Current Market Analysis

It has been a wild month in the stock market since I wrote to you. After plunging below important support levels to a new year low of 10,962 on July 15, the Dow Jones Industrial Average has surged about 700 points to 11,660 as I write this today. There is a whiff of euphoria in the market as the price of oil has swooned and the financials, led by the bailout Fannie Mae and Freddie Mac, have rallied from near death. Indeed, some of the big money-center banks like Citigroup, Bank of American and JP Morgan Chase are being applauded for losing less money than expected and their shares of risen dramatically over the past week or so.

Interestingly, on July 15, the day the market made it's low for the year, of the 3299 stocks that traded on the New York Stock Exchange, 39.5%, or 1,304 stocks, hit new lows for the year. That is the highest single day percentage in the history of the NYSE. And the 7.2 billion shares traded that day was the second highest ever (thanks to Richard Russell of Dow Theory Letters for those statistics). So has "THE LOW" been made yet? Is the worst now behind us? I honestly have no idea. It is important that the Dow Transports did not make a new low along with the Industrials. It's also important that the Dow remained above the huge support level of about 10,750 that I talked about last month. That being said, I think it's too early to call a bottom. The economy still stinks, housing is still a mess, as is the financial sector. And I don't think we've seen the end of high oil prices by a long shot. So we watch the action and wait for further news.

So let's take a look at the charts to see what the market is telling us. Below is a daily chart of the Industrial Average so far this year. We clearly see the plunge below the March low, taking the Industrials below 11,000 before the recent rally. Considering how dramatically oversold that drop way, it isn't surprising to see a bit of a run-up now. Again, I just want to remind you of the next support level on the downside of about 10,750, which would represent the midpoint of the low set in July 2006 to the high set in October 2007. It is very important that the Industrials remain above that key support level.

The Transportation average remains remarkably strong and could be the one indication that the market is more likely headed higher than lower in the coming months. The Transports are more than 1,100 points higher than the January low and within shouting distance of the May high. Again, according to Dow Theory, the Transports and the Industrials must make new lows (or highs) at the same time to confirm the trend. Therefore,this lack of confirmation suggests that the market may have seen its worst days. We will continue to monitor this action closely. I expect to see the Transports consolidate a bit before making its next decisive move.

Not surprisingly, the S&P 500 broke below its year-long trading range, as shown below. The latest rally though has returned it to the lower range. Interestingly, the approximate midpoint of the S&P 500 from its low in 2002 to its high in 2007 is 1,165. That's a number worth keeping an eye on.

Bond yields are at the high end of the year-long spread between 3.3% and 4.3%. It made sense that bond prices would fall (lifting yields) as equities soared then rise (depressing yields) as equities fell. Bond investors also demand a higher yield in response to the falling value of the dollar. Looking ahead, I expect yields to remain near the high end of this basic trading range for the next few months.

Last Month's Results

• According to the Department of Labor, the most recent four-week average for seasonally-adjusted initial jobless claims, for the week ended July 12, was 376,500, a decrease of about 1,750 from the prior month, and an increase of 18,000 from the prior week's revised number. These figures continue to be poor no matter how you look at it. The actual, unadjusted number of initial jobless claims was a much higher 475,954, a large increase from the prior week.
• Non-farm payroll employment fell by another 62,000 in June. This was the fifth month in a row that payrolls dropped, with about 300,000 jobs being reported as lost since February. As these statistics are revised in the future, you can be sure that the real number of jobs lost could be more than twice than figure. Average hourly wages grew a bit to $18.01 while the average workweek remained steady at 33.7 hours.
• The number of workers reported in June as unemployed held steady at 8.5 million, keeping the unemployment rate at 5.5%. The seasonally adjusted number of people who could only find part-time work rose to 5.4 million and the number of marginally attached workers rose to 1.6 million. The number of people holding multiple jobs increased to 7.69 million. My Comprehensive Labor Index™ rose to 11.26%, the highest level since the end of 2005. My CLI™ is much closer to the true unemployment number in this country.
• According to the CBO, the government posted a budget surplus of $51 billion in June, which was $23 billion more than a year ago. This surplus is mostly attributable to one-time events and timing. Normalized, the surplus would have been less than last year. The deficit of $268 billion for the first nine months of the fiscal year billion is running about $148 billion more than a year ago, and is partly attributable to tax rebates included in the the so-called economic stimulus package.
• According to the Census Bureau, the U.S. trade deficit in May was $59.8 billion, down slightly from a revised lower April figure. I continue to expect this deficit to fall due to the weak dollar.
• The Census Bureau reported that privately owned housing starts jumped 9.1% in June, after a small decrease in May, but was still down 26.9% from a year ago, to a seasonally adjusted annual rate of 1.066 million units. New building permits were also up a surprising 11.6% from last month and down 23.9% from last year. I'm not sure if the June figures represent a trend or not. We'll have to wait and see.
• The National Association of Homebuilders/Wells Fargo Confidence Index fell to a record low of 16, below the previous record low of 18 set last month. This index was created in 1985. This incredibly low confidence number belies the one month increase in housing starts and new permits.
• The Census Bureau reported that on a seasonally adjusted annualized basis, sales of new homes in May fell 2.5% from the prior month and 40.3% from the same period last year, to a projected 512 million units. That is the lowest figure in the four plus years I've been tracking new home sales. The estimate of homes for sale is now 453,000, which represents a whopping 10.9 months of supply at the current rate of sales. The median sales price fell to $231,000 and is below the 12-month moving average price of $236,817.
• The National Association of Realtors reported that on a seasonally adjusted annualized basis, sales of existing homes in May actually increased 2.0% from the prior month, but were down 15.9% from the same period last year, to a projected 4.99 million units. The estimate of homes for sale, at 4.485 million, represents 10.8 months of supply at the current rate of sales. The median sales price rose to $208,600, which remains below the falling 12-month average of $210,042.
• According to RealtyTrac, after three straight months of increases, foreclosures decreased by 3% in June to 252,363, but remained 53% higher than a year ago. Nevada, California and Arizona, respectively, continued to report the highest foreclosure rates in the country.
• The Institute for Supply Management (ISM) index of manufacturing activity was 50.2 in May, breaking a run of five out of six months in which the manufacturing sector failed to grow. The ISM index of non-manufacturing activity decreased to 48.2, suggesting that the service sector continues to struggle.
• The Conference Board reported that in June it's index of Leading Economic Indicators fell 0.1%, following a revised drop in May. Reductions in the money supply and losses in the stock market helped to pull down the indicator. The six-month rate of decline is -0.9% (or -1.7% annualized). The economy remains weak, but the weakness is moderating.
• According to the Bureau of Economic Analysis, the "final" estimate of GDP growth in the first quarter was 1.0%, up from the "preliminary estimate" of 0.9%. Remarkably, this was an improvement over the 0.6% GDP growth reported in the fourth quarter. Personally, I find that almost impossible to believe. If GDP were calculated today in the same way as twenty years ago, GDP growth would clearly be negative. I'm convinced we've been in a recession since the fourth quarter of last year and that it continues today.
• The Federal Reserve reported that in May the amount of outstanding consumer credit increased by 0.3% from the prior month, to $2,571 billion. Amazingly, the American consumer continues to borrow and spend. I maintain that this MUST stop sometime in the coming months, but I've been wrong so far.
• According to the Census Bureau, retail trade and food service sales rose a meager 0.1% in June and were 3.0% better than a year ago. That retail sales are up at all is pretty amazing, all things considered. I wonder, though, how much of that little increase was due to the tax rebate checks.
• The Fed held the supply of M-2 steady June. I honestly can't remember the last month in which the Fed did not increase the money supply. The amount of M-2 has increased by only 1.2% in the last three months and 6.1% in the last twelve months. After decreasing the rate of increase the prior two months, the Fed actually decreased the actual supply this month (it was statistically flat). What does that mean for this economy?
• Consumer confidence continues to decline. The June Conference Board Consumer Confidence Index fell to its fifth lowest figure ever. Looking ahead, consumers' economic outlook is so bleak that the Expectations Index has reached a new all-time low.

This month we've seen major reversals in some of the key trends in the market, specifically the fall of the financials and the rise in the price of oil. I have long believed that the financials are an important indicator of the health of the stock market and the economy - the canary in the coal mine if you will. So did that canary, previously thought to be dead or dying, just spring back to life? One month does not a trend make, so we'll just wait and watch. I do know the losses are not done yet. The question is are the worst of the losses behind them? Personally, I'm not fishing in this pond yet.

Like the financial sector, housing has turned up recently. But we've seen this picture many times before, as you can see below. It will take a rise above at least 160 to convince me that the housing sector has turned the corner. I think this is another in a long line of "false bottoms" for housing.

The precipitous decline in the price of oil over the past week has gotten a lot of breathless coverage by the talking heads on CNBC and others. Just as they have been looking for the "bottom" for the banks and the overall market, they've been scanning the heavens for the "top" in oil. The nearly $20 drop in the price of West Texas Crude has helped propel the market to a strong rally. I wouldn't go out an buy a new Hummer quite yet. I think this is simply a natural correction and consolidation. The series of higher highs and higher lows has not yet been violated. I wouldn't be surprised to see the price fall to the low $120's before heading back up again.

Gold continues to consolidate between $850 and $1,000 while it builds a powerful base from which I believe it will ultimately move higher. I feel confident that we'll see $1,000 per ounce again before we see $850. I'll say it again, I don't recommend that you trade gold. It's better to establish a position and simply sit with it. Part of why we own gold is for "portfolio insurance". And part is to protect us against rampant inflation and the debasement of our currency. If I'm wrong about the general upward trend of gold, it will likely mean the stock market is headed much higher, and we would be more than compensated for our "losses" in our gold positions by higher equity prices.

This month, for the first time, I'm going to include a chart showing the daily movement in the price of silver. Guess what? Here is another stealth bull market that is getting little to no mention in the press. The movement in the price of silver looks very much like the action of gold, which isn't too surprising in that they are both considered real currency, although more so for gold than silver.

Dr. Copper continues to be amazingly resilient. Should this index fall below 350 for any length of time, it would suggest that deflationary forces have gained strength around the world and that big problems could be around the corner. Until then, inflation continues to rule the day.

The modest early-June rally in the dollar increasingly looks like a distant memory. The dollar has again rolled over and fallen in the face of weak economic data, mixed corporate earnings and the realization that the Federal Reserve simply cannot raise interest rates. While I believe the Fed must eventually raise rates to curtail inflation, doing so now would send this economy into a deep recession, or possibly a depression. So for now, we'll continue to live with a weak dollar.

I present the following chart of the MSCI EAFE index to remind you that we are not alone in the losses suffered by our stock market. The markets of the rest of the world, in the aggregate, are doing equally poorly. As I said last month, the world markets are becoming more and more correlated, which makes it increasingly difficult for investors to find uncorrelated assets in which to invest.

If you want to feel even better, look at the Shanghai Index, which I use as a proxy for China. Here we have a drop of almost 60%. Over a year and a half of gains have been erased. And look what happened in Pakistan recently, where investors rioted at their stock exchange after incurring massive losses. It isn't easy anywhere these days my friends.

What I'm Thinking and Doing

Personal News and Notes

Greg Werlinich
President