MARKET UPDATE AND COMMENTARY
August 3, 2014


It has been a number of weeks since my last Market Update and Commentary and it is time to get back to my regular schedule. First, I would like to say that during part of my writing absence I traveled to Ireland and Scotland with my wife, Virginia, and some of my dearest friends Toliver and Jeanette. A trip to the land of my ancestors has always been on my bucket list. I was thrilled to make the journey and I came home with some fabulous memories and impressions. First, Ireland and
Scotland are countries of immense beauty. Both countries are rustic, green, and lush. Irish communities are very different than other European countries I have visited in that the Irish did not build village clusters, rather their homes are scattered throughout the countryside. Dublin was actually a Viking settlement not Irish; and I learned that Irish redheads, like my daughter, all have their origins from the Vikings. Second, the Irish are fiercely independent. Irish independence is not yet 100 years old and the struggle to gain their autonomy from England is still very much in the public discourse. Third, the food was not nearly as bad as I was told it would be, not fabulous, but not bad. This leads me to my final observation and that is the Irish, and Scottish, people are every bit as friendly as you hear. Everyone we encountered was genuine and welcoming. All in all a great trip.

For the first part of the summer, the markets have been indifferent. This has followed a theme that has persisted through much of the year. The financial media has been obsessed with the notion that the markets were at the top of a bubble and we are poised for a major correction. Last week certainly felt terrible with the Dow Jones Industrial Average (DJIA) losing 467 points (-2.75%) and the S&P 500 falling 53 points (-2.69%). The weekly performance was the second worst week of the year for the DJIA and the worst week for the S&P 500. However, when you stand back and put all of this into perspective, the markets are flat to up slightly for the year. I have written many times in previous Updates that markets do not move steadily higher and that pullbacks are a very common aspect of investing. That 5% corrections have historically occurred between 2 and 3 times each year. This is fact and yet no matter how many times you might have experienced a small or large correction, it always feels terrible. Therefore it is imperative to not lose sight of the goal of most investors and that is strive for long-term gains to support a future lifestyle.

I would also suggest that the markets have actually done pretty well considering the unsettling turmoil that has gripped the world stage. Investors do not like the uncertainty global events can bring into markets and given the ever increasing connectivity of markets, seemingly isolated world events can have an impact on stock and bond prices here in the US. What I believe will have the greatest impact on future market performance in relation to the current global unease is whether or not investors believe the outcome of these key events (Ukraine and Israel/Gaza) will lead to a better business environment. Only time will tell on this point.

KEEPING IT ALL IN PERSPECTIVE

July was the second weakest month for the markets after January so far in 2014. January was, except for the Russell 2000, significantly worse than July. The DJIA was down -1.56% in July compared to -5.30% in January. The S&P 500 was down -1.51% in July compared to -3.56% in January. The Russell 2000 gave back -6.11% in July compared to -2.82% in January. For the year, the DJIA is has lost just 13 points (-0.08%) from where it started 2014. The S&P 500 is up 4.45%, the NASDAQ is up 4.63%, while the Russell 2000 has fallen 3.74%. Given the rather uninspiring results of the major equity markets both here and abroad, I find it interesting that so many pundits keep asserting the markets are in a bubble. Bubbles come when markets keep going up and up and up. I do not see that pattern here. Furthermore, I do not hear any clamor for investors to jump in and start buying stocks because they might miss the next big move upward. What I believe is happening is that the markets have paused and are reflecting the fifth year of sluggish growth in the economy.

The Gross Domestic Product (GDP) has averaged 2.1% growth over the past five years. This year is no different with the 1st Quarter registering in at -2.1% and the 2nd Quarter rebounding to 4.0%. The recovery continues to be the slowest in the modern era. It is also the longest, but that is due, I believe, to the very sluggish nature of the recovery. I also believe that the decline in workforce participation has also helped keep wages down. The markets recovered, in my view, in the previous years because US companies adapted to the post-recession economy and made money surprising many investors. I will concede that a very accommodative Federal Reserve keeping short-term interest rates at near 0% for five years has certainly helped companies. However, I do not believe that the Fed is primarily responsible for current market valuations as many bearish pundits suggest.

It is necessary, I believe, to keep the bond markets included in the discussion of markets and valuations. Keep in mind that the Federal Reserve does not control all interest rates. They set the overnight lending rate and they influence rates through monetary policy (overnight interest rate and the supply of money). The supply of money is extremely important because the more of anything will cause the price to go up (inflation) as you have more dollars chasing the same goods. I have noted previously that the supply of money is not expanding at an above average pace which has kept inflation expectations down.

Investors determine the yield on bonds based upon credit risk, growth expectations, and inflation expectations. US Treasuries are unique in that they are considered to be risk-free because no one expects the Federal government to default. Therefore, when looking at the current yields on Treasuries investors consider just growth and inflation expectations over the period of the bond. That is why I routinely refer to the 10-year and 30-year US Treasury yields as the bond markets’ view of future growth and inflation. Today, the 10-year yield is 2.50%. When you factor in inflation and growth, it does not offer a very optimistic view of future growth rates but it also does not imply that inflation will be running out of control anytime soon.

Another important consideration is what impact low interest rates have on investors. With interest rates historically low for so many years, investors who are seeking income may have been forced to invest in securities that might be considered too risky in normal interest rate periods. Examples of this behavior include investments in high yield bonds, real estate, and utility stocks--equity or equity-like investments by investors who would rather invest in a good old-fashioned boring bonds. As demand for these securities increases, so do the prices. If rates do start jumping upwards, conservative investors may sell higher risk assets in favor of more traditional bonds causing prices in the higher-risk assets to fall.

So as I look across the investment landscape I see a view virtually unchanged in 2014, and I believe the markets are seeing the same. Economic growth is continuing at a very modest pace, inflation remains under control (this can always change and must be watched carefully), monetary policy is expected to be the same for at least the next 9 to 12 months, and I believe there is virtually zero likelihood that the fiscal policy coming out of Washington will change this year. So put the recent moves of the market in proper context as part of the natural ups and downs found in typical markets.

LOOKING AHEAD

The recent sell-off in the markets has pushed down a number of key technicals that I follow. The New York Stock Exchange Bullish Percent (NYSEBP) fell from a very bullish 69.25 to a more moderate 62.35 in July. The first trading day of August saw the NYSEBP fall another 2 points to close at 60.35. This key DorseyWright indicator is also in a defensive posture indicating the potential for some weakness ahead. I believe that if the markets continue their recent pullback, I would expect the reading (and markets) to fall a bit further.

US Stocks continue, however, to be favored on a long-term basis followed by International Stocks. These major asset categories remain the #1 and #2 of the six asset classes I follow. Bonds are third, Currencies and Cash are tied at fourth and fifth, and the Commodity asset class remains in last position.

Looking more closely at US Stocks, the S&P 500 is currently 35% oversold. Anything closer to 100% oversold and beyond would make an attractive entry point for new cash. According to The Wall Street Journal, the trailing 12-month S&P 500 Price/Earnings (P/E) ratio is currently 18.80 with a dividend yield of 1.93%. The 18.80 P/E level is slightly elevated over the long-term average of 15.7.

The International stock asset class ranks number two of the six major asset classes. The European-heavy STOXX 600 lost 1.72% in July putting its loss slightly greater than the DJIA and S&P 500. The Emerging Market region gained 1.67% while the Developed Market region lost 1.25%. The Emerging Market region has been the best performing International sector that I track gaining 6.81% year-to-date. I like this sector, however, not all emerging markets are the same and great care must be taken in gaining exposure in this area.

Bonds continue to fall below stocks on a relative strength basis, however, most bond sectors have performed well so far in 2014. The Barclays US Aggregate Bond Index is up 3.91% for the year as interest rates have generally fallen throughout 2014. Falling interest rates pushed longer maturity bond returns higher making long-term bonds the best performing bond category so far in 2014 (long maturities are also more vulnerable to rising interest rates). The High Yield and Bank Loan bond sectors are currently the most oversold standing at -159% and -173% respectively. Even with the recent sell-off, nearly all bond sectors are positive for the year.

Commodities have lost a lot of strength in the past couple of months. The Dow Jones UBS Commodity index (a broad basket of different commodities) has fallen 5.6% since the end of June and is now up just 1.1% for the year. Oil and Gold tend to be the most reported commodities on the daily news and WTI Oil is down 0.7% for the year while Gold is up a healthy 7.6%. What investors should keep in mind is that Gold is currently $657 (-33.7%) below its all-time high of $1952 reached in August 2011. I do not believe Gold will see a return to the 2011 prices as long as the Federal Reserve keeps the supply of US Dollars within an appropriate growth rate (about 6%) as it transitions into a new era of monetary policy next year. It is important that investors keep in mind that commodities typically trade in a supply and demand environment and if demand falls or supply grows, prices are likely to fall as well.

While I am going to approach the next couple of weeks with caution, I am not going to start selling stocks for selling’s sake. I will be looking very closely at the various DWA technicals that I use to make buy and sell decisions and I would anticipate that some of the weaker relative strength ranked securities will be trimmed. I have learned over the years not to get to heavy handed in trading on down markets, but rather be selective and thoughtful in selling decisions. This time is no different.




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

May 31, 2014

 

 

May saw all the major stock indexes both here and abroad post positive gains.  Interest rates continued their steady decline, and many commodity prices fell as well.

 

For the month of May the Dow Jones Industrial Average (DJIA) gained 0.8%, the S&P 500 grew by 2.1%, the Russell 2000 added 0.7% (first monthly gain since February), and the NASDAQ rose 3.1%.  Year-to-date the major indexes look like this:  DJIA +0.8%, S&P 500 +4.1%, Russell 2000 -2.5%, and the NASDAQ +1.6%.

 

As I noted in my previous Update, the second revision of the 1^st Quarter 2014 Gross Domestic Product (GDP) was expected to slip into negative territory and it did falling to -1.0%.  This is the first negative quarterly GDP number since the first quarter of 2011.  Markets, as expected, shrugged off this bad news and posted gains for the day.  While a contraction in the economy is obviously not good, remember that this number is now two months into the rear view mirror and much more current data is suggesting the 2^nd Quarter GDP may rebound back into positive growth.

 

International markets followed US markets higher in May led by a 3.5% jump by the Emerging Markets region, a 3.3% gain in the Asia/Pacific region, a 1.9% improvement in the European-focused STOXX 600, and the broad Dow Jones Global ex-US index grew 1.6%.  For the year the DJ Global ex-US index is up 2.7%, the STOXX 600 is up 4.9%, the Emerging Markets region has gained 2.4%, the Asian/Pacific region is up 0.9%.

 

Within the Commodity sector Gold fell $45.90 (-3.8%) per ounce in May closing at $1246.00.  Despite the decline in May, Gold is still up $43.00 (+3.6%) for the year.  I have been reporting recently that food prices have been rising because of poor weather early in the year; however, Corn and Wheat fell significantly in price during May (-12.5% and -8.1% respectively) although both remain up for the year.  I believe it is too early to see if the lower prices will work their way into reduced prices for many of the foods we consume, but if this trend holds, I think it is possible to expect cheaper food prices down the road.

 

Interest rates continue to slide.  The yield on the 10-Year US Treasury fell 17 basis points (one basis point is equivalent to 0.01%) in May to close at 2.47% on Friday.  As yields have fallen, the Barclays US Aggregate Bond index has moved up in value adding 1.2% in May and 4.1% for the year.  A couple of years ago I read an article in the Wall Street Journal that opined that of all major economic indicators, interest rates were the hardest to predict.  So hard in fact that not only did the vast majority of economists incorrectly forecast the size of the change in interest rates, they could not even predict the direction of change!  2014 is proving to be no different.  Most economists thought rates were clearly headed up with the expected start of tapering (reduction in bond purchases by the Federal Reserve and ultimately ending the program).  The Fed has started tapering just as anticipated; however, rates have not followed expectations and have fallen.  I believe this has happened because real growth in the US economy continues to stagnate.  I would like to see rates rise slowly and steadily because that would signal a growing economy beyond the low to mid 2% growth rate we have experienced for so many years now.

 

A FOLLOW-UP TO MY COMMENTS ON INFLATION EARLIER THIS MONTH

 

Two of my favorite economists are Brian Wesbury of First Trust Advisors and Scott Grannis who writes the Calafia Beach Pundit.  They are my favorites because, in my opinion, they get it right much more often than they get it wrong.  They also look dispassionately at the economy unlike some economists who might be influenced by politics or other external, non-economic factors.  Because they are so good, I frequently share their thoughts with you to help you understand what is going on and this week is no exception.

 

Both Wesbury and Grannis have been bullish on the economy and markets for the past five years.  They have said, and are currently saying that the markets are not on the verge of another recession or collapse even though other media outlets and economists have been calling for just such a pullback.  Their points of view in the recent past and today are further substantiated by the market data I receive from DorseyWright & Associates.  The US Stock major asset category remains firmly in control and has shown no weakness or signs of breaking down.  This does not mean there will not be ups and downs along the way—a straight upward stock market does not exist; however, it does appear to me that factors that could contribute to a rising market are emerging.  With this background in place, I found their most recent comments very interesting.

 

While each said it differently, their conclusions were roughly the same: the US stock market is not overvalued and there are early signs that the supply of money in the economy could be increasing.  This in turn will help push asset prices (including stocks, real estate, and commodities) higher.  They also feel that over the short-term inflation will remain in check; however, as the supply of money increases in the economy, the risk for inflation will grow with it.  In short, we may be at the beginning of another upward movement in the stock market, which for the first time in recent market history, could be helped by more money coming into the markets—the proverbial “sugar high” some commentators have said already exists.  This is good news for now, but both gentlemen caution the Fed will have a difficult task to keep the economy expanding while holding the inevitable rise in interest rates to a reasonable pace.  If the Fed gets it wrong and asset values get far ahead of themselves, we could see another nasty correction at some point in the future.  It is far too early to know if the Fed will be up to the challenge.

 

I will conclude this section by sharing with you a couple of the key indicators that I will be watching as we continue on this journey.  First, I will watch how the Money Market Fund category ranks overall in the DorseyWright list of fund categories.  Currently the Money Market Fund category sits at 130 out of 134.  Should the ranking rise, it is an early sign of a weakening of most asset classes.  Second, I will be watching the US Dollar index.  The US Dollar index compares the US Dollar to a basket of six foreign currencies with the Euro (58%) and the Japanese Yen (14%) the largest holdings followed by the British Pound, Canadian Dollar, Swedish Krona, and the Swiss Franc.  A weakening US Dollar could be an indicator that more US Dollars are flowing into markets and anytime you have more of something (supply), supply and demand basics tell you that all things being equal, the price of that asset will fall.  Finally, I will be watching the Price/Earnings (P/E) ratio of the S&P 500.  In simple terms, the P/E ratio represents how much an investor is willing to pay for $1 of earnings.  In the past, when P/E ratios have moved significantly above their averages it has often been a warning sign that too many dollars were chasing stocks and pushing prices up beyond the true value of a stock/company.  According to Bloomberg, the current P/E ratio is 17.6 compared to the 55-year average of 16.6.  The current P/E ratio is slightly elevated, but not in any meaningful or harmful way. 

 

LOOKING AHEAD

I continue to believe that the economy (1^st quarter not withstanding) will continue to plod along.  There are early signs that some of the excess US Dollars sitting in bank reserves may be finding their way into the economy increasing the risk for asset price inflation.  For asset investors I believe this will initially be a positive but again increases the risk of a meaningful asset price correction some time in the future.

 

I am maintaining my broad guidance.  I favor US stocks overall of the six major asset classes I follow.  Within US stocks I prefer small and middle capitalization companies over large cap.  Looking at the major economic sectors, the Materials and Financials sectors are now favored.  I should point out that from a pure performance perspective (as compared to relative strength which is slower to move) Real Estate, Utilities, and Energy continue to be the best performing sectors while Consumer Discretionary the weakest. 

 

The International stock asset class still ranks number two of the six major asset classes.  I am liking this category more as international stocks are sharing in growth along with US stocks, and I am beginning to add positions again to the international asset class.  I am pulling back from my outright ban on the Emerging Markets region and will be looking to selectively add to this category as well.

 

Bonds have shown some life with the pullback in interest rates.  I continue to like the High Yield bond sector, however, I am going to begin trimming my Floating Rate positions and increasing my exposure to the Multi-Sector bond sector.

 

Gold has taken a bruising lately and I have not been favoring this commodity sector for sometime and I still do not.  The Energy sector is my favored Commodity asset class investment area.

 

Two of the major exonomic reports being released next week are the May ISM Manufacturing index (June and the May Employment Situation report (June 6th). The ISM Manufacturing index is expected to show continued modes expansion manufacturing in the US, while consensus of the Employment Situation report is for the creation of 213,000 non-farm payroll jobs. This reflect adrop from the 288,000 jobs created in April, but 213,000 jobs would still be considered a good report.

 

I want to finish my article by taking a moment to recognize the upcoming 70^th anniversary of the invasion of France at Normandy on June 6, 1944.  As a professional soldier and former paratrooper I have the highest admiration for the soldiers, sailors and airmen who overcame so much and sacrificed even more to free the French and help rid the world of Hitler.  I have vivid memories of walking the beaches of Normandy on June 6, 1964 and staring out at the great expanse of Omaha Beach in front of me as I looked up to the bluffs which had been full of German soldiers just 20 years before.  Even as a young boy I could comprehend in a small way what it must have been like on that fateful day so long ago.  Please take a moment to reflect on the sacrifice of those men and honor their memory.

 

 

 

 

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
May 18, 2014


Financial markets continue to move without clear direction with the possible exception of small capitalization stocks.

Over the past two weeks, the Dow Jones Industrial Average (DJIA) fell 0.13%, the S&P 500 gave back 0.17%, the NASDAQ dropped 0.81%, and the Russell 2000 (small cap stocks) fell 2.29%. For the year, the DJIA is down 0.5%, the S&P 500 is up 1.6%, the Russell 2000 is down 5.2%, and the NASDAQ is down 2.1%.

Economic news, like the markets, was mixed. There were ten key economic reports over the past two weeks. The Wall Street Journal defines these key reports as “market moving” indicators. Six were better than consensus, three fell below, and one met consensus. I will have more to say about some of the most significant report in my next section.

International markets have shown some interesting short-term trends. Russia has rallied 9.8% over the past two weeks, as investors there feel more comfortable for now that Putin apparently is not going to invade Ukraine triggering more and substantial sanctions from the West. India just elected Narendra Modi as Prime Minister. Mr. Modi’s election signals a shift to a strong pro-growth, pro-business agenda and in the process, he has pushed out the more progressive Congress Party after 67 years of rule. India’s primary market is up 7.7% over the past two weeks. Russia and India are two key emerging market countries and helped push the Emerging Markets region up 2.6% last week. For the year, the Emerging Market region is also up 2.6%. The Developed Markets region is up 1.5% year-to-date, and the European focused STOXX 600 is up 3.3%.

Commodity markets have shown little change recently as I noted in my last Market Update and Commentary. The Dow Jones UBS Commodity Index (a broad indicator of commodity performance) is down each week so far in May (-1.9% for the month) leaving the index up 7.5% for the year. Gold is flat for May and up 7.5% for the year. WTI Oil has shown recent strength and is up 3.7% for the year. Agricultural commodities are generally up for the year primarily because of drought conditions in much of the growing regions in the US.

The Barclays US Aggregate Bond index is up 0.9% over the past three weeks and is now up 3.2% as bond yields continue to fall. The US 10-Year Treasury yield closed last Friday at 2.52%. This is the lowest Friday close for 2014. While bond investors have seen a nice bump in returns so far this year, I do not consider this a particularly positive development. Lower yields, in my opinion, signal a lower economic growth outlook—not the direction any of us want to see right now. Lower yields in turn foster a weaker US Dollar which, over the long-term, is not a positive.


IS INFLATION CREEPING INTO THE ECONOMY?

Of all the key economic reports released over the past couple of weeks, I want to focus on the Producer Price Index (PPI) report for April released last Wednesday. This report measures the average price changes in the final price of goods and services produced in the US. Consensus had expected a jump of 0.2% but the April number came in at 0.6%. This suggests that inflation is now running at a rate of about 2% over the past year when the same data six months ago showed inflation running at just 1%. Why is this significant?

One of the primary concerns of the Federal Reserve’s current and long-running accommodative monetary policy has been that by keeping interest rates so low for so long coupled with the unprecedented purchases of bonds (Quantitative Easing—QE) was that this would ultimately cause inflation to rise beyond the Fed’s ability to control it.

I am not of the opinion, as some commentators have suggested, that last year’s run up in equity markets was caused by a flood of money into the economy from the Federal Reserve’s QE program. Rather I believe that the rise in stock market prices resulted from strong corporate profits. I have also stated recently that I do not believe the markets are headed for some kind of severe correction because the Fed’s monetary policies are accommodative and we have not seen a Fed-induced rise in interest rates. However, I do feel that if the Fed does not get future monetary policy right (returning monetary policy to a more neutral position compared to the accommodative policies in place now), we could be in store for some inflation and higher interest rates. Inflation has been kept in check up to this point because banks have not made loans with their excess reserves. I also believe that this is also the reason why the stock market has not been stimulated artificially. Simply put, much of the money created by the Fed by QE is not in circulation in the day-to-day economy.

Bankers have understood all along that the Fed pumped up bank reserves in the hope that the banks would then lend the money to get the economy kick started. However, I believe that bankers have been fearful that the Fed could quickly pull back the excess reserves creating cash shortages at the banks because most loans are made over a multi-year period. No banker would make a multi-year loan if they were concerned that the Fed could pull money back next month. If you look at the graph above, you can see in the blue line (Monetary Base) how the Federal Reserve created a lot of money via bond purchases (QE), but there has been no discernible change in money (gold line) actually moving into the economy (Money Stock: M2). Money Stock (M2) is the source of inflation, not the Monetary Base. If banks sense that the Fed is not about to pull back the money that is currently in reserve, lending will increase, money stock will increase, and I believe inflation will follow. To counter the outflow of money from the Monetary Base, the Federal Reserve, in my opinion, will be forced to raise rates currently paid on reserves to entice banks not to lend out the money.

It is too early to determine if the rise in the PPI is a signal that money is moving out of reserves and into the economy, but it is certainly something to watch closely. If the Fed is forced to raise interest rates before the general economy is on solid footing, it could increase the likelihood of a contraction in economic growth.

I will conclude by saying that Fed monetary policy is not the most interesting of subjects to discuss, but hopefully you can get a sense of how influential the Fed can be on the markets.

LOOKING AHEAD

I believe the economy is stuck in a rut and we will be in this rut for the time being. This does not change my current belief that US stocks are the favored major asset category. There has been no changes in the overall relative strength relationships between the major asset classes for some time now.

Therefore, my broad guidance remains in place. I favor US stocks overall of the six major asset classes I follow. Within US stocks I prefer small and middle capitalization companies over large cap. I am very aware of the recent weakness in the small cap sector and am considering a change from small cap growth to small cap value. Looking at the major economic sectors, the Materials and Financials sectors are now favored. I should point out that from a pure performance perspective (as compared to relative strength which is slower to move) Real Estate, Utilities, and Energy have been the best performing sectors in 2014 while Consumer Discretionary the weakest. As of Friday, the Industrials sector, along with the Information Technology, Financials, and Consumer Discretionary have not exceeded the S&P 500 in performance. Only Consumer Discretionary is negative year-to-date.

The International stock asset class still ranks number two of the six major asset classes. The weakness in International markets in relative strength terms continues and I am not selling current positions but not adding new money to this major asset class. While I continue to strongly advise against owning the Emerging Market region, I am aware of the recent positive performance of this region. I believe that the sudden improvement in Russia and India are behind the numbers. I do believe India is a country on the rise.

Bonds have shown some life with the pullback in interest rates. A defensive move for sure. However, I continue to like the High Yield and Floating Rate sectors.

Commodities appear to be stymied at this time. The Energy sector is my favored Commodity asset sector.

Home sales will be the most significant reports out next week with Existing Home Sales for April scheduled for release on Thursday followed by New Home Sales on Friday. The second revision of the 1st Quarter Gross Domestic Product (GDP) will be released the following Thursday, May 29th. Recall that the first estimate came in at 0.1% growth. It is too early for the consensus figures to be available, however, several economists whose opinions I value expect to see this number fall to the -0.3% range. I do not believe the markets will overreact to this negative number given the understanding of the winter’s negative impact on the economy.




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
May 5, 2014


The past week provided financial pundits with plenty of topics to fill their pages. At the top of the list were the initial estimate of the 1st Quarter, 2014, Gross Domestic Product (GDP) and the April Employment Situation Report. The GDP came in at a very anemic 0.1% while the economy created 288,000 new jobs in April. The GDP report was generally ignored by the markets which had been expecting a bad number given the impact weather had throughout most of the US, but the positive Employment report did not help stocks and surprised some investors by the general weakness in the markets.

As of the market close of Friday, the Dow Jones Industrial Average (DJIA) is down 0.4%, the S&P 500 is up 1.8%, the Russell 2000 is down 3.0%, and the NASDAQ is down 1.3%. A mixed bag for sure, and after last year’s strong performance, a bit of a letdown. I have previously referred to the markets as lackluster and that description seems to remain firmly in place. Eighteen weeks into the year, the S&P 500 has been up nine weeks and down nine weeks. No direction and no performance.

International markets have continued to generally track US markets. The European-heavy STOXX 600 is up 2.9% and one of the strongest performing regions in 2014. A broad index of international markets is the Dow Jones Global Dow X US and is up 1.5%. The Emerging Market region is down 0.2% so far this year while the Developed Market region is up 1.7%. It appears that the tension within the Ukraine has not hurt Western European economies; however, Russia is now down 20.4% for the year the worst performing major stock market within the world. Venezuela is the second worst performing market in 2014 losing 13.6%. What do both Russia and Venezuela have in common? Strong-arm regimes that are more focused on their political power rather than growing their economies.

There has been little change in the commodity markets over the past month or so. The UBS Dow Jones Commodity Index, a broad basket of commodities, has fallen slightly recently but is still up 8.7% for the year. Gold is up 8.3% for the year, but has been bouncing around the $1300 per ounce level for the past six weeks resulting in only small changes in overall value. I believe that gold prices are very indicative of the level of fear in markets—fear of a weak currency, fear of global turmoil, and fear of inflation. For now, at least, fear appears to be in check. WTI Oil has been slipping slightly in value much like many other commodities. I continue to believe that oil and most other commodity prices are being influenced by basic supply and demand issues, not by speculative investing.

US Treasury yields have surprised most investors and economists by continuing to drift downward so far in 2014. The US 10-year Treasury yield closed Friday at 2.58% well below the 3.03% at the start of the year. I believe that falling interests today represent diminished expectations of economic growth by bond investors. I would like to see interest rates trending upwards, but for now that is just not happening. Falling yields are occurring simultaneously with the Federal Reserve’s continued reduction of bond purchases (referred as tapering in most financial media). Most economists had hypothesized that as soon as the Fed started to reduce its bond purchases, yields would start to rise. That simply has not happened. Demand remains strong for US Treasuries as well as corporate bonds raising questions about improving economic growth.


SEEKING A CATALYST

I was fortunate to have spent a couple of days in Boston recently interacting with about a dozen money managers who collectively manage well over $50 billion in assets for Putnam Funds. Each manager came into a room of about 30 other advisors like myself and talked about their process for managing money. In the course of two days of discussions, I kept hearing the word “catalyst” mentioned repeatedly. The money managers were focused on what catalyst or event that it would take to unlock additional value in the companies they follow. I have been looking at the broad economy asking the same question. By nearly every measure, this has been the most disappointing recovery in the modern era. The US GDP has grown in the low 2% range on average for the past four years. However, stock markets have risen substantially since the bottoms in March 2009 because the banking/housing crisis has been managed, a second recession never materialized, and companies have been profitable. Brian Wesbury of First Trust Advisors calls this the Plow Horse economy because it moves slowly and steadily forward. Nothing has really changed. So why have the markets been flat for the past four months and will we see any growth this year?

The environment we find ourselves in is not all that much different than what we have experienced for some time now. According to Bloomberg, as of April 29th, companies within the S&P 500 that have reported earnings for the first quarter this year have posted solid gains of 3.7%. The unemployment rate has fallen to 6.3%. The Federal Reserve continues an accommodative monetary policy. Interest rates remain low. Inflation remains well below the 2% target set by the Fed. Domestic energy production is reaching record levels and steadily improving. I draw several conclusions from all of this. First, I am reminded that stock markets are always forward looking so you cannot look backwards and try to make sense of current market performance. Second, for many of the reasons I just cited, I do not believe a major market correction is just around the corner. The financial media has been publishing lots of dire predictions recently, but keep in mind—dire sells and that is the objective of all financial media. Third, the political strife in this country is quite pronounced and both sides of the aisle have been, in my opinion, misrepresenting the economy in order to score political advantage. And finally, we all live in the shadow of the Great Recession of 2008. The memories of that year are still fresh and weigh heavily on the conscious and behavior of many investors.

Looking for a catalyst I need to find something different than what we have been experiencing for some time now. Monetary policy is, in my opinion, not going to change much. We have seen the Federal Reserve taper its bond purchases and hold short-term interest rates very low. I do not expect this to change over the next six to nine months. Fiscal policy, those rules, regulations, and laws set by governments at all levels, may have the potential to change after the coming mid-term elections. I believe that the fiscal policy, especially from the Federal government, has been the single biggest drag on the economy. Regulations are exploding along with the cost of compliance with those regulations, new taxes have come into existence, and Washington is in a log jam with little hope of more growth-oriented policies like lower corporate tax rates likely to emerge in the near-term. However, early polls indicate that change may come this November with a Congress that may be more willing to change fiscal policies to be more growth-oriented. If markets see this change coming, I would not be surprised to see this serve as a catalyst to move the markets higher in the fourth quarter.

Finally, geopolitical risks always remain a concern. The situation in the Ukraine is not resolved and there could still be fallout there. China, North Korea, and the Middle East always seem to be in a constant state of low boil, but for now the markets have not reacted to these concerns.

LOOKING AHEAD

We are coming upon a generally quiet period for the markets. Summer has traditionally not been a great time with regards to market returns, and I suspect this year will be no different. Coming off a slow start for the year, I believe we have more of this in store for now. As I noted above, any real positive change will come in the fourth quarter as we approach the mid-term elections and the possibility of real change in current fiscal policies.

I remain committed to my long-standing recommendations. US stocks are still the favored major asset category followed by International stocks, Bonds, Foreign Currency, Money Market, and Commodities. There has been no deterioration of the relative strength of US stock to any of the other asset classes.

I still favor small and mid-capitalization stocks even as I see some weakness in the small capitalization area. Small cap stocks are generally about 50% to 60% oversold meaning they are below their previous ten-week pricing and potentially more affordable. Stocks do not reach the extreme oversold level until they reach 100% or higher. Sector recommendations include Materials, Industrials, and Financials. Finally, I continue to prefer equal-weighted indexes over capitalization-weighted indexes.

Within the International stock asset class there has been some improvement in the Emerging Market region; however, Developed Markets remains the strongest in terms of relative strength and thus the focus of my investment recommendations.

Bonds have shown some life with the pullback in interest rates. A defensive move for sure. Although long-term government and corporate bonds have been the best performing bond sectors so far in 2014, I believe they come with great interest rate risk. I continue to like the High Yield and Floating Rate sectors.

The overall rally in the Commodity asset class has stalled much like the rest of the markets. The Energy sector is my favored Commodity asset class investment.

Economic data continues to come in mixed and I do believe investors and economists have not been able to figure out the markets recently. I see little change and thus expect more of the same.




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 sub-indices, measuring both sectors and stock-size segments, are calculated for each country and region.

MARKET UPDATE AND COMMENTARY
April 20, 2014


Let me begin by saying that I realize I am a week behind in publishing my Market Update and Commentary, but I have been suffering from a terrible case of the flu. It is the first time I have had the flu in years, and I am reminded that being sick is always a terrible alternative to everything else!

At times I have felt that my recent physical health has been mirroring the general health of the markets. However, upon closer examination, the markets feel worse than they really are. For the year, the Dow Jones Industrial Average is off 1% while the S&P 500 is up 0.9%. The worst performers of the major indexes I track are the tech-heavy NASDAQ (-1.9%) and the small/mid stock-heavy Russell 2000 (-2.2%). Within the broader context of the indexes there has been even greater turbulence within some of the best performing sectors in 2013. The Biotech sector is off 3.8% year-to-date (YTD) and down 12.6% over the past month, and the Internet sector is down 2.0% YTD and is down 11.5% over the past month. Quietly, the Utilities (+10.6%), Real Estate sector (+9.1%), and Energy (+4.8%) lead among the major sectors so far in 2014.

International markets have continued to keep up with US markets. The European-heavy STOXX 600 is up 1.3% in 2014. The Asia/Pacific region is the weakest performer (-1.3%) followed by the Emerging Market region (+0.3%). Japan has seriously underperformed most countries so far this year losing 10.9%. The big question hanging over most international markets is what impact will the daily escalation of tensions within Ukraine have on European and other international markets going forward. Russia appears to be the economic loser in 2014 with that country’s major exchange down 16.7%.

Commodities continue to perform relatively well in 2014. The UBS Dow Jones Commodity Index, a broad basket of commodities, is up 9.5% led by strong gains in the agricultural commodities such as coffee (+82%), pork (+45%), and orange juice (+21%). Rises in many of the agricultural commodities appears to be the result of weather-related supply/demand problems due primarily to drought troubles in many agricultural-producing areas in the US. Pork is suffering from an unprecedented loss of piglets to a virus causing prices to spike upwards. Energy prices have also been on the rise in 2014 with WTI Oil gaining 5.8% while the price of natural gas has jumped 14.0%. Gold is up 7.6% helping to bring this metal off multi-year lows. All of this is causing energy and food prices to push up at a higher rate than core inflation.

Bond traders, in my opinion, are very undecided about the future direction of interest rates. One day traders believe Fed Chairman Yellen is ready to raise interest rates earlier causing rates to jump upwards, the next they are convinced that the economy will remain sluggish and interest rates fall. The net effect has been for bonds to post modest gains in 2014 as interest rates remain range-bound and below where they finished 2013. The Barclays Aggregate US Bond index is up 2.3%. The US 10-year Treasury yield is currently 2.72% and well below 2013’s close of 3.03%. The Long Government, Preferred, and High Yield sectors are leading among bond sectors, however, almost all bond sectors are slightly positive so far in 2014.


COPING WITH VOLATILITY

Market volatility has returned in 2014 after a relatively benign 2013. As I pointed out in early Updates, the strongest performing sectors of 2014 (biotech and internet) are the biggest losers so far in 2014. This is not unusual as investors take profits in these sectors after strong runs. The lower-volatility sectors like Real Estate, Utilities, and Energy have outperformed as investors appear to be seeking relief from the wide swings found in the more volatile sectors like small capitalization stocks and the other sectors already mentioned. I have trimmed some of my positions in biotech and internet stocks, however, I still maintain that these sectors have the potential to provide strong returns in the future. I will return to these investments when they are no longer providing sell signals.

My pullback from the biotech and internet sectors does not reflect a retreat from stocks in general. US stocks still remain as the strongest major asset class according to DorseyWright & Associates (DWA). Let me repeat myself: US stocks remain the strongest major asset class and I am not abandoning stocks. I am moving stocks away from some of the higher volatility securities into core holdings and even a few value securities. I am maintaining my allocation to stocks, just trimming the higher volatility positions.

Another reason that I have not trimmed my allocation to stocks in general is that the Money Market fund category has actually fallen during this period of increased volatility. At the start of the year, the Money Market Fund category ranked 110th out of 129 category sectors tracked by DWA. Today, the Money Market Fund is ranked 130th out of 133. If the Money Market Fund category starts rising substantially, I believe it is a key warning sign that the underlying fundamentals of the market may be deteriorating, and this just has not happened. Nor has general strength of the US stock major asset class weakened. In fact, it has not relinquished a single tally to the other major asset categories since October 2011—an impressive show of relative strength.

Sixteen weeks (31%) of the year have now passed and there is little to excite most investors, however, as I have said before, a pause is not necessarily a bad thing at this time.

LOOKING AHEAD

Earnings season is in full swing. Publicly traded corporations are now reporting earnings for the first quarter of this year. Many analysts and investors are expecting a subdued quarter due to the terrible weather experienced by some of the most populated portions of the US. I share that view, however, it will be important to listen to what CEOs and CFOs say about earnings expectations for the remainder of the year. Profits drive the stock market, so earnings are critical.

There remains no shortage of doom and gloom in the media regarding a pending correction. One of the most common arguments for a large decline (>10%) comes from the simple fact that the US markets have not suffered a 10% correction since September 2011. I have written previously that this market has been less volatile than historical norms, however, saying we are due for a correction simply because we have not had a correction is a dubious claim in my view. My guidance is to stay focused on the data, and the data does not currently suggest that the markets are extremely overbought or expensive. They are not cheap, but they are not terribly extended either.

My broad guidance remains in place. I favor US stocks over all of the six major asset classes I follow. Within US stocks I prefer small and middle capitalization companies over large cap. I also continue to favor the Materials, Industrials, and Financials sectors. My sector recommendation has dropped Health Care and Consumer Discretionary for now, and Materials is a new addition. Finally I prefer equal-weighted indexes over capitalization-weighted indexes.

The International stock asset class still ranks number two of the six major asset classes. The weakness in International markets in relative strength terms continues. I am not selling current positions but not adding new money to this major asset class. I continue to strongly advise against owning the Emerging Market region. I include China in the Emerging Market region.

Bonds have shown some life with the pullback in interest rates. A defensive move for sure. However, I continue to like the High Yield and Floating Rate sectors.

The overall rally in the Commodity asset class continues and is looking slightly more attractive in the short term. The Energy sector is my favored Commodity asset class investment area.

While economic data released over the past week or two has been somewhat favorable, most investors seem to focus on the next set of data. Highlighting this week’s releases are the Existing and New Home Sales reports for March (Tuesday and Wednesday morning respectively), and Durable Goods Orders and Jobless Claims on Thursday. Existing home sales are expected to drop slightly while new home sales are expected to increase slightly. Jobless Claims are expected to increase by 9000 claims to 313,000 from the previous week’s tally of 304,000 while Durable Goods Orders for March are expected to drop marginally. The “plow horse” economy continues to plow along!

I will close my Update and Commentary by providing this year’s bracket analysis for the Men’s NCAA Basketball Championship (please go back and read my bracket analysis in the March 16th Market Update and Commentary if you missed it). As we all know by now, Connecticut won the championship as a #7 seed, the second lowest seed to win since 1985. The chart on the next page compares the overall record by seed for 2014 against the average record by seed from 1985 until 2013:



A couple of things jump out. First, the #16 seed failed to win over a #1 seed in the opening round keeping this record intact for now. Second, even though a #1 seed failed to reach the Championship game, they still posted the best overall record of all seeds. Finally, #7 Connecticut raised this year’s winning percentage for all #7 seeds. This is a fun example of the merits of relative strength and how it might be applied to investment decision making.




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.