The 2012 presidential election is finally behind us.  What lies ahead is the prospect of significantly higher taxes and drastic cuts to government spending (the fiscal cliff) unless the President and Congress can find ground to compromise and diminish the potential setbacks to the US economy.  If you look at the market’s performance since the election, I believe investors are signaling that they do not have a lot of confidence that such compromise will be forthcoming.

The Dow Jones Industrial Average (DJIA) fell 278 points (-2.1%) last week including a 312 point loss on the day following the election.  The S&P 500 lost 2.4%, the Russell 2000 fell 2.4%, and the NASDAQ gave back 2.6%.  These losses have helped take some of the luster off what has been a good year for US stocks.  For the year, the DJIA is now up 4.9%, the S&P 500 has risen 9.7%, the Russell 2000 has gained 7.3%, and the NASDAQ is up 11.5%. 

The major economic sectors here in the US were all negative this past week.  Utilities lost just over 4% to lead all sectors to the downside.  This sharp negative move pushes Utilities into an overall negative return for the year.  Telecom, Financials, and Consumer Discretionary were the next three poorest performing sectors behind Utilities losing between 3.5% and 2.4%.  Materials, Industrials, Consumer Staples, and Health Care were the best performing sectors and all lost between 1% and 2% for the week.  For the year, Consumer Discretionary, Financials, Health Care, and Telecom remain the best performing sectors and all have outperformed the NASDAQ.  The top three sectors that lost ground last week are also some of the highest dividend payers of the eleven major sectors.  With the looming tax increases on capital gains, dividends, and interest payments ready to go into place on January 1^st, I believe that investors are adjusting their expectations for the after-tax value of the income they receive from their investments in these sectors.

International markets were also down last week.  The MSCI (EAFE) index fell 2.1% and the European-only STOXX 600 lost 1.7%.  While I believe some of the weakness in markets abroad is a sympathetic sell-off with US markets, European markets were also hurt by the riots in Greece and concerns that Greece may run out of money before European leaders approve the next round of bailout funds even as the Greek Parliament passed a new round of austerity measures.  The European Union (EU) has also seen its unemployment rate surge to new post-WWII highs and European Central Bank (ECB) President Mario Draghi warned last week that the European economy would remain “weak” through next year.

Bonds were the beneficiary of investor worries about stocks last week as the Barclays Aggregate Bond index gained nearly 0.2% and is now up over 4.5% for the year.  Extended duration US Treasuries and corporate bonds were the best performing bond sectors as investors’ purchases pushed the US 10-year and US 30-year yields down to 1.614% and 2.747% respectively.  The one-week drop in interest rates was the largest in seven weeks.  High yield, preferreds, and high quality corporate bonds were the weakest sectors.

The US Dollar index gained 0.5% last week and this index is now up for the third consecutive week.  The Euro fell just over 1% to close at $1.271.  This was the largest one-week loss in two months.  I believe the challenges facing the EU are overwhelming currency traders who also see continued weakness in the US Dollar due to the expectation for continued outsized budget deficits in Obama’s second term.  I think the US Dollar’s strength can be equated to PIMCO’s Bill Gross’s worldview that the US is the “cleanest dirty shirt” in the closet.   

The Dow Jones UBS Commodity index gained a slight 0.3% last week primarily on the strength of precious metals.  Gold added $55.70 (3.3%) to close Friday at $1730.90 per ounce.  This gain is, I believe, primarily due to the increasing likelihood that the re-election of Mr. Obama will result in the continuation of a highly accommodative monetary policy to help finance the large deficits his administration may run in his second term.  Since many see gold as a hedge against weak paper currencies, gold and silver purchases were strong and reversed a recent trend of weakness.  WTI Oil gained $1.21 per barrel (1.4%) closing Friday at $86.07.  The Bloomberg news service said that the bump in oil prices was attributable to a higher-than-expected jump in the Consumer Confidence index released this past Friday.  Another story in the Wall Street Journal reported that daily oil consumption in the US has fallen by two million barrels of oil from its high of 20.8 million barrels in 2005 to just 18.8 million barrels today. 

LOOKING AT THE REST OF THE YEAR AND BEYOND

I like clichés.  I like them because they have their roots in some truism of human behavior.  My cliché today is, “the only certainty in life is death and taxes.”  However, I am going to add one more caveat, and that is “media pundits telling all of us what this presidential election means.”  I will humbly add my name to the list of people commenting about the election and what it means to us.

As I have said repeatedly, I generally avoid all attempts at making predictions because I believe the effort is a fool’s errand.  Instead, I prefer to focus on data, and specifically the data provided by Dorsey Wright & Associates.  My belief is that most economic circumstances that impacts what happens in markets both here and abroad are beyond our control so we must focus on making the best decisions given the circumstances at the time we make a decision and then revisit those decisions as events evolve.  However, I am going to make some general observations about where things stand after the election and how they might affect all of us going forward.

The most pressing of issues is the fiscal cliff.  The law currently on the books says that unless Congress and the President act to change existing law, a nearly $600 billion tax increase will go into effect on January 1^st along with $500 billion in spending cuts—half aimed directly at Defense.  The spending cuts are referred to as “sequestration.”  A number of different analysts have stated that the fiscal cliff, if enacted as is, would reduce the nation’s Gross Domestic Product by about 4%.  Through the first three quarters of this year, the GDP is growing at an overall rate of 1.7%, and the most optimistic estimates of further growth are no higher than 2%.  This means that the fiscal cliff will put the US squarely back into a full recession with a net GDP growth rate of -2%.  I cannot fathom any scenario where the President and Congress would knowingly and willingly not take bipartisan action to reach a compromise on this matter and reach an agreement.  I believe the markets will remain nervous and this nervousness translates into increased volatility until an agreement is reached.

Like it or not, it now looks like Obamacare will now become a way of life in our economy.  I am not going to debate the argument about whether this legislation is good or bad, but rather focus on the economic impact this sweeping legislation will have on businesses.  If the early headlines are any indication, the news is not positive.  John Schnatter, President and CEO of Papa John’s Pizza (and a Romney supporter) was quoted by WPTV.com saying that Obamacare “would add 10-14% for customers buying a pizza,” and that it “was likely that some franchise owners would reduce employees' hours in order to avoid having to cover them,” referring to the requirement that any worker who works more than 30-hours per week must be covered by health insurance.  A franchisee for Applebee’s has been excoriated on Twitter for suggesting on the Fox News Channel that with Obamacare going into effect he would be forced to consider a hiring freeze or slowing expansion.  Again, I am not taking a position pro or con on Obamacare, I am just saying there are consequences to every law and regulation that the government places on businesses, and in the end, the economic data will give us some idea of the true costs of such legislation and regulations.

I also believe that the chances of reducing the federal deficit in a meaningful way will be muted.  President Obama has shown little inclination to actually do something about the budget deficits (and raising taxes on the upper income earners will not close the gap in a meaningful way) so expect more of the same.  I believe the surge in gold prices following the election was an indication that gold traders see it the same way.  As I have said in previous Updates, my view is that the price of gold is a referendum on how much money the Treasury must print to fund these deficits.  The bigger the deficits, the more money the government prints,  the weaker the US Dollar will eventually get, and the greater the possibility gold will be purchased as a store of real value.

Interest rates will also be an important indicator of how the markets grade the President and Congress’ ability to manage the economy.  US Treasury rates fell sharply this past week signaling bond investors’ belief that the economy is not going to grow in a meaningful way for a very long time.  Remember, that with inflation currently at 1.99%, anyone who buys a US Treasury note with a maturity of 10-years or less is actually losing money in real terms for the duration of owning the note.  Now I recognize that there is a great deal of debate about the future course of interest rates.  Most analysts believe, and I share this belief, that interest rates will eventually go higher.  The question no one really can answer is when this will happen.  I believe that interest rates will rise sometime during the next four years and they will rise because either the government works well together and real growth kicks in (good higher interest rates), or because the private sector loses patience with the political class and forces interest rates higher because of concerns over repayment of funds (bad higher interest rates).  Either way, investors must pay attention to interest rates closely to avoid the possibility of taking significant losses in their bond portfolios.

I believe we are in for some challenging times over the next several quarters.  However, I do believe there are some notable and very positive factors that will be working on the economy in the next four years that will help mitigate the mess we have in Washington.  I will address those factors in my next Commentary in two weeks.

LOOKING AHEAD

The New York Stock Exchange Bullish Percent (NYSEBP) turned negative Friday in response to market actions during the week.  This move by my most important technical indicator suggests that supply (or selling pressure) is now the dominant theme in the markets.  US equities and Bonds still remain the top two favored major asset categories, so I will be looking at reducing some of the risk in my portfolios but not moving away from stocks on a whole—for now.  The value of the NYSEBP is 59.91.  Not a bad number overall, but it has been slowly weakening over the past couple of months.

The S&P 500 has violated its key long-term support level of 1380.  This support line (trend) has been in place since Thanksgiving of last year and is an important signal to investors.  This does not mean that stocks are ready to fall off the cliff, but it does suggest that there is greater downside risk in the markets and all investors should pause and evaluate their portfolios at this time.

We have a number of important economic reports coming out this week.  The biggest, in my view, is the October Retail Sales report scheduled for release at 8:30 AM on Wednesday.  Consensus is expecting a drop of 0.1% compared to an increase of 1.1% in September.  This report is always important because of the importance consumer spending is to our GDP.  The October Producer Price Index report on Wednesday morning and the October Consumer Price Index report on Thursday will give investors a sense of the rate of inflation in the country.  Expectations are that price increases will be muted compared to September’s numbers.  The weekly Initial Jobless Claims number on Thursday is expected to increase from 355,000 the week before to 376,000, and October’s Industrial Production report on Friday is expected to show an increase of 0.2% following September’s increase of 0.4%.

The Dorsey Wright & Associates analysis of the markets remains unchanged as it has for most of the year at this point (other than the NYSEBP reversal).  Data indicates 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.  On a relative strength basis, the top three major economic sectors remains unchanged: Consumer Discretionary, Health Care, and Financials.  Consumer Staples has pushed into the number four position while Real Estate slipped to number five.  US Treasuries and International Bonds are favored in the Bond category, while US and Developed Markets are favored within the International stock category.  Energy and Agriculture are the favored sectors within the Commodity category.

In honor of Veteran’s Day I would like to ask everyone to take a moment to thank a a soldier, sailor, marine, or airman for their service.  I am blessed to have a step-grandfather who served in World War I, another grandfather who served in WWII, a father who served in Korea and Vietnam, and a step-father and father-in-law who also served in Vietnam.  I am always mindful of their service to this great nation and we should never forget the sacrifice that these, and millions of other, men and women have made for our great country.

After much thought and consideration, I have decided to reduce my Market Commentaries to every other week rather than weekly for now.  The holidays are a welcome distraction for all of us and the time we spend with our families is important, and I have some additional writings I want to complete regarding individual investors and their retirement plan investing.  You will be able to find those writings on the NTrust Facebook page (as you can all of my market commentaries), as well as on LinkedIn, and on blogger.com.  So going forward, please look for my market commentary every other week.

Sincerely,

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.

Market returns were mixed this past week following a 205 point drop (-1.5%) in the Dow Jones Industrial Average (DJIA) on Friday.  Several third quarter earnings “misses” by Google, Microsoft, McDonald’s, Chipotle Mexican Grill, and General Electric among others raised concerns about the strength of the economy.  Markets have been unforgiving towards companies when their earnings have not met expectations.  Chipotle shares fell 16.3% last week and are down 29.2% over the past month, Microsoft is down 7.8% over the past month while losing 1.9% last week, and GE lost 2.0% last week and is down just 1.0% for the month.  The largest company in the world in terms of market capitalization, Apple, has fallen 13.6% from its recent mid-September high.  The common theme among all of these companies is that revenues are not growing as fast as they had been, and margins are getting squeezed.  McDonald’s and Chipotle are facing higher food costs, Google is lacking pricing power for its services as more users focus on mobile devices, and Apple is seeing competition explode in the mobile device space.  The Wall Street Journal reported Saturday that, “nearly six in 10 companies are reporting weaker sales than Wall Street expected, and revenue for the S&P 500 is expected to slip slightly below where it was a year earlier by the time all reports are tallied.”  The markets have taken notice.

Despite Friday’s loss, the DJIA gained 15 points (0.1%) for the week and the S&P 500 gained 0.3%.  The Russell 2000 fell 0.25% and the tech-heavy NASDAQ lost 1.3%.  Three weeks into October, the DJIA is off 0.7%, the S&P 500 is down 0.5%, the Russell 2000 has dropped 2.0%, and the NASDAQ has given back 3.6%.  With 42 weeks now completed for 2012 (yes, there are only ten weeks left in the year) all the major indexes are up led by the NASDAQ’s 15.4% gain followed by the S&P 500 which is up 14.0%.  The Russell 2000 is up 10.8% and the DJIA is up 9.2%

Like the major indexes, performance by the major economic sectors was mixed.  Materials led the eleven sectors with a gain of over 2%.  Utilities, Financials, Energy, and Real Estate followed and were all up between 1% and 2%.  Information Technology was the weakest sector losing just over 2% followed by Telecom, and Consumer Staples.  For the year, Financials is now the best performing sector with gains of just over 21%.  Consumer Discretionary, Health Care, and Telecom have all returned greater than 18%.  Utilities, Energy, and Consumer Staples are the weakest sectors but all have positive gains for the year.

International markets did well for the week.  The MSCI (EAFE) index was up 2.5% and the European-only STOXX 600 gained 1.7%.  The Asia/Pacific region helped the MSCI (EAFE) index with a solid 2.1% gain (its best performance in the past five weeks).  The Emerging Markets region gained 1.0% and the Americas region added 0.4% for the week.  In Brussels, the European Union (EU) held a major summit on Thursday and Friday agreeing to create an EU-wide banking regulator with the ability to recapitalize banks with funds directly from the European Stability Mechanism (ESM).  However, the European leaders did not announce a schedule or amount for Greece’s next round of bailouts, and Spanish President Rajoy continued to retreat from seeking money from the ESM for his country’s troubled finances.  Markets reacted negatively to the news about Greece and Spain on Friday.  I remain firm in my belief that Europe has a very long way to go before it is out of trouble and I believe that economic weakness in Europe is beginning to hurt China and is a contributing factor to weak revenue growth here in the US. 

Bond sector performance was also mixed last week.  Overall, the Barclays US Aggregate Bond index was down 0.2% for the week.  US Treasury yields increased over the week making extended duration Treasuries the poorest performing sector of the week.  The US 10-year yield closed Friday at 1.766% compared to the previous week’s close of 1.660%.  The US 30-year yield finished the week at 2.937% up from the previous Friday close of 2.833%.  Spain saw the yield on its 10-year sovereign fall to 5.372% from the previous week’s close of 5.625% although the yield did rise slightly on Friday after the EU announced that Spain had not asked for bailout funds.  The game of chicken continues to play out in Europe.

The US Dollar index fell 0.1 % last week principally on the strength of the Euro, which closed Friday at $1.302 to the US Dollar.  The Euro is now virtually unchanged over the past two weeks reflecting the ongoing uncertainty of currency traders.  I believe that a strong Euro is one of the key signals for the “risk on” trade with investors.  For now, it appears that traders believe that Europe will get its act together, just not yet.   

The Dow Jones UBS Commodity index fell 0.4% last week marking the third consecutive week of declines for this broad commodity index.  WTI Oil lost $1.81 per barrel (-2.0%) closing Friday at $90.05.  It appears that oil traders are feeding off the news coming from corporate earnings reports and are growing concerned that the overall decline in US and global economic activity will translate to decreased demand for oil.  The price of gold fell $38.10 per ounce (-2.2%) to close Friday at $1721.60.  Over the past two weeks, gold has now fallen $59.20 per ounce (-3.3%).  Reviewing a number of different gold analysts’ comments about recent trading, about the only consistent themes I could find is that traders are like most investors today—uncertain, and that most of the effects of the Federal Reserve’s third round of quantitative (QEIII) easing was fully discounted into the price of gold when it was trading at the upper $1700’s.  It appears that gold has pulled back as investors question the efficacy of QEIII. 

RELIVING THE CRASH OF OCTOBER 1987

This past Friday marked the 25^th anniversary of the Crash of 1987 or Black Monday as it is often called.  At the time, I was a young US Army captain teaching ROTC at the University of Cincinnati and pursuing my Masters in Business Administration.  I clearly remember walking into the offices of the business college’s graduate program around 2 PM and hearing everyone talking about the “crash” that was underway.  I was just an interested spectator of the markets that day, and the pain felt by investors did not have a direct impact on me.  Over time, I grew fascinated about what had happened and what led up to that fateful day when the DJIA lost 508 points representing 22.6% of the market’s value.  My interest was so keen that I ended up writing my MBA thesis on “portfolio insurance,” one of the culprits blamed for the staggering loss that day.  In the end, I came to understand that many factors contributed to the huge sell-off that Monday in October.  With the anniversary date just passed and a 205-point sell-off, I could not help but take time to use some of the tools I use today and compare that timeframe to today’s markets.  Using data provided by Dorsey Wright & Associates and Google, it is possible to go back and look at what happened just prior to the crash and afterwards.

The New York Stock Exchange Bullish Percent (NYSEBP) is the key technical indicator I follow.  This indicator provides me with an idea of the overall trend in equity markets by looking at the nearly 3000 stocks that trade on the New York Stock Exchange (NYSE).  At any moment in time, a stock is either in a buy or sell signal using point and figure charts (I will not cover the concept of point and figure charts here, but if you have questions, just call me).  The NYSEBP adds up all of the stocks on a buy signal and divides that by the total number of stocks on the NYSE.  The result is the NYSEBP.  The higher the NYSEBP, the stronger the markets.  Additionally, the NYSEBP can either be increasing or decreasing.  If it is increasing it means that investors are generally buying stocks (demand is in control), while when it is decreasing, investors are selling stocks (supply is in control).  The value of the NYSEBP is that it is dependent upon the collective actions made by many traders over a wide swath of stocks.

The second indicator I look at is momentum.  In this case, the monthly momentum.  Simply put, the monthly momentum indicator takes any investment, in this case the DJIA, and compares its current average to its moving average over the past five months.  If the DJIA (or any stock or index for that matter) is trading above its moving average, that is a bullish signal.

Looking back to 1987, the DJIA closed out September at 2596.28 and was up a strong 27% through the first nine months of the year.  The DJIA continued to rise the first couple of days in October nearly reaching the highs of the year that had been achieved in late August.  However, a troubling signal had been flashed by the NYSEBP on September 4^th when this important indicator reversed to signal that supply was now in control.  So while the DJIA continued to climb for another month, the NYSEBP was retreating.  As Tom Dorsey of Dorsey Wright & Associates likes to put it, “the generals were still on the field fighting while the soldiers had all turned and fled.”  Additionally, the monthly momentum had reversed by the end of September.  The broad market was weakening while the key index was climbing masking possible trouble to many investors.

Today, there is a lot of worry out there.  The DJIA had a 205-point sell-off on Friday.  The Europeans are a mess, the fiscal cliff is rapidly approaching, investors are nervous about the elections, and the US and global economies are slowing.  The Investment Company Institute reported that for the week ending on October 10^th investors were pouring cash into bond investments and cutting positions in their stock investments.  Unlike 1987, however, the NYSEBP has held its ground in October and stocks remain in demand.  In other words, the soldiers are still on the field fighting.  Additionally, the monthly momentum for the DJIA recently turned positive after being negative since June.  With all the worry in the minds of investors and negative headlines, the markets are saying that stocks are still favored.  Reality and perception are not always the same.  From a technical standpoint, today is very different from 1987.

LOOKING AHEAD

Last week’s economic data did little to change the view that the economy is plodding along.  Some data was good, some mediocre, some not so much.  Traders will now turn their attention to this week’s data looking for trend signals.  This is how investors have spent most of the year and this week will be no different.

The key economic events for the coming week are the release of the first estimate of the third quarter Gross Domestic Product (GDP) on Friday and the Federal Open Market Committee (FOMC) meeting Tuesday and Wednesday.  The GDP number is extremely important, and as I said last week, the number (and all data reported between now and November 6^th) will be heavily scrutinized because it is the last GDP report prior to the election.  Consensus is expecting an increase to 1.9% compared to 1.3% in the second quarter.  The FOMC meeting is not expected to produce any headlines.  The Federal Reserve’s last meeting set the FOMC’s policies for the next few quarters, so investors are expecting little more than a confirmation of the previous monetary policy announcements.  September new home sales will be released on Wednesday morning.  This is an important report because housing remains such a critical component to the US economy and may give some insight to the third quarter GDP number.  Consensus is anticipating a slight increase in new home sales to an annualized rate of 385,000.  Initial Jobless claims on Thursday morning is expected to report a slight decrease from last week’s rate of 388,000 to 372,000.  Finally, September Durable Goods Orders will be released on Thursday.  Consensus calls for an increase to 7% from August’s unexpected decline of 13.2%.  All of the week’s reports may offer some insight into how the GDP number will look on Friday morning.

The NYSEBP gained 0.93 to close Friday at 66.26.  As I noted earlier, the soldiers are still on the field and demand remains firmly in control.  The NYSEBP would have to fall to 61.38 in order to reverse and put supply in control of stocks. The CBOE Volatility Index, referred to as the VIX, and is a measure of future volatility in the stock market, did rise last week and finished the week at 17.06 compared to last week’s close of 16.14.  Although elevated from the previous week, the VIX remains somewhat subdued.

The Dorsey Wright & Associates analysis of the markets has remained unchanged for most of the summer and now into the fall.  Data indicates 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, Health Care, and Financials.  Financials pushed Real Estate to the fourth position this past week, but it would not cause me to sell or reduce Real Estate positions at this time.  US Treasuries and International Bonds are favored in the Bond category, while US and Developed Markets are favored within the International stock category.  Energy and Agriculture are the favored sectors within the Commodity 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

Investors turned cautious this past week shifting money away from stocks and into safe-havens like US Treasuries and the US Dollar.  A report issued by the International Monetary Fund (IMF) and the downgrade of Spanish sovereign debt by Standard & Poor’s refocused concerns about the effectiveness of the European Union’s (EU) efforts to deal with the on-going debt crisis in Europe.  While here at home, the consensus is growing that earnings for the 3^rd quarter will not be as robust a previous quarters due to the slowing global economy.  I believe that companies have trimmed every bit of fat out of their budgets and therefore, if any real growth is going to emerge in profits, it will have to come from revenue growth, not spending cuts.

The Dow Jones Industrial Average (DJIA) fell 281 points (-2.1%) last week for its worst weekly loss since the week ending June 1^st some 19 weeks ago.  The S&P 500 lost 2.2%, and the Russell 2000 gave back 2.4%.  The technology-heavy NASDAQ lost 2.9% as Apple fell 3.5%.  Let me take a brief moment to describe how the NASDAQ Composite index is constructed.  The NASDAQ is like many indexes and is a capitalization-weighted index.  This means that the weighting given to Apple and other companies within the index is in direct proportion to the market size of each company.  Apple is the largest company in the world in terms of market capitalization (total number of shares outstanding multiplied by the current share price) and makes up just over 9% of the NASDAQ, so the performance of Apple greatly influences the performance of the NASDAQ. 

For the year, the DJIA is up 9.1%, the S&P 500 is up 13.6%, the Russell 2000 has increased 11.1%, and the NASDAQ has gained 16.8%.

Not a single major economic sector was positive last week.  Real Estate and Utilities were the best performing sectors losing less than 1%.  Energy, Financials, Consumer Staples, and Industrials followed in order of performance and all outperformed the DJIA.  Information Technology, Consumer Discretionary, and Telecom were the weakest and all lost more than 2%.  For the year, Consumer Discretionary, Health Care, Financials, and Telecom are the strongest performing sectors while Utilities, Energy, and Industrials are the weakest.

The protests that greeted German Chancellor Merkel in Greece early in the week or Wednesday evening’s downgrade of Spanish sovereign debt to one notch above junk by S&P failed to shake European markets.  This leads me to believe that some of the obvious bad news is already discounted into European stocks.  The STOXX 600 fell a modest 1.7% for the week while the MSCI (EAFE) index fell 2.1%.  The Emerging Market region was the best performing region losing just 0.5% for the week while the Asian/Pacific region fell 1.5%.  I remain, as I have all year, skeptical about international markets and European markets in particular.  I remain skeptical first because the technical indicators provided to me by Dorsey Wright & Associates in Richmond, Virginia, have placed international equities either in last or next to last place relative to the other four major asset categories in 2012.  Second, I do not believe that the EU is progressing quickly enough to alter fiscal policies anchored in bloated government-dominated economies toward more robust private sector-based economies.  Therefore, I believe the risk/reward attributes of European stocks are not attractive. 

I mentioned at the top of the Update that US Treasuries regained some popularity last week as a safe-haven investment and that was reflected by the 10-year and 30-year yields falling over the past week.  The 10-year yield fell from 1.737% to close Friday at 1.660%, while the 30-year yield fell from 2.965% to 2.833%.  The latest move in Treasuries marks the third time in six weeks that their prices have risen (yields down).  What I see, especially in the 30-year yield, is that each successive high has been higher than the previous high, and that each successive drop in yield has been higher than the previous drop.  Higher highs and higher lows in yields provide a longer-term upward trend to interest rates, and I will be watching this closely to see if a trend is developing.

The rally in longer duration US Treasuries helped bonds outperform stocks last week.  The Barclays US Aggregate Bond index was up 0.4% for the week and is now up 4.4% for the year.  The best performing bond sectors last week were the long duration US Treasuries and corporates along with high quality corporate and emerging market sovereign debt.  Treasury inflation protection notes (TIPs), mortgage-backed bonds, and short duration international treasuries were the weakest performers losing less than 0.5% for the week.  Yields on Spanish, Italian, and French sovereign debt all fell like US Treasuries.  The drop in Spanish debt may be perplexing in light of S&P’s downgrade, buy yields did drop.  I will attempt to explain the market’s reasoning shortly.

The US Dollar index gained 0.4% last week marking the third week out of the past four that the US Dollar has strengthened against a basket of foreign currencies.  The Euro lost almost a penny (-0.6%) against the US Dollar to close Friday at $1.295.  Worries about the European debt crisis continues to keep currency traders off balance and unsure about the success of the EU, European Central Bank (ECB), and the IMF in dealing with the current situation on the ground.  I believe the recent US Dollar weakness over the past several months was influenced by the Federal Reserve’s decision to engage in another round of Quantitative Easing (QE III), however, the effect of that policy on currency traders has lessened and most attention is now focused on the EU.  Traders can be a finicky lot, so next week may bring an entirely different story (think US elections and fiscal cliff) and an entirely different set of behaviors.

Commodities pulled back for the second week in a row with the UBS Dow Jones Commodity index falling 0.6%.  Natural gas and oil prices were both higher last week.  Natural gas because of lower than expected inventories.  Oil, according to reports, because of fears over political uncertainty in the Middle East coupled with the increasingly hostile activities on the Turkey/Syrian border.  The Organization of Petroleum Exporting Countries (OPEC) went to great lengths to reassure markets and told the IMF at its meetings last week that OPEC was prepared to insure adequate supplies for world consumers.  Despite OPEC’s efforts, WTI Oil still jumped $1.94 per barrel (2.2%) to close Friday at $91.86.  Gold fell $21.10 per ounce (-1.2%) to close at $1759.70.  I believe that anytime the US Dollar strengthens, as it did last week that helps push down or hold gold prices steady.  There were also reports that China had slowed gold imports over the past few months, and China’s activities have a huge influence over commodity prices, including gold. 

IS SPAIN PLAYING A GAME OF CHICKEN WITH THE EU?

Oh boy.  Here I go again writing about Europe and the debt crisis.  For those of you who read my Updates regularly know how tired I have become writing about Europe and their economic and debt mess, yet events in Europe compel me to pick up my pen and address this subject once again.  My focus this week is on Spain and the dangerous game of chicken I believe that country is playing and what it means to us.

The game of chicken takes on many forms from benign games little kids will play to the more serious life-and-death games countries play with each other.  The one thing all players have in common is that they try to outlast their opponent even in the face of perceived or real doom.  Each  player believes the other will flinch first and victory will be to the steely-nerved one, but if neither makes a move, both players will suffer.  This is precisely the game, I believe, that Spanish President Mariano Rajoy is playing with the EU.

Before the Olympic Games in London this past summer, ECB President, Mario Draghi, assured the world he would do “whatever it takes,” to keep the euro together.  A couple of days prior to Mr. Draghi’s comments on July 26^th, the yield on the Spanish 10-year sovereign bond reached 7.69% and Spain was on the verge of economic collapse.  When markets closed just a day after Draghi’s comments, the yield on Spain’s 10-year had fallen to 6.74%.  Not perfect, but clearly much better than earlier in the week.  Since then, Mr. Draghi has outlined a specific plan for any EU country to obtain aid and the EU has formalized its bailout mechanism now known as the European Stability Mechanism (ESM).  The Germans, who have never been enamored with bailouts, were able to drive one key concession in the structuring of the ESM, and that concession was that a government would have to formally request the bailout.  Now you might think that is a rather innocuous concession, but just look at the three previous countries that sought and received bailouts:  Greece, Portugal, and Ireland.  The political parties in power at the time of the bailouts were all voted out of office at the first national elections following the bailout.  The political price to pay for seeking a bailout can be extremely high.

Spanish President Rajoy certainly understands this.  He also understands that with the S&P’s downgrade of his country’s debt, it is more clear than ever that his efforts to stabilize Spain and turn things around has either not worked, or are not working quickly enough.  Spain has the highest unemployment rate (25.1%) in the EU, and Spanish banks require over €100 billion ($129.5 billion) of recapitalization.  The economy is in recession and shows no sign of improving.  Demands on the government treasury are increasing, not decreasing.  Yet the yield on Spanish 10-year debt fell following S&P’s downgrade.  Are investors mad?  No.  They believe that Rajoy will be forced sooner, rather than later, to formally request a bailout.  With the ESM in the mix, Spanish bond investors believe they have downside protection on their investments and are willing to buy Spanish bonds.  Rajoy also understands that without having to go to the ESM so far, his bond yields have fallen dramatically and he has been able to refinance most of the debt Spain has coming due in 2012.  Pressure has been relieved and all of this accomplished without approaching the EU and having conditions established over Spanish sovereignty that would certainly be part of any bailout from the ESM.

How long can this last?  This is the game of chicken Rajoy is playing.  He is betting that he can get things turned around in Spain before the markets turn on him and drive up borrowing costs thus forcing him to go to the EU and the ESM.  Critics say that Rajoy should go to the ESM now while the debt levels are still manageable and expectations were that the S&P downgrade would make him understand the necessity of that course of action.  If Rajoy does not tap into the ESM and he cannot turn the country around, the cost of the bailout will increase significantly hurting not only Spain but also the EU, and jeopardizing the entire global economic balance.  I believe that Rajoy should act now, and that the longer he waits, the more uncertainty will creep into the markets, and the more unpleasant the outcome will have on the global economy.

LOOKING AHEAD

The coming week is going to be busy in terms of new economic data which is certain to keep all the talking heads buzzing on TV.  Given the proximity to the presidential election, every economic data point is going to be scritinized and dissected ad nauseum.

September retail sales get things kicked off Monday morning.  Retail sales is an important number because two-thirds of the US’s Gross Domestic Product (GDP) is based upon consumer consumption.  Consensus calls for a slight decrease from 0.9% in August to 0.7% in September.  The September Consumer Price Index and Industrial Production numbers will be released on Tuesday.  Prices are expected to increase at a slightly lower rate (0.5% vs. 0.6% in August), and Industrial Production is expected to increase 0.2% after falling 1.2% in August.  This will be an especially politically sensitive number, I believe.  New Housing Starts will be released Wednesday morning and are expected to continue increasing over previous monthly numbers.  The annualized rate for new home construction in September is expected to be 765,000 compared to 750,000 in August.  The Jobless Claims report on Thursday will also be carefully watched for political reasons.  Last week’s number of 339,000 was an unexpectedly sharp improvement, but was quickly discounted after it was learned that the Bureau of Labor Statistics had not included California’s number in their data.  This week, a arge upward revision is expected on the previous week’s number along with 765,000 new claims for last week.  Friday will conclude with September Existing Home Sales.  This number is expected to decrease from an annualized rate of 4.82 million homes to 4.75 million.  As I noted, with the presidential elections so close, all of these number will come under extraordinary scrutiny, but as we have seen most of the year, there is really nothing newsworthy in the numbers other than what we already know—economic growth is stuck in slow-motion.

The New York Stock Exchange Bullish Percent (NYSEBP) fell 1.03 to close Friday at 65.33.  This marks the third down week in the past four following two very strong weeks in early September.  I sense that momentum is waning and that this indicator feels like a plane stalling at the apex of a climb.    For now, however, there appears to be enough power in the engine to keep the plane right where it is, but I will be watching to see what direction the bullish percent moves from here.  The CBOE Volatility Index (VIX) has increased slightly over the past couple of weeks, but remains at a subdued 16.14.  Finally, the Standard and Poor’s 500 index is now 3% oversold, meaning that the current value of the index is about neutral based upon the past ten weeks of activity.

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, Health Care, and Real Estate.  Information Technology has fallen from third position to sixth on a relative strength basis.  US Treasuries and International Bonds are favored in the Bond category, while US and Developed Markets are favored within the International stock category.  Energy and Agriculture are the favored sectors within the Commodities asset category.

Sincerly,

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.