Werlinich Asset Management, LLC

LinkedIn      Facebook      Twitter      Blog

July 18, 2013

The Bernanke Correction (and Recovery)

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

Current Market Analysis

As I write this the Dow Jones Industrial Average stands at 15,548, a new all time high and up 369 points, or 2.4%, from when I wrote to you last month, and up a remarkable 18.6% from the 2012 year-end closing price of 13,104. As importantly, The Dow Jones Industrial Average today also closed at a new all time high. Therefore, with the two averages hitting new highs together, according to Dow Theory, the market is solidly bullish. And given that this wonderful confluence is happening during the normally weak summer season, I think the action is especially constructive. Barring any unforeseen global histrionics, we should anticipate a solid second half of the year.

Preceding this recent rally the market dipped in early June, following comments by Fed Chairman Ben Bernanke that the central bank may be preparing to "taper" their QE stimulus programs as the economy recovers. Immediately after these comments the markets quickly cratered and interest rates soared. As a result, Bernanke quickly back tracked, saying the tapering wasn't imminent, and would require a more robust economy before taking place. That was all the market needed to hear in order to power higher. The "correction" that I was waiting for was therefore brief and painless. In fact, it was so quick that if you blinked, you missed it. So this year, "sell in May and go away" was a complete failure.

Below you can see the "Bernanke" correction pause, but not stop, the incredible bull run we've been enjoying for the last eight months. The current price is well above the trendline and both moving averages. Every price correction has happened at higher prices than the prior one, which is very good. RSI has not yet reached oversold levels. All in all, everything looks positive.

As I mentioned earlier, the Dow Jones Transportation Average has just set a new all time high after quickly recovering from the June correction. The current price is well above both moving averages and support around 6,000. There is nothing worrisome at all in this chart.

The recovery in the Dow Jones Utility Average continued over the past month. The index has now drawn a clear inverse "head and shoulders" pattern. It would seem I made a timely call last month when I said that "I think investors have been presented with another chance to buy into higher yielding utility stocks after a significant pull back of about 11.5% (which grew to about 14%)." Importantly, the current price has moved above both moving averages. It's a little worrisome that the gains have come on weak volume. If Treasury yields stabilize below 2.5% I think the utility sector will be just fine.

This is the chart that has rocked the investment world over the past month or so. As you can see, the yield on the 10-year Treasury burst out of its trading channel and jumped over an important resistance level around 2.1%. As the yield traded as high as 2.7% bond investors began to suffer significant losses. Fortunately, the panic has cooled a bit and rates have moved back to 2.5%. Still, this has powerful consequences for everyone, not just fixed income investors, not the least of which is the mortgage market. For months I've been warning everyone that this day would come and to take the proper steps to protect yourself. I hope you lightened your bond holdings before the carnage began. And don't be fooled by the little recovery we're enjoying right now, even higher rates are coming.

Last Month's Results

After five straight monthly advances, the market took a little breather in June. All the major domestic averages produced double digit gains. The only laggard is the EAFE, which eked out only a modest gain as foreign markets have struggled this year. The big disappointment was clearly the bond market as sharply higher rates in June led to quick, and to many complacent investors, surprising losses. The lesson to be learned is that you can, in fact, lose money while investing in "riskless" government bonds. That trade is unlikely to improve much over the next few years.

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 July 6 was 360,000, an increase of 16,000 from the prior week's revised figure. The four-week average of 351,750 is about 6,000 higher than the tally from a month ago. The four week average has remained relatively stable for most of the year. According to the seasonal average, about 3.0 million people continue to collect unemployment insurance, which is roughly the same as the prior month. Overall, this picture remains modestly positive but not getting appreciably better.
  • The non-farm payroll employment report in June once again met, but did not exceed, expectations. The establishment survey reported that a solid 195,000 jobs were added in the month, while the figures for April and May were both revised higher, adding an extra 70,000 new jobs. The household survey reported that the unemployment rate remained essentially unchanged at 7.6%. The 11.8 million workers counted as unemployed was the same as last month. The labor force participation rate ticked up to 63.5%.
  • The more comprehensive U-6 "underemployment" rate jumped from 13.8% to 14.3%. While 4.3 million people continued to be unemployed longer than 27 weeks (down from the prior month), the seasonally adjusted number of people who could only find part-time work increased to 8.2 million and the number of marginally attached workers jumped to 2.6 million. That isn't very good. The number of people holding multiple jobs fell to 7.0 million. The average hourly wages for blue collar workers inched higher to $20.14 while the average work week held steady at 33.8 hours. Overall, the picture seems to be two steps forward with one step back.
  • The Congressional Budget Office (CBO) estimated that on a net present value basis, the Treasury reported a federal budget surplus of $115 billion in June, an improvement of $174 billion over the same month last year. That leaves a deficit of $512 billion for the first nine months of fiscal 2013, almost $400 billion less than the record figure reported for the same period of fiscal 2012. This is due to significantly increased tax revenues and a decline in government spending.
  • The Census Bureau reported that the U.S. trade deficit of goods and services was $45.0 billion in May, the second monthly increase in a row as imports increased but exports remained flat.
  • The National Association of Homebuilders/Wells Fargo Confidence Index had another big increase in July, rising 52 to 57. This is the strongest reading since January 2006 and suggests growing optimism.
  • The Census Bureau reported that privately owned housing starts declined 9.9% in June to a seasonally adjusted annual rate of 914,000 units, after gaining 9% in May, leaving them 10.4% higher than a year ago. New building permits also dropped 7.5% from the prior month yet remained 16.1% higher than the year before.
  • The Census Bureau reported that on a seasonally adjusted annualized basis, 476,000 new homes were sold in May, a 2.1% increase from an upwardly revised April, and still 29% higher than a year ago. The estimate of number of homes for sale was an ever growing 161,000, which represents a tiny 4.1 months of inventory at the current rate of sales. The median sales price dropped to $263,900, which remains above the rising 12-month moving average price of $253,033. I'm not concerned about the small decrease in sales prices; as more homes hit the market, prices should fall a bit.
  • The National Association of Realtors reported that on a seasonally adjusted annualized basis, 5.18 million existing homes were sold in May, an increase of 4.2% over April and 12.9% higher than a year ago. The estimate of homes for sale increased to 2.2 million, about 500,000 more than just four months earlier, as rising prices and higher mortgage rates likely spurred more homeowners to quickly put their homes up for sale. The median sales price jumped to $208,000, $16,000 higher than the prior month, and far above the rising 12-month average of $198,675. This is all very good news.
  • According to the Institute for Supply Management (ISM), economic activity in the manufacturing sector expanded in June after a one month contraction, as the index increased to 50.9. On the other hand, the ISM index of non-manufacturing activity was 52.2, which marked growth in the service sector for 42 consecutive months. The problem is that growth seems to be slowing as this is the lowest figure since last June. These figures do not inspire confidence in our economy.
  • The Conference Board reported that it's index of Leading Economic Indicators increased by only 0.1% in May following a robust 0.8% increase in April. Says Ataman Ozyildirim, economist at The Conference Board: "Despite month-to-month volatility, the LEI's six-month growth rate remains steady, suggesting that conditions in the economy remain resilient. Widespread gains in the leading indicators over the last six months suggest there is some upside potential for economic activity in the second half of the year." Says Ken Goldstein, economist at The Conference Board: "Growth will depend on continued improvement in the housing market and an easing of consumer and business caution which would allow overall consumption and investment to gain traction. Cutbacks in public spending programs and the drag from foreign trade remain headwinds."
  • According to the Bureau of Economic Analysis, the "third" estimate of GDP growth for Q1 2013 was only 1.8%, a further decrease from the advance estimate of 2.5% and the second estimate of 2.4%. The trend is not good, but still a marked improvement over the anemic growth of 0.4% in Q4 2012. For comparison, growth was 3.1% in Q3, 1.3% in Q2 and 2.0% in Q1. This tepid growth isn't likely to stir the Fed to reduce their policy of monetary expansion in the near future.
  • The Federal Reserve reported in that in May the amount of total outstanding consumer credit continued to grow, reaching $2.84 trillion, up from the prior month and growing at a frightening 8% annualized rate. This is the highest figure I've noted since I first started reporting this statistic in 2007. This could lead to problems should the economy turn south again.
  • The Conference Board's Consumer Confidence Index surged again in June to 81.4 from 74.3 in May. Says Lynn Franco, Director of The Conference Board Consumer Research Center "Consumer Confidence increased for the third consecutive month and is now at its highest level since January 2008 (Index 87.3). Consumers are considerably more positive about current business and labor market conditions than they were at the beginning of the year. Expectations have also improved considerably over the past several months, suggesting that the pace of growth is unlikely to slow in the short-term, and may even moderately pick up." This is the likely explanation for the increase in consumer credit.
  • According to the FDIC, only 2 banks failed in June, bringing the total for the year to 16, versus 31 through the first half of last year. I'd be surprised if more than 25 banks go under this year.

Trends To Watch

The dollar index failed for a third time to pierce and remain above resistance just north of 84 and it has fallen back towards the primary trading zone (marked by the red dotted lines). Still, the greenback remains on the high end of the trading range and retains its status as a "safe" and desired currency as central bankers around the world fight to the death to devalue their currencies. Should the Fed follow through on its intention to eventually taper off the Quantitative Easing, the dollar will likely gain even more strength.

Could the floor have finally been made? I've been wrong so many times over the past year or so as I've tried to call the bottom in the bear market for gold that I hesitate to stand back out on that limb. Just last month I suggested that "a floor around $1,340 may have been set. Twice [it] held." Well, that was wrong, big time (thanks Ben). So I'm not going to call the bottom just yet. But I did pick up a few shares of one of the leading gold miners are dirt cheap prices. Just saying. A rise above $1,300/oz, followed by a move back above $1,350 would make me much happier.

Unlike many other commodities, which are stagnating, the price of West Texas crude is on fire. It has surged out of the primary trading range (dotted green line) and is headed toward major resistance at $110. Last month I suggested that "with RSI and MACD both gaining strength maybe it'll break through [interim resistance at $100] this time." It certainly did that. Now RSI is overbought and MACD is a bit on the high side. It's probably time for a breather.

The bull market in the financial sectors continues as the index remains above the rising trendline and both moving averages and has powered to another new high. Last month I wrote about a little pullback and posited that "this could provide a buying opportunity for investors looking for an entry point into this rising sector." I hope you took the advice. I did.

The action in the housing sector over the past two months is a little puzzling. While home prices have increased, builder optimism has soared and general sentiment has improved the sector has turned down. The decline from mid-May to the end of June brought the index below the rising trendline as well as the 50-day moving average. Fortunately, it remained above the slower moving 200-day average. While some gains have been made recently, one has to ask is this simply a profit-taking pause, or is there a bigger issue here? Should investors be concerned or was this simply a buying opportunity? Last month I said that "the overall trend remains bullish so this too could be a possible entry point for investors. If the past is any prelude, and given my expectation of a strong summer selling season, I would expect this sector to move higher over the next few months." So far, so good.

After moving almost straight up for the past year, the index for the developed international markets appears to be in a solid consolidation range right now between 56 and 64. The current price is right on the 50-day average, but still above the 200-day. Things are a bit unsettled right now through much of Europe, not to mention the Middle East, so I wouldn't expect this to change any time soon.

The Shanghai index, a proxy for the Chinese economy, continues to be the ugly stepchild of the global stock markets. After showing some much needed life in May the index plunged again in June to again test major support at 1,950. The good news is that support held and the index has bounced a bit higher in July. The question is whether this is a "dead cat bounce" or something more positive. Until proven otherwise, I would stay away from China, and by extension, underweight commodities.

The NYSE Bullish sentiment index is bullish right now, but not overly so, which is good. It's been eight months and counting since the index has fallen below 60, which has nicely tracked the gains in the broad stock market. This chart suggests to me that the current rally has more room to run.

Next we see that about 65% of stocks traded on the New York Stock Exchange are currently trading above their 50-day moving average, up from 22% only a few weeks ago (after the Bernanke Correction). This is only a modestly bullish number, so again, I think the market can rise even higher from here.

Finally, as you can see, the VIX, or the "fear index", has been a roller coaster this year. Yet for all the volatility, there have been no spikes into "fear" territory. So in the big picture, this is normal and doesn't concern me. Indeed, a little less complacency is a good thing and helps make the market more interesting.

What I'm Thinking and Doing

Last month I wrote that "everyone is on Fed watch right now" and that holds just as true today. What will Ben do and when will he do it? Market watchers are parsing everything the Fed Chairman says, or doesn't say, looking for clues as to when and how the central bank will begin to taper off their QE. Obviously, this has massive implications for the stock and bond markets. It wasn't pretty last month when he simply intimated that he may begin a modest taper of the $85 billion a month in mortgage bonds.  Investors need to just relax. The world won't be coming to an end when he does start the process. Our economy can handle 3% - 4% interest rates. That's still pretty low by historical standards. I think the sooner we begin to normalize interest rates, the better it will be for everyone, especially savers.

I had an unusually busy first half of the year as I eliminated more than two dozens positions in a continuation of the purge that I began in the fourth quarter of last year. I have dramatically cut back on my commodity holdings and many of my foreign energy companies. I've eliminated laggards and small positions in a renewed effort to focus on my core holdings and position the portfolios to benefit from the growing sectors of the market. In addition to raising cash, I've added to my positions in housing, pharmaceuticals, finance and consumer staples. I'm emphasizing strong companies with excellent competitive positions that pay above average dividends. In the 401k accounts that I manage for select clients I've done a lot of rebalancing, reducing bond and international exposure while increasing the allocation to domestic equity because that's likely where the greatest growth will come from through the rest of the year.

News and Notes

On a personal note, my oldest daughter Nola returns tomorrow from a two week Baltic cruise with her Grandmother. Then one month later she's off to college. Yikes!! My middle daughter Lily returns on Sunday from a three week trip to southern Africa. I bet she can't wait for a long, hot shower. It'll be great having both girls home. Tomorrow I visit Ezra at camp, where he's been for the past month, playing lots of tennis. About a week later, he returns home. It's disturbing how quickly the summer is flying by.

Next month I'm hosting my networking group, the Rising Tides Alliance, for an end of summer backyard pool party. This is a wonderful group of local professionals who have joined together to build friendships and develop business connections. If you'd like more information, or if you'd like to join us for the afternoon, please let me know. There will be great music, plenty food and drinks, and lots of laughs. I hope to see some of you here.

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

Paladin Registry                WiserAdvisor                Brightscope

"News and Views", Copyright, Werlinich Asset Management, LLC and All Rights Reserved.