditions in a context of price stability.”  Mr. Draghi also signaled his willingness to take action in support of the Euro back on July 26th when he said that he would “do whatever it takes to preserve the Euro.”  Investors will be looking for specifics on how and when these central bankers will act and, I believe, will not be moved by just words.  They are looking for action.

As we proceed into the fall investors will begin to place bets on how the two big events will unfold.  If investors believe that the US will fall off the fiscal cliff or Europe will spin out of control, then I believe we will see US Treasury yields begin to fall (bond prices up) as traders move to safety.  Bill Gross of PIMCO said last week that he did not expect to see any rally in 10-year Treasuries that would push yields below 1.5%.  So the largest bond manager in the world just drew a line in the sand at 1.5%.  If investors believe the US will avoid the fiscal cliff and Europe is able to manage its way through its current challenges, then I would expect to see stock markets and commodities rise.  The classic “risk on” scenario will be in force.

For now, however, investors are on the sidelines and not taking strong bets either way.  They will not be able to sit there for long.  World leaders will act, investors will react, and we will all be in for an interesting ride this fall.

LOOKING AHEAD

The summer vacation season is ending and the developed world will be back to work after Labor Day.  The US election cycle will be moving into its final phase as the conventions wrap up and campaigning moves into high gear.  Some of the uncertainty will begin to removed and more and more investors will begin to stake out their positions.  The data I follow from Dorsey Wright & Associates will help me analyze their movements and I will certainly pass on that information to you.

The upcoming week brings two important economic events.  First, the second revision to the 2^nd Quarter Gross Domestic Product (GDP) will be released Wednesday morning.  Recent economic reports have pushed the consensus to call for an increase of 0.2% to 1.7%.  The second big event is the speech by Mr. Bernanke at Jackson Hole on Friday.  While there is no official consensus to report about the speech, I do believe that investors are expecting Mr. Bernanke to talk about how and when he will move to provide further monetary easing.  It is clear that Mr. Bernanke favors some kind of action, however, if the GDP number comes in better than expected Wednesday, it may be more difficult for him to take action.  I further believe he is sensitive to taking strong action just two months before a national election.  We will have a better idea on Friday of just how committed Mr. Bernanke is to easing.  Other important economic reports include the weekly Initial Jobless Claims on Thursday morning.  Last week’s number came in 7000 above consensus at 372,000 and economists are expecting 370,000 this week.  Also coming in on Thursday morning is the Personal Income report for July with consensus expecting an increase of 0.3% which is down 0.2% from June’s number.

The New York Stock Exchange Bullish Percent (NYSEBP) closed Friday at 59.79 up from 58.96 the previous week.  This tenth consecutive weekly increase shows that positive momentum remains in the US stock market even in the face of a small decline in stock prices last week.  The market decline did cause the Overbought reading to drop to 45% for the S&P 500.  This means that stocks are still trading above their ten-week average, but are not especially overpriced.  Bonds are the most overbought asset class, but have pulled back markedly the past two weeks.

Another set of data I watch which is provided by Dorsey Wright & Associates is score direction.  Score direction looks back over the past six months and monitors whether the technical strength of an asset category or sub-category is rising or falling.  It allows me to see what categories are generally improving or weakening on a technical basis.  Score direction is not a primary indicator that I evaluate but does help me to identify trends over time. Emerging market bonds have shown the most positive improvement over the past six months.  Convertible bonds, cash, and small capitalization value round out the top four most improved asset classes.

The Dorsey Wright & Associates analysis of the markets indicate that US stocks and Bonds are the two favored major asset categories followed by Foreign Currencies, International stocks, and Commodities.  Middle capitalization stocks are favored, as is growth over value, and equal-weighted indexes over capitalization weighted indexes.  Equal-weighted indexes are those where each stock in the index is weighted the same, while in capitalization-weighted indexes the larger stocks have the largest weighting consistent with their size relative to the other stocks.  The relative strength sector weightings favor Consumer Discretionary, Real Estate, Information Technology, and Health Care.  US Treasuries and International Bonds are favored in the Bond category, while US and Developed Markets are favored within the International stock category.

I would like to close this week’s Update by offering a final salute to Neil Armstrong who passed away this past Saturday.  For those of us old enough to remember, one of the most defining moments in our lives occurred on a July afternoon 43 years ago when Neil Armstrong became the first man to step on the moon’s surface.  In the years that followed we have developed a much better understanding of the risks he, Buzz Aldrin, and Michael Collins took getting to the moon and back.   We also stand in awe of the collective efforts of the thousands of American men and women it took to land Armstrong and Aldrin on the moon.  Job well done Commander Armstrong!

Paul L. Merritt, MBA, AIF^®, CRPC®

Principal

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.

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.

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