MARKET UPDATE AND COMMENTARY
January 2, 2014

2013: THE YEAR IN REVIEW

I am not going to spend a lot of time recapping the big stories in 2013 or talking about their impact on the markets. I believe I address these topics during each of my regular Market Updates over the course of the year, so I intend to focus on lessons learned and what, if anything, we should take away from 2013 as we look ahead to 2014.

By all measures, 2013 was a terrific year for stocks and a lame year for bonds. The Dow Jones Industrial Average gained 26.5%, the S&P 500 added 29.6%, the Russell 2000 rose 37.0%, and the NASDAQ led all major indexes with a gain of 38.3%. When dividends are added back into the S&P 500, the total return for 2013 was 31.9%. This ranks 2013 as the 13th best year since the S&P 500’s creation in 1926 and the best year since 1997.

International stocks also did well. The Dow Jones Global Dow Index gained 20.8%, however, the emerging markets region failed to join in the gains with the Dow Jones Emerging Market TSM index down 6.0%.

Bonds widely underperformed stocks in 2013 as interest rates climbed dramatically during the second half of the year. The Barclays US Aggregate Bond index fell 2.2% while the yield on the 10-year US Treasury bond increased from a low of 1.623% to close the year at 3.030%. Not every bond sector underperformed. The High Yield and Bank Loan sectors provided total returns of about 6.9% and 5.6% respectively.

Commodities in general was the worst performing of the six major asset classes I follow. The Dow Jones UBS Commodity index fell 9.6% in 2013 led by a 28.2% drop in gold prices. Silver, corn, coffee, and wheat also fell more than 20%. Natural gas ended the year 24.6% higher and WTI Oil gained 7.3%.

LESSONS LEARNED

When it comes to addressing the lessons to take away from 2013, I am reminded that we are talking about just a single year out of the history of the markets. I prefer to think about lessons learned as more like a refresher course on investing fundamentals. So here are my takeaways:

#1. Dismiss the noise surrounding the markets and focus on the data. Going into 2013 it was clear that the political dysfunction in Washington would be the dominant story and it was. The media told everyone who would listen that the turmoil surrounding the budget deficits, sequestration/spending, Obamacare, the government shutdown, and the Federal Reserve’s curtailment of Quantitative Easing (tapering) would wreak havoc on the stock market and that a market meltdown was just around the next political curve. Both political parties fed into this narrative because each side blamed the other’s policies for causing the expected pain in the market. During all of 2013, the data I follow and provided to me by DorseyWright & Associates was saying that US stocks was the favored asset class, and performance ultimately supported this observation. International stocks pushed Bonds out of the second spot on January 25, 2013 and remained a solid number two the rest of the year. No asset class (International stocks, Bonds, Currencies, Commodities, and Money Market) ever came close to challenging the dominance of US stocks during the course of the year, and this is how we are going into 2014. Keep your emotions out of your investment decision making process.

#2. Allegiance to simple asset allocation for allocation’s sake can be costly—also known as doing nothing. The bond market, as measured by the Barclays US Aggregate Bond index, was down 2.2% and significantly underperformed stocks. Many financial experts suggest that it is appropriate to adhere to a sizeable bond portfolio simply because that is what has become the norm. I share the belief that owning bonds is appropriate when an investor’s cash needs warrant a steady stream of interest payments, or their risk tolerance is such that they simply cannot stomach the typical volatility in the stock market. However, in years like 2013, owning bonds just because it has become an industry standard, cost investors dearly. If you look at the total return of a typical 60/40 portfolio of stocks and bonds, the return for 2013 comes in around 18.6%. A good return, but well below the potential returns offered by a more stock-heavy portfolio.

#3. It is important to pay attention to sector investments. Being able to identify and rotate in and out of the major economic sectors is important not only in stock portfolios but bond portfolios as well. The difference between being invested in the best performing stock sector (Consumer Discretionary) and the worse (Real Estate) was over 41% this past year. Focusing on the strongest sectors and avoiding the weakest proved a profitable strategy in 2013. Bonds are really no different. Morningstar® has 15 different bond sectors it follows. The best performing sector (High Yield) outperformed the weakest (Long Government) by 20.2%.

#4. Don’t lose focus on the future by using the past to make investment decisions. Every performance report is required to have the disclaimer, “Past performance is not indicative of future returns.” I know you have seen it and I am required by my compliance department to include this disclaimer whenever I talk about performance. Past performance is what many investors I come into contact with use to make their investment decisions. Just think about how Morningstar® ranks the various managed investments they track. Their five star system is officially known as the Morningstar RatingTM and is based entirely on past performance. The problem is the past is the past and just as the disclaimer says—it is not indicative of future performance. I believe “trend following” offers investors a more robust way to make investment decisions. “Trend following” is neither predicting, nor ignoring (blind adherence to an allocation strategy—see #3), but rather taking enough information from the market to reasonably identify what the prevailing trends are today and making investment decisions on what is happening not what has happened.

LOOKING AHEAD TO 2014

I avoid the act of making predictions because I believe that being consistently correct is a near impossibility. I will leave the long range predictions to the economic and investment pundits. However, I am not afraid to make near-term observations based upon the data I see in the market or pointing out some historical trends that have occurred simply to provide perspective to the discussion.

#5. US stocks remain favored. Current conditions favor US stocks over all of the other major asset classes I follow. I am overweighting my stock allocation to US stocks going into 2014. Small capitalization stocks are currently favored, however, large cap stocks continue their recent outperformance and this is a trend I have been watching closely for the last month or so.

#6. International stocks remain in the favored #2 status among the six major asset classes. I believe there is more uncertainty surrounding international markets than there is the US at this time, but this asset class has shown strength. Developed markets are clearly favored over Emerging markets. I have heard the repeated mantra in the financial media that Emerging markets is the place to be, and that may eventually prove to be true; however, now is not that time. Stay focused on the strongest developed countries.

#7. Volatility remains subdued, but that can change quickly. This observation is based upon historical data. 2013 will go down as one of the least volatile markets in recent memory. During the course of 2013 there were no 10% or greater corrections and only one correction greater than 5% (7.5% between May 22nd and June 24th). Since this bull market began in March 2009 until the end of 2012, there have been an average of one 5% or greater correction every 4.6 months (3.8 times per year) and a 10% or greater correction once every two years. The last large correction ended September 3, 2011 marking a two-year four-month time span since the last major correction. Statistically, we are certainly due for a large correction and we should expect smaller corrections along the way. Markets never travel upward in a straight line.

#8. Interest rates will continue to rise. The benchmark US Treasury 10-year yield has moved considerably higher since May 2012 closing above the important psychological level of 3% at the end of the year. This move pushed “real” yield into positive territory. “Real” yield is after inflation yield and is determined by subtracting the rate of inflation from the current yield. While there are many ways to calculate inflation, I prefer to use the Gross Domestic Product (GDP) deflator which is also known as the GDP price index. This is the factor that determines “real” GDP growth. Third quarter 2013 is the most recent data available and the GDP deflator was 1.9%. This means that the “real” yield on the US Treasury 10-year yield is about 1.1%. At the beginning of May 2013 and using the same GDP deflator of 1.9%, the “real” yield on the 10-year US Treasury was a negative 0.3%. In other words, investors were literally paying the Federal Reserve to hold their money in the form of 10-year Treasury bonds. The impact of rising rates on bond investors in 2014 will be similar to what happened in 2013. I believe that the loss of price value will offset some of the gains from interest payments leaving investors with another so-so year. For now I continue to favor the High Yield and Bank Loan bond sectors.

#9. Expect political rhetoric to be even more shrill than 2013. I happen to believe this observation is a total no-brainer. Mid-term elections for Congress will occur in November. There is a lot at stake for both parties so I expect the media noise will be deafening and it may be easy for sound decision making to get lost in this media onslaught (refer back to #1). Stay focused on what the market data is saying.

Investing is not easy and it really never has been. Hindsight can remove many of the memories about the uncertainty surrounding past decision making and can mask the stress investors might have felt at the time, but for investors this remains a tough business. I believe this is why so many people will not open statements or why they rarely make changes in their 401(k) plans. They simply don’t know what to do. The good news is that there are more tools available today to help investors than ever before, and if you know how to use them in a systematic way, you will improve your chances of meeting your goals. Helping you navigate the chaos and uncertainty of today’s markets is what I do.

I want to say thank you to my clients who have given me the privilege of helping them meet their financial goals and guiding them through these turbulent and challenging times. I trust all of you have found my Market Update and Commentaries informative and useful. For those who are interested in learning more about how I manage investments and long-term planning, I welcome the opportunity to share with you more of my knowledge and expertise.

I wish each of you a very Happy New Year and a Prosperous 2014.




Paul L. Merritt, MBA, C(k)P®, 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. The Dow Jones Global ex-US index represents 77 countries and covers more than 98% of the world's market capitalization. A full complement of subindices, measuring both sectors and stock-size segments, are calculated for each country and region.

MARKET UPDATE AND COMMENTARY

December 8, 2013

The Dow Jones Industrial Average (DJIA) and the S&P 500 posted their first weekly loss last week after eight straight positive weeks. For the week, the DJIA fell 0.4% and the S&P 500 dropped 0.04%. The Russell 2000 continued its recent trend of underperformance falling 1.0% while the NASDAQ posted a 0.06% gain.

With 49 weeks of trading completed for the year, the DJIA is up 22.2%, the S&P 500 is up 26.6%, the Russell 2000 has gained 33.2%, and the NASDAQ leads the major indexes with a gain of 34.5%.

Prior to last Friday, US markets traded down for the previous five trading sessions even as economic data were indicating growing strength in the economy. Friday’s nearly 200-point gain in the DJIA followed the release of the November Employment Situation report showing unexpectedly high jobs growth bringing the overall unemployment rate down to 7.0%. The consistent message of recent economic data is that the economy is growing steadily in the face of strong fiscal (governmental) headwinds and, I believe, has increased the likelihood that the Federal Reserve will begin reducing (tapering) its current $85 billion per month bond purchase program.

International markets have tracked the US markets relatively closely this year, but without the same level of gains. The European-heavy STOXX 600 index fell 2.7% last week but is up 13.2% for the year. The Wall Street Journal’s Developed Market index is up 20.7% for the year, while the Emerging Market index is down 5.6% and the Asia/Pacific index is up 8.6%.

The Commodities asset class has been a big disappointment in 2013. The Dow Jones UBS Commodity index is down 9.8% for the year; however, this broad-based commodity index has added 1.8% over the past three weeks led by a 13.0% increase in natural gas and 4.1% increase in WTI Oil. Gold remains very weak giving back 26.6% in 2013. The increase in energy prices and other consumable commodities, I believe, is a positive short-term indicator that investors believe a strengthening economy will increase demand for basic commodities and push up prices.

Interest rates continue to trend higher. The US Treasury 10-year yield closed Friday at 2.86% up from the previous Friday’s close of 2.74%. The Barclays US Aggregate Bond index lost 0.5% for the week and is now down 2.1% for the year. Remember that rising interest rates push the value of most bonds down and that this trend of rising interest rates leaves many bondholders at risk for further losses.

BUBBLE, BUBBLE, TOIL AND TROUBLE

As markets continue to remain at or near all-time highs, more and more articles are appearing warning investors of the over-extended position of US stock markets. The common thesis of these articles is that with the DJIA above 16,000 we must be in a bubble and gains in the stock market are artificial and induced by the Federal Reserve’s accommodative monetary policies. None other than Nobel Laureate and Yale Professor, Robert Shiller, told the German weekly publication, Der Spiegel, last week that “many countries stock exchanges are at a high level,” and that he is “most worried about the boom in the U.S. stock market.” The recent market pullback in the face of improving economic news certainly gave some credence to this point, but how do you explain Friday’s strong move?

I believe the answer to this critical question is corporate profits. As I have noted in previous Updates, corporate profits remain at near all-time highs in terms of a percentage of profits with respect to the Gross Domestic Product (GDP). The 3rd Quarter revision of the GDP reported corporate profits at about 10% of GDP and well above the historical average of between 6% and 7%. In the final analysis, I believe the value of companies is all about profitability and companies are making money today.

Looking at the overall valuation of markets, Scott Grannis of the Calafia Beach Pundit, blogged last week that the S&P 500 is, based upon historical averages, actually undervalued. He points out that there are many different ways to determine the overall price/earnings (PE) ratio (how much companies are valued compared to how much they are earning), and some do show the markets overvalued. However, Grannis believes that using NIPA profits (the Bureau of Labor Statistic’s calculation of total economic after-tax corporate profits) is the most accurate measure of profits, and that the NIPA PE ratio of the S&P 500 is about 12 compared to the historical average of 16. He goes on to explain that investors are pricing in very weak future earnings because many investors believe corporate profits will fall significantly going forward, yet the economic data that continues to be reported simply does not support this perception.

It is unrealistic to expect markets to move upward in a straight line, however, those investors who have listened to the bearish pundits and sat on the sidelines have missed the strong stock rally over the past few years.

The rise in interest rates since the middle of the year supports the argument that the economy is growing. Rising interest rates typically occur in a growing economy because investors tend to sell bonds and buy stocks. This trend is confirmed by cash flow statistics reported by the Investment Company Institute which show that through the week ending November 26th, taxable and municipal bond investments have had an outflow of $59.5 billion this year while US and International stock investments have had inflows of $157.9 billion. This buying and selling has, in my opinion, clearly put pricing pressure on bonds and pushed up interest rates.

Friday’s market action was significant because it was the first time that the market rallied recently on good news. The concern regarding tapering is real and I am not dismissing the potential psychological impact on investors when the Federal Reserve begins to (and they will) taper. If you belong to the school of investors who believe that the market is artificially high due to cheap money, then you would expect a pullback as tapering begins. If you belong to the school that believes markets have rallied because the economy is still growing and corporate profits will continue to remain strong (as I believe), then we should expect to see the upward trend in markets to continue. I do expect there will be increased volatility as the two schools of thought battle it out in the months to come, however, as long as the economic data continue to support economic expansion and corporate profits remain strong, the rising trend of markets should continue.

LOOKING AHEAD

My DorseyWright & Associates (DWA) technical indicators continue to favor small and mid-capitalization stocks over large cap. Growth is favored over value, and equal-weighted indexes are favored over capitalization-weighted indexes. US stocks are favored over all other major asset classes with International stocks remaining firmly in second position. Fixed income ranks third followed by Currencies, Money Market, and Commodities.

Money Market as an investment sector currently ranks 116 out of 132 of the sectors tracked by DWA meaning that the vast majority of sectors are outperforming cash. I cannot stress enough how important this ranking is in providing a key indicator of what is happening within the broad market. If Money Market begins to climb higher, it would be an important signal that more and more investments are beginning to weaken and caution will be warranted. This is one of my key risk indicators and I will certainly keep you informed of any changes to this important statistic.

Two major economic reports are due out this week. November Retail Sales will be released Thursday morning. This monthly report will take on added significance because we are in the all important holiday shopping season. The November Producer Price Index will be released Friday morning. This too will be an important data point because it will be a signal of the potential for increased inflation in the months ahead. Both of these data points will certainly be looked at closely by the Federal Reserve.

The Federal Reserve has one more meeting this year on December 15th and 16th. Guidance from the Fed will be released on Wednesday afternoon, December 16th. Economists and investors will be listening closely for clues of when tapering is likely to begin.

My next Market Update and Commentary will be published the last weekend in December.

I want to thank each of you for your support and feedback this year. I hope each of you have the opportunity to share this holiday season with family and friends.




Paul L. Merritt, MBA, C(k)P®, 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. The Dow Jones Global ex-US index represents 77 countries and covers more than 98% of the world's market capitalization. A full complement of subindices, measuring both sectors and stock-size segments, are calculated for each country and region.

MARKET UPDATE AND COMMENTARY

November 17, 2013

Just when you think Washington cannot get any more dysfunctional, our political leadership manages to find new ways to outdo themselves. Thankfully, the stock market’s collective view has been to watch warily but not lose focus on earnings and economic data that shows a slow, plodding economy continuing to grow. The Wall Street Journal reports that according to FactSet, of the 460 companies reporting earnings for the third quarter so far, 73% have exceeded their consensus earnings forecasts. Additionally, at Janet Yellen’s confirmation hearings this past week to succeed Ben Bernanke as Fed Chairman, she made clear that she would continue the Federal Reserve’s accommodative monetary policy for the time being. This relieved one of the immediate fears of investors that the Fed would begin drawing down the bond purchase program before the economy was strong enough to stand on its own.

Two full trading weeks into November, the Dow Jones Industrial Average (DJIA) has gained 2.7% for the month. The S&P 500 is up 2.4%, the Russell 2000 is up 1.5%, and the NASDAQ is up 1.7% over the same period. For the year, the DJIA is up 21.8%, the S&P 500 is up 26.1%, the Russell 2000 has gained 31.4%, and the NASDAQ leads the other indexes with a gain of 32.0%.

The dovish (favoring accommodative monetary policies) position taken by Ms. Yellen during her confirmation hearing helped bonds find some stability. Looking at changes to the 10-year US Treasury bond yield so far in 2013 (above), you can see where interest rates shot up in early May after Mr. Bernanke indicated he would begin tapering bond purchases in 2013. At the September Fed meeting, Bernanke suddenly changed his tune and signaled that tapering would not begin for some time causing interest rates to fall and the 10-year yield has remained within a range of 2.5% and 2.8% ever since. The Barclays US Aggregate Bond index has improved by 2% since mid-September although it still remains down 1.5% for the year.

International stock markets continue to perform well. The broad international index, the MSCI EAFE NR, is up 20.0% year-to-date (YTD). The European-heavy STOXX 600 index is up 15.5%, the Asia/Pacific region is up 10.2%, while the Emerging Markets region continues to trail with a loss of 5.3% YTD.

YOU AND DURATION

I am going out on a limb and make a prediction.

Now everyone who has read my Market Update and Commentary since I began writing them some four years ago knows that I do not like making predictions. The reason is that predictions are nearly impossible to get right repeatedly. So while it may be fun to speculate about future events and outcomes, they rarely provide the basis for consistently sound investment decisions. However, today I am going to do it anyway and here it is: 98% of people find talk about bonds and bond theories boring! Yep, that’s it. With this prediction in mind, I am going to have a discussion with you about bond theory. Why? Because it is very important and many, many investors have a lot of money tied up in bonds. So consider yourselves forewarned and grab a cup of coffee or Red Bull before you read the next couple of paragraphs.

One of the most important concepts for investors to understand is that when interest rates go up, bond prices fall. This happens because as rates increase, a bond owner with a fixed-rate bond must reduce the value of their bond in order to attract buyers. If the bond owner has a bond paying 5% and yields for similar bonds is now 6%, why would a bond buyer purchase a 5% bond when they could get a 6% bond? The answer is they would not, so the bond owner drops the price of their bond until the effective yield to the buyer is 6%.

Therefore, bond owners realize that if interest rates go up, they are likely to lose principal. If they own one bond, the calculation to determine how much the bond’s value will fall as rates rise is relatively easy to determine. But what happens if the bond owner has many different bonds and they want to know the impact of rising interest rates on the overall value of their portfolio? This is where the concept of duration comes in.

Technically, duration is the measurement in years that it will take for the price of a bond to be repaid by internal cash flows (interest and ultimately principal). The longer the duration, the greater the risk of price volatility. Like many tools in finance, there are multiple types of duration calculations and they are all complex to determine. For most of us, the most important duration we need to be familiar with is modified duration which is designed to tell the investor how much principal they could expect to lose if interest rates rise by 1%. Modified duration can be found from many sources but is most readily available from Morningstar. If, for example, your bond investment has a duration of 4.5 years you could expect to lose about 4.5% of principal for every 1% rise in interest rates. Because bonds pay interest, those interest payments help offset the loss of principal in the bond portfolio. This last point is a key concept I want to you to come away with.

Although we have been in a 30-year bull market for bonds where interest rates have been falling since the early 1980’s, many bond managers (include me in this group) believe that interest rates will go up from the historic lows reached in the past year (1.4% in July 2012 for the 10-year Treasury). Interest rates, like most other economic data, do not rise or fall in one straight line; rather they go up and down in the overall directional move. The year 1994 is considered one of the most painful in terms of bond prices in the modern era. The 10-year US Treasury yield began 1994 at 5.75% and closed the year at 7.78%--a rise of 2.03%. A portfolio with a duration of 4.5 years would have lost about 9%. However, investors received interest payments over the year. Assuming for purpose of discussion, an investor received 7% in interest for the year; their net loss would have been approximately 2%. Today, with interest rates starting from such a low level, a 2% jump in interest rates on a portfolio with a duration of 4.5 years would result in more significant losses because investors will not have the higher interest rate income to offset the same loss in principal.

If you are still with me, here is what I want you to take away:

1) You must be very aware of the duration of any bond portfolios you own.
2) This time it is different because interest rates are coming off historically low bottoms.
3) I believe there is more risk in bond portfolios than most people realize today.
4) There are more options to invest in bonds than ever before and a smart bond sector strategy can help mitigate the risks of a rising interest rate environment.

LOOKING AHEAD

Markets continue to reach higher and higher levels. As this happens more articles are appearing in the media about bubbles and corrections. There have only been two down months so far this year (June and August for the DJIA and S&P 500) and these pullbacks were relatively modest. The analysis provided by DorseyWright & Associates continues to favor stocks over bonds, currencies, money market, and commodities. Therefore, I am continuing to recommend that investors stay focused on stocks (US and International) for now.

One possible trend I am watching closely has been the recent underperformance of small capitalization stocks compared to the large caps. This trend has been in place only since October and even then in just sporadic patches. Small capitalization stocks represent the riskier aspect of the market and when investors start to lose faith in stocks, there can be a rotation from small cap over to large cap stocks before the markets begin to fade. There is not enough data to support this as a real trend yet, however, I am watching to see how this develops.

I would like to close my Update and Commentary by reminding everyone that this Tuesday, November 19th, marks the 150 anniversary of Abraham Lincoln’s Gettysburg Address. I personally believe that the Gettysburg Address is the finest speech ever given by an American president at what was one of the most critical junctures of our great past. If you have not read Mr. Lincoln’s “humble” remarks recently, I strongly encourage you to do so. His words are as vibrant and strong today as they were 150 years ago, and they capture what is so great about the American character—strength, sacrifice, righteousness, and a true belief in the greatness of our Country.

My next Update and Commentary will be published in two weeks.




Paul L. Merritt, MBA, C(k)P®, 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. The Dow Jones Global ex-US index represents 77 countries and covers more than 98% of the world's market capitalization. A full complement of subindices, measuring both sectors and stock-size segments, are calculated for each country and region.

MARKET UPDATE AND COMMENTARY
November 3, 2013


Despite media expectations to the contrary, the sky did not fall, the sun came up, and life as we know it did not end in October.

For the month of October the Dow Jones Industrial Average (DJIA) finished up 2.8%, the S&P 500 added 4.5%, the NASDAQ gained 3.9%, and the Russell 2000 trailed with a 2.4% gain. This does not mean there were not some tense moments along the way. The cacophony of doom and gloom reporting surrounding the budget and deficit talks in Washington was deafening; however, when the dust cleared, we survived. Our political leaders have yet again kicked the can down the road until after the first of the year, when the political fighting is expected to emerge again.

President Obama has officially nominated Janet Yellen to assume the Chairmanship of the Federal Reserve, but expect some political fighting during the nomination process. Ms. Yellen is expected to continue the more accommodative monetary policies (translation: low interest rates and continuation of bond buying) of her predecessor, Mr. Bernanke. In the meantime, some positive economic data in the manufacturing sector late last week brought out a chorus of pundits suggesting that the Fed will have to start reducing (tapering) bond purchases sooner than anticipated (late 2013 vs. spring 2014). While I have argued many times that the Fed is NOT responsible for the strength of the stock market this year, I believe there remains a strong psychological crutch associated with the Fed’s policies and investors’ perception of market strength. It is unclear what impact pulling this crutch will have on the markets once some form of tapering actually begins.

I fully expect Ms. Yellen’s nomination process, taper talk, and the next round of budget/deficit negotiations on Capitol Hill to increase investor worries and with it, greater volatility over the next three or four months.

ASSESSING WHERE WE ARE TODAY

I am struck by how quickly the end of the year is approaching. My wife, Virginia, recently posted on Facebook that one of our local easy listening radio stations is already playing Christmas music 24/7. Wow. What happened to Thanksgiving?

With just eight trading weeks remaining in the year, I want to do a quick recap of where we are today.

The major US stock market indexes are all up nicely for 2013. The DJIA is up 19.2%, the S&P 500 is up 23.5%, the small and mid-capitalization heavy Russell 2000 is up 29.0%, and the tech-heavy NASDAQ has gained 29.9%.

Returns are not shared equally between the eleven major economic sectors I follow. The Consumer Discretionary sector leads all with a gain of nearly 36% for the year. Health Care and Industrials follows with gains of 35.6% and 32.3% respectively. Real Estate, Utilities, and Materials have been the weakest sectors with year-to-date returns of 5.6%, 13.3%, and 17.7% respectively.

Bonds have been very disappointing for most investors. The Barclays US Aggregate Bond index, which is a representation of a cross section of US bond sectors, is down 1.2% for the year. Much of this poor performance is attributable to the rise in interest rates (when interest rates rise, bond prices/values fall). The benchmark US 10-year Treasury yield began the year at 1.76% and closed October 31st at 2.55%--an increase of 79 basis points (one basis point is equal to 0.01%). Interest rates have tended to trend along with investor sentiment of when the Federal Reserve is likely to start tapering. Low risk of tapering, lower interest rates; greater expectations, higher interest rates. Not all bond sectors have been negative for the year, however. The High Yield and Bank Loan bond sectors have been notable exceptions with total returns of 6.0% and 4.8% respectively. Long Government, Inflation Protection, and the Emerging Market bond sectors have been the weakest losing about 9.9%, 6.4%, and 5.6% respectively (source: Morningstar).

International markets have quietly shown some strength this year, particularly in the European region where the STOXX 600 has gained 15.3%. While the Emerging Markets region has rebounded a bit in the last couple of months, it remains down 2.6% for the year. Small and mid-capitalization international stocks have led all sectors within the international category.

Commodities continue to struggle and remains the weakest of the six major asset categories I follow. The Dow Jones UBS Commodity index, a broad measure of commodities, has lost 10.9% year-to-date. Within the commodity space, gold has been a major loser posting a decline of 22.4% with WTI Oil up just 3.2%. However, WTI Oil has been particularly hard it recently posting a 10.4% drop since August 30th.

I have recently noticed that there has been an increasing sense of worry over the strength of equity markets; however, this negative sentiment has been prevalent most of the year as equity markets posted solid gains. We have just completed what historically has been the weakest six months of the market, and the S&P 500 posted a 9.95% gain. When compared to other periods (back to 1954) where the S&P 500 managed to gain 10% or more over this same time frame, the S&P 500 on average added another 14.9% over the subsequent twelve months and 24.1% over the next two years (source: DorseyWright & Associates). While past performance is not indicative of future performance, it does offer a compelling argument that momentum can continue for a while.

As I have discussed before, I watch the relative strength of the Money Market sector compared to the other 131 sectors I track, and Money Market currently ranks 116 out of 132 (bottom 12%). In simple terms, this means that 115 categories are beating Money Market on a relative strength basis. Think of cash today as the market’s equivalent of pro football’s New York Giants. If I see this relationship begin to change, I will certainly let you know.

LOOKING AHEAD

The dysfunction in Washington remains. This is not good for our country nor is it good for business. However, sound investing requires a tin ear when it comes to listening to the pundits and media. Much relevant data indicate that the economy is growing not contracting. In this environment, that is what is necessary for the markets to continue to gain or avoid a major (>10% correction) in my view. Growth could be much better, but broad, slow growth does remain. So while I am not discounting the potential impact of the political battles our nation is currently enduring, I am also not losing sight on the momentum the equity markets are currently carrying.

I will repeat what I have been saying all year. US stocks remain the favored major asset category as tracked by Dorsey Wright & Associates. US stocks continue to hold the number one position while the International stocks asset category is a solid number two. Fixed-income is in third place, Currencies is fourth, Money Market is fifth, and Commodities remain in last place where this category as been since June 21, 2012. Small and middle-capitalization stocks are preferred over large-capitalization stocks. Equal-weighted indexes are preferred over capitalization-weighted indexes. Within the Fixed-Income category, high yield and bank loan bond sectors are favored, while energy is now favored in the weak Commodities category.

I currently favor the Consumer Discretionary, Health Care, and Industrials sectors. Within the sub-sectors, I like the Technology (Internet) and Biotech sectors.

Looking at key economic reports for the coming week, the first estimate of the 3rd Quarter Gross Domestic Product will be released on Thursday morning. There is great uncertainty around the consensus of this number and the Wall Street Journal’s estimate ranges from 1.5% to 2.7%. As a matter of comparison, the first quarter and second quarter official growth rates were 1.1% and 2.5% respectively. The October Employment Situation report will be released on Friday with a slight decline in jobs over the previous month expected. There may be some discussion regarding the impact on the employment numbers due to the temporary closure of the federal government in October. All of these reports will be parsed in order to draw some indication of whether or not a strengthening economy will cause the Federal Reserve to begin tapering its bond purchases earlier than the late spring consensus.

On a personal note, you may have noticed that I missed publishing the Market Update and Commentary last week. I was in Chicago sitting for my C(k)P Certified Professional 401(k)® designation exam which I am happy to announce that I passed. This rigorous course of study is sponsored by The Retirement Advisor University in conjunction with the UCLA Anderson School of Management Executive Education.

My next Update and Commentary will be published in two weeks.

Paul L. Merritt, MBA, C(k)P®, 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. The Dow Jones Global ex-US index represents 77 countries and covers more than 98% of the world's market capitalization. A full complement of subindices, measuring both sectors and stock-size segments, are calculated for each country and region.

MARKET UPDATE AND COMMENTARY OCTOBER 13, 2013

MARKET UPDATE AND COMMENTARY

October 13, 2013

Washington is a mess while the rest of America pushes on.

I believe this pretty much sums up where we are as our nation enters the third full week of a federal government shutdown.

The stakes are very real, but markets here and abroad have not overreacted at this point. Volatility has increased, but most key US and international indexes are higher two trading weeks into the month.

Both the Dow Jones Industrial Average (DJIA) and S&P 500 are up 0.7% so far into October. The technology-heavy NASDAQ Composite has gained 0.5% for the month, while the small- to mid-capitalization dominated Russell 2000 was down 0.3%. For the year, the DJIA is up 16.3%, the S&P 500 is up 19.4%, the NASDAQ has gained 25.6%, and the Russell 2000 still leads all major US indices with a year-to-date gain of 27.7%.

Traditional safe-haven assets, gold and US Treasuries, have both fallen in value since the shutdown. Gold has fallen $56.20 (-4.2%) per ounce in the past two weeks closing Friday $1270.80 per ounce. After a brief rally earlier in the summer, gold has now fallen $403.70 (-24.1%) for the year. The yield on the US 10-year Treasury has increased nearly 8 basis points in October to close Friday at 2.688%. Recall that bond values drop when interest rates increase. The Barclays US Aggregate Bond index is down a fraction for October and off just over 2% for the year. In general, bonds have not contributed any real gains to overall portfolio returns.

Every major economic sector is positive since the shutdown began. Real Estate, Financials, and Utilities are all up over 2% for the month. For the year, Health Care (+31%), Consumer Discretionary (+30%), and Industrials (+27%) are the top performing sectors, while Real Estate (+6%), Utilities (+14%), and Materials (+14%) are the weakest.

International stocks continue to perform well. The Dow Jones Global ex-US index, a very broad international index, is up 1.2% in October while the European-heavy STOXX 600 index is up 0.4%. Emerging markets added to their recent gains rising 3.9% for the month. For the year, the Dow Jones Global ex-US index is up 9.7%, the STOXX 600 is up 11.4%, and the Dow Jones Emerging Markets Total Stock Market index is down 3.6%.

While the rhetoric in Washington is reaching new lows of civility and investor fears are heightened, the markets have, for the most part, stayed on the sidelines.

MARKET TIMING

The greatest aspect of my job is my clients. When asked by friends about what I do for a living I always begin my answer by saying, “I work with really terrific people!” My clients come from all walks of life, they each have unique and fascinating life stories, they work hard, and are successful. Moreover, unlike other professions that tend to be more transactional relationships (i.e. real estate sales, mortgage brokers, or sadly—divorce attorneys); my relationship with clients is ongoing, regular, and very interactive. Over time, I get to know a lot about not only my clients but also their families, their goals, and their aspirations. They also ask me a lot of tough questions about the markets and their investments--especially during times like these. This is how we learn about each other, and for me, I get the true measure of each person’s risk tolerance. From this comes the necessary level of understanding that allows me to develop an appropriate investment strategy for each client and family.

One of the tough questions I have been asked over the past two or three weeks is whether we should sell given the growing crisis in Washington. My answer begins by saying that I cannot time the markets. In fact no one can—period! I then follow with a question of mine, “what signal would you use to time your re-entry into the markets?” From there I explain the difference between trend following (which I believe in) and market timing (which I do not). I conclude my answer by analyzing the current data the markets are providing. I always conclude each Market Update and Commentary with a summary of this information.

I would like to devote a few comments to what market timing is and how it differs from trend following.

Market timing is making buy and sell decisions based upon predictions about the future. Numerous technical analysts have developed models in an attempt to predict the future and then trade accordingly. While it may be possible to predict future actions occasionally, it is very difficult to do it consistently. Trend following is ongoing analysis that studies relative strength of investments and making buy and sell decisions based upon which investments have the strongest relative strength. There is no effort to predict the future in trend following, rather decisions are made by the belief that trends come and go—sometimes for extended periods, and, I believe, it is better to own investments that are trending in a positive manner. Trend following is also very adaptive when trends do change.

Looking at today’s circumstances with the dysfunction in Washington, I believe that after watching the markets over the past couple of weeks, it is possible to generalize that markets tend to go down when a deal looks unlikely, and markets rally when a deal (or the possibility of a deal) is in the works. Do I know whether Congress can work out an immediate deal, or whether the President will allow the Treasury to default on debt to make a point, or if the Federal Reserve will begin tapering tomorrow or in 2014, no I don’t. Neither does anyone else. Even if I did, the speed of events and the swift news cycle, you can be right one minute and wrong the next. So I do not believe it is possible to time the market, and I will continue to rely on the trend data provided by Dorsey Wright & Associates to guide my investment recommendations.

LOOKING AHEAD

The brinksmanship in Washington is reaching a fever pitch. Both sides are firmly entrenched and there seems to be little public discussion by our political leaders over how to get an agreement about the budget or the debt ceiling. The government shutdown is proving to be a non-event because the vast majority of government is still running and all those furloughed workers will receive all back pay. The debt ceiling is another matter. The decision to default sits directly with the President. According to the Wall Street Journal, the US Treasury takes in roughly $200 billion per month and owes interest on the debt of about $25 billion each month so there is no legitimate reason not to pay interest. The Treasury could issue new debt to retire the old debt without raising the debt ceiling. So any default will rest squarely with the White House despite much of the reporting in the media.

No one believes that President Obama will default on the debt because that would do grievous harm to the United States and its standing in the world. This is why I believe that it is extremely doubtful that the President will allow the country to technically default on any debt. Should he choose otherwise, there will be, in my opinion, great stress in the markets.

The data I follow also suggests that the odds of default are minimal at this time. US stocks remain the favored major asset category as tracked by Dorsey Wright & Associates. US stocks continue to hold the number one position while the International stocks asset category is a solid number two. Fixed-income is in third place, Currencies is fourth, Money Market is fifth, and Commodities remain in last place where this category as been since June 21, 2012. Small and middle-capitalization stocks are preferred over large-capitalization stocks. Equal-weighted indexes are preferred over capitalization-weighted indexes. Within the Fixed-Income category, high yield and bank loan bond sectors are favored, while energy is now favored in the weak Commodities category.

I currently favor the Technology (Internet), Health Care, and Industrials sectors.

We are facing yet another week of Washington dysfunction. The statutory debt ceiling is expected to be reached this Thursday (October 17th). It is completely uncertain how this will play out, however, I continue to believe some last minute, short-range deal, will be reached. I also believe that volatility in the markets will continue if negotiations continue to drag out.

As I said in my last Update and Commentary, it will be an interesting couple of weeks ahead.

My next Update and Commentary will be published in two weeks.

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. The Dow Jones Global ex-US index represents 77 countries and covers more than 98% of the world's market capitalization. A full complement of subindices, measuring both sectors and stock-size segments, are calculated for each country and region.