Werlinich Asset Management, LLC

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April 16, 2013

Minor Bump or Beginning of Correction?

Current Market Analysis
Last Month's Results
Statistics to Watch
Trends To Watch
What I'm Thinking and Doing
Professional News and Notes

Current Market Analysis

As I write this a couple of hours after the market opened for trading, the Dow Jones Industrial Average stands at 14,700, up 189 points, or 1.3%, from when I wrote to you last month, and up 12.2% from the year-end closing price of 13,104. It is also the day after the horrific events at the Boston Marathon. So before I go any further I want to send out my heartfelt condolences to the families touched by this tragedy. I hope that Boston can heal quickly and that we quickly determine and punish the perpetrators.

As for the market, we seem to have reached a dangerous time. After leading the market higher for most of last year, the Dow Jones Transportation Average appears to be breaking down (see below) while the Industrials continued higher. This divergence between the Transports and the Industrials is disturbing, and could portend a big decline coming up. Concurrently, we are about to reach the "sell in May and go away" time of the year, which is an historically weak period. Ominously, there were market corrections in the summers of 2010, 2011 and 2012. The summer of 2013 is just around the corner. That should give one pause. On the plus side, we still have the highly accommodative central bankers around the world flooding the global markets with liquidity. These inflationary actions continue to prop up stock markets around the world, except for China (more below).

Last month I wrote that "given the accommodative Federal Reserve (as well as most central banks around the globe) I expect the rally to continue, at least for another month or so. Come summer, we may see our next correction." It turns out the rally continued until yesterday when the market tanked. Only time will tell if that was a simply a minor bump in the rally or the beginning of a larger correction. Looking at the chart below, the DJIA is still way above the blue trendline and both moving averages, so for now, things are ok.

The Dow Jones Transportation Average, on the other hand, does not look good. The more than 6% decline has left the index below its 50-day moving average and the trendline, and RSI is approaching oversold levels. The next support level looks to be around 5,800. If that level is breached, it could be a long way down.

Until the broad sell off yesterday, the Dow Jones Utility Average had been an upward projectile for almost five months. Earlier this month the index pushed through resistance around 500 and soared to new record levels. As with the other averages, only time will tell if yesterday is a blip or the beginning of something serious.

After rising steadily for almost seven months, contravening every effort by the Federal Reserve to keep rates down, the yield on the 10-year Treasury has once again dropped into the "safe" trading zone as investors are once again fleeing to the safety of treasuries. If the correction comes, we could see rates seek the support levels around 1.4%. On the other hand, if this is simply a two or three day event, they will probably move up again toward resistance around 1.9% and higher.

Last Month's Results

The stock market had a great year in the first quarter, with double digit returns across most of the broad indices. The bond market, not surprisingly, has been a disappointment. And recent activity notwithstanding, I expect the full year results to be more of the same. The excellent results for equity in March followed the equally solid gains in January and February. And the market managed to continue higher so far this month, until yesterday. As I write this, the market has recovered about half of yesterdays losses so far. The tech-heavy NASDAQ continues to be a conspicuous laggard, enabling the Dow to continue to outpace the S&P.

Name of Index





S&P 500




Large-cap stocks

Dow Jones Industrial Average




Large-cap stocks

NASDAQ Composite




Large-cap tech stocks

Russell 1000 Growth




Large-cap growth stocks

Russell 1000 Value




Large-cap value stocks

Russell 2000 Growth




Small-cap growth stocks

Russell 2000 Value




Small-cap value stocks





Europe, Australia, Far East

Barclays Aggregate




US government bonds

Barclays High Yield




High-yield corporate bonds

* Return numbers include the reinvestment of dividends

Statistics To Watch

  • According to the Department of Labor, the figure for seasonally-adjusted initial jobless claims for the week ended April 6 was 346,000, an decrease of 42,000 from the prior week's revised figure. The four-week average of 358,000 is about 18,000 higher than the prior month's tally. According to the seasonal average, about 3.1 million people continue to collect unemployment insurance, which is roughly similar to the figure from a month ago. 
  • Non-farm payroll employment in March was a huge disappointment. The establishment survey reported that a paltry 88,000 jobs were added in the month, a staggering drop of 180,000 from February, and less than the 12-month average of 169,000, while the household survey said that the unemployment rate fell to 7.6%. Jobs losses in retail and government work hurt the numbers. Revisions to January added 29,000 jobs while February added another 32,000. The total number of workers counted as unemployed fell to 11.7 million and the labor force participation rate dipped to 63.3%. The more comprehensive U-6 "underemployment" rate dropped to 13.8%. Normally most of these numbers would be good, but it's disturbing that the labor participation rate keeps falling. 
  • A lower 4.6 million people continued to be unemployed longer than 27 weeks. The seasonally adjusted number of people who could only find part-time work fell to 7.6 million and the number of marginally attached workers fell to 2.4 million. The number of people holding multiple jobs inched lower to 7.2 million. The average hourly wages for blue collar workers slipped to $20.03 while the average work week held at 33.8 hours. Overall, the job increases are terrible, and well below estimates. Yet the prior month revisions were strong, suggesting that these numbers could be revised higher in subsequent months. 
  • The Congressional Budget Office (CBO) estimated that on a net present value basis, the Treasury reported a federal budget deficit of $107 billion in March, and $600 billion for the first half of the fiscal year, which is $178 billion less than the record figure reported for the same period of fiscal 2012. The CBO anticipates a full year deficit of $845 billion, assuming no new tax legislation, or about $240 billion less than last year. 
  • The Census Bureau reported that the U.S. trade deficit of goods and services was $43.0 billion in February, down about $1.5 billion from January. For the most part, the trade deficit is at a manageable level.
  • The Census Bureau reported that privately owned housing starts inched up 0.8% in February, still far below the five year high set in December. Housing starts are now 27.7% higher than a year ago, to a seasonally adjusted annual rate of 917,000 units. New building permits rose 4.6% from the prior month, and were 33.8% higher than the year before, to easily the highest level in more than a year. The recovery in the housing market continues.
  • The National Association of Homebuilders/Wells Fargo Confidence Index dropped for the third straight month in April, to 42. This falling indicator contrasts with the growing health of the housing market and remains below a healthy figure of around 50 or above. Builders are faced with increasing costs for labor and building materials as well as a decreasing supply of developed lots.
  • The Census Bureau reported that on a seasonally adjusted annualized basis, 411,000 new homes were sold in February, a 4.6% drop after a huge increase in January, yet still 12.3% higher than a year ago. The estimate of number of homes for sale was 152,000, which represents a tiny 4.4 months of inventory at the current rate of sales. The median sales price increased to $246,800, which is just above the rising 12-month moving average price of $244,325. For the past year average sales prices have remained between $240,000 and $255,000. Still, the overall trend remains positive as a tight market augurs well for future price increases and the spring selling season should continue to reduce the inventory of foreclosures and short-sales.
  • The National Association of Realtors reported that on a seasonally adjusted annualized basis, sales of existing homes inched higher in February, at 4.98 million units, but remained 10.2% higher than a year ago. The estimate of homes for sale jumped to 1.94 million as the more robust market spurred more homeowners to put their homes up for sale. The median sales price rose slightly to $173,600, which is slightly below the rising 12-month average of $178,275. As with new homes, the existing home market is likely to pop in the spring.
  • The S&P/Case-Shiller Home Price 10-city index, which uses a three-month moving average to track the value of home prices across the US, inched slightly higher in January. The composite posted a 7.3% increase for the trailing twelve-month period. The composite posted the largest year-over-year monthly increase since 2006.  
  • The Institute for Supply Management (ISM) index of manufacturing activity suggests that the economy has been growing for four straight months, albeit at a lower rate, as the index declined to 51.3 in March. In addition, the ISM index of non-manufacturing activity was 54.4, which marked growth in the service sector for 39 consecutive months.But like manufacturing, growth in the service sector also slowed in the month. If this lasts more than a couple of months it will be very worrisome.
  • The Conference Board reported that it's index of Leading Economic Indicators increased by 0.5% in February following a modest 0.2% gain in January. Says Ataman Ozyildirim, economist at The Conference Board: "This month's increase in the U.S. LEI - the third consecutive - was widespread and driven by a majority of its components. Even though consumer expectations and manufacturing new orders remain weak, the economy continues to expand slowly, and may be developing some resilience against headwinds from, for example, federal spending cuts due to improving residential construction and labor market conditions." Says Ken Goldstein, economist at The Conference Board: "The U.S. economy is growing slowly now, and with this reading increases hope that it may pick up some momentum in the second half of the year. However, this latest report does not yet capture the recent effects of sequestration, which could dampen the pickup in GDP."
  • According to the Bureau of Economic Analysis, the "third" (and final) estimate of GDP growth for Q4 2012 showed an anemic growth of 0.4%, which thankfully was a little better than the second estimate of 0.1%. For comparison, growth was 3.1% in Q3, 1.3% in Q2 and 2.0% in Q1. It is also far worse than the 3.0% growth recorded in Q4 2011. Thanks to sequestration, there's little hope for much improvement in Q1 2013.
  • The Federal Reserve reported in that in February the amount of outstanding consumer credit was $2.80 trillion, up from the prior month and growing at a 7.75% annualized rate. Consumer credit grew for the seventh consecutive month. But when will it begin to really make a positive impact on the economy?
  • According to the Census Bureau, retail trade and food service sales actually fell 0.4% in March after posting solid gains in February, yet remained 2.8% higher than a year ago. Furniture stores, miscellaneous retailers and restaurants were the only bright spots in an otherwise dismal report.
  • The Conference Board's Consumer Confidence Index fell in March, eradicating almost all of the big gains from February, falling to 59.7 from 68.0. Says Lynn Franco, Director of The Conference Board Consumer Research Center "The recent sequester has created uncertainty regarding the economic outlook and as a result, consumers are less confident."
  • According to the FDIC, only 1 bank failed in March, bringing the total for the year to 4, versus 16 through the same month last year. I would be surprised if more than 20 banks go under this year.

Trends To Watch

Last month the dollar index broke out of the tight range between 78.5 and 81.75 (the two dotted red lines) and headed towards resistance around 84, but it didn't make it. Notwithstanding a little short-term weakness, the dollar remains a "safe" currency in the face of global uncertainty, no matter how hard the Fed tries to kill it. As the Bank of Japan, and other countries, work to devalue their currencies, the dollar should hold strong. That has negative implications for the commodities markets in the short-term.

The trading in gold this year has been an unmitigated disaster for gold bulls like me. Yesterday we suffered through the largest one day sell off in over 30 years as a myriad of circumstances converged to hammer the precious metals market. Resistance around $1,520 was swiftly breached during the plunge. The only good news is that the price is now extremely oversold and due for a rally.

Looked at through a longer-term lens, we can see that the next major support level is around $1,227 so there is a lot further that gold could drop. Yet given that all the reasons why gold increased in the first place still exist, I'm not throwing in the towel just yet. The severity of the current decline is not without recent precedent. There was a 22.6% correction from peak to trough in 2006, and a 29.5% correction in 2008. The price of gold has now dropped 22.1% since the peak in late 2011. So while the twelve year bull run in the price of gold has certainly stalled, I don't think the final chapter has been written just yet.

The chart for silver is equally grisly for those of us with long positions. During the recent two day carnage the price plunged below support around $26. Also like gold, silver is wildly oversold and due for a bounce.

The chart for copper paints an ominous picture. If in fact the price of copper has predictive powers for the economy and the stock market, we are headed for trouble. Support at $3.30 has held three times in the past year. Yesterday that level was breached. Should it quickly turn around and head north it won't really matter. Should the price move even lower, I think it would have dire implications for the future.

The price of West Texas crude is suffering with the rest of the commodities. The good news is that while it is currently trading below the midpoint of the trading range (dotted green line), it remains above interim support around 84. The bad news is that it's below both moving averages. I think if the current panic subsides we should see the price rise back up above 90.

The financial index has escaped the recent turmoil virtually unscathed as it continues to move onward and upward to new highs. The current price remains well above the trendline and both moving averages. Q1 earnings reports have been pretty good so far, although there has been some compression in net interest margins as the artificially low rates hurts their lending spreads. Still, this sector continues to outperform.

The housing index also remains basically bullish, although it does appear to be taking a breather right now. After peaking at 196, the index has backed off a bit and fallen back to the trendline. The first support level appears around 174. We'll have to keep an eye on this, although I think this is just a temporary setback, and that the housing market is likely to move higher through the spring and summer. 

The index for the developed international markets also seems unaffected by any unease and is headed straight towards resistance at 62, a high achieved almost two years ago. While the current price is above both moving averages, RSI is heading towards oversold levels. Still, the chart looks bullish.

China is once again the fly in the ointment. After failing to pierce resistance at around 2,475, the index has tanked over the past month and headed lower. Not surprisingly, this weakness has put a lot of pressure on copper and other base metals. The next resistance is around 2,135, but let's hope the Chinese market recovers before it gets that low. If China doesn't grow, the rest of the world stagnates.

Interestingly, the NYSE Bullish sentiment index is more bullish than one might have expected, even though it's fallen a bit recently and RSI has plunged. I wrote last month that "history shows that when bullish sentiment gets this high, a correction isn't far behind." This may be the beginning, or it may just be a hiccup.

Next we see that less than 50% of stocks traded on the New York Stock Exchange are currently trading above their 50-day moving average, down from almost 90% three months ago. As a contrary indicator, this is good as it shows that some of the froth has been taken out of the market. Should the market move higher we'll see this indicator move higher with it.

Finally, the VIX, or the "fear index", shows the effects of the last two days of trading as the index has spiked from 12 to almost 18. Last month I wrote that "it [wouldn't] take much to see the index jump as I suspect traders have a short fuse right now." That proved to be very true. Now we'll see what the next few days bring.

What I'm Thinking and Doing

I have been nervous, or cautiously optimistic, for a number of months now as the rally drove the market higher and higher in spite of every problem providing headwinds to the global economy. And like many of you, I had simply been enjoying the rally and rooting for it to continue ever higher, all the while knowing that it must come to an end sooner or later. To that point, I wrote last month that "while the market appears "reasonably priced" and the Fed remains highly accommodative, it wouldn't take much to turn things negative. The fragile economies of Europe could quickly turn down, possibly led by the solvency crisis in Cyprus. I'm also concerned about what's really going on in China and why their market is doing poorly while much of the rest of the world is soaring." I'm going to go out on a limb here and say I think we'll have one last push higher, maybe even above 15,000 on the Dow before the real correction comes. Q1 corporate earnings appear good enough, tax refunds are coming in and there are no really big problems on the immediate horizon. The lunkheads in Washington D.C. appear to be truly interested in working on a budget deal, which would be a good thing. But again, it wouldn't take much to tip the entire market on its head and move lower, so be vigilant.

So where does all of that leave me and my investors? I started raising some cash for clients last month and plan to continue doing so over the next month or so, depending on the overall health of the market. I much prefer to sell into a rising market whenever possible. I have been reducing my long-held commodity exposure just a bit. Honestly, I wish I has trimmed my precious metals position but that's water under the bridge now. I still believe in the long-term thesis of owning gold, although it has certainly been painful over the past few months. I've maintained my holdings in gold since 2001 and I plan on holding on until the fundamentals change.

Professional News and Notes

The introduction of my new website did not go as smoothly as I would have liked. I was forced to migrate to a different server due to problems with new one. I'm pleased to report that everything is now up and running properly and all the major kinks have been worked out. Over the next few weeks I will continue to tweak the site and add more content. Overall, I'm very happy with the new look and feel and I welcome your feedback. So please take a moment and visit the site by clicking here then let me know what you think.

The same problems that affected the website itself sabotaged the publication of my newsletter last month. For those of you who didn't receive it, and would still like to read it, simply view the newsletter section of my website and click through the archives. Every newsletter I've ever written is stored there and can be viewed at any time.

For the past year I have been a member of an excellent local networking group called the Rising Tides Alliance. The mission of this group of business owners and entrepreneurs is to create a comfortable networking environment whereby like-minded professionals can do business with people they know and like. We are actively seeking to increase our membership this year. If you are interested in meeting some new business professionals in a unique setting, please let me know. You can look for information about the group on Facebook, LinkedIn and Twitter.

As always, I thank you, my readers, and remind you that this newsletter is for you. I have been writing News and Views for over nine years now. If you'd like to read any prior edition, simply go to my website and click on the link to my newsletter archives. I hope you have learned something about our economy and our stock market, and that you will continue to follow along with me in the future. If you have any thoughts or suggestions on how to make it better, please let me know. And if you'd like to speak with me about your investment needs, or if you know someone that might benefit from my guidance, I'd be pleased to be of service. Simply give me a call or drop me an email.

Best regards,

Greg Werlinich

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