NEWS AND VIEWS
Werlinich Asset Management, LLC
914-481-5888
greg@waminvest.com
www.waminvest.com

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August 20, 2013

 
Crossroads

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 15,010, down 538 points, or 3.5%, from when I wrote to you last month, but still up a solid 14.5% from the 2012 year-end closing price of 13,104. The day I wrote to you last month the DJIA also had reached a new all time high. It subsequently moved even higher, reaching its apex of 15,658.36 on August 2. Since then, it's been almost straight downhill on worries about fighting in the Middle East (again), concerns about our fragile economy and questions about when the Federal Reserve will begin "The Taper". It's like Groundhog Day all over again. And again. And again.

So what should we make of this latest pullback? Is it simply a normal, and healthy, correction in an ongoing bull market or does it presage a greater danger on the horizon? We'll use the following charts and economic analysis to try to divine the answers. My feeling is that it's the former, and that by Labor Day the markets will have turned around and headed north.

Below is the chart of the Dow Jones Industrial Average. As you can clearly see, it's been quite a bull run since the last correction ended last November. You'll notice that trading volume peaked on the day the index hit bottom towards the end of June. Then the market again headed higher on increasingly lower volume (blue line). This is a normal summer slowdown. After Labor Day we should see trading volume return to more normal levels, which will help to smooth out volatility. The current price is just below the 50-day moving average, but well above the 200-day. It's also right on the rising trendline (the upward trending blue line). RSI is somewhat oversold and due for a bounce. I'd expect a recovery shortly. 

The Dow Jones Transportation Average hit its high of 6,670 on August 1st. Since then its tracked back to its 50-day moving average, but also remains well above the 200-day average. Major support comes in just above 6,000. As of today, this chart still looks ok.


The Dow Jones Utility Average has quickly headed south this month. Rising interest rates have clearly hurt utility stocks. The peak around May 1 clearly overlaps the bottom in interest rates (see the next chart). Since then, rates have risen and utilities have suffered. The index has fallen to support (blue line) around 475. The next support (red line) comes at 465. Watch interest rates; if they stabilize we could have a buying opportunity. Until then, be wary.


This could be the most important chart in the market right now. As you can see, the yield on the 10-year Treasury burst out of its trading channel last month and burst through an important resistance level around 2.1%. It is now headed towards 3%, a yield not achieved since August 2011. This jump in yield (which is the inverse of price) has caused significant losses for bond investors and has had a big impact on the mortgage industry. 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 you bond holdings before the carnage began. It's not too late; if you are long fixed income instruments, you should seriously consider making some changes.


Last Month's Results

After a little pause in June, the market roared back to life in July with strong gains across the board. All the major domestic averages have produced 20% or better gains for the year. Even the struggling EAFE has managed to eke out a 10% gain which is a great result in any book considering all the problems in Europe. The bond market continues to struggle. Expect the losses to build in the second half of the year as rates continue to rise. As I've said many times, the lesson to be learned is that you can, in fact, lose money while investing in "riskless" government bonds.

Name of Index

Jul

QTD

YTD

Description

S&P 500

5.1

5.1

19.6

Large-cap stocks

Dow Jones Industrial Average

4.1

4.1

19.9

Large-cap stocks

NASDAQ Composite

6.6

6.6

20.9

Large-cap tech stocks

Russell 1000 Growth

5.3

5.3

17.7

Large-cap growth stocks

Russell 1000 Value

5.4

5.4

22.2

Large-cap value stocks

Russell 2000 Growth

7.6

7.6

26.3

Small-cap growth stocks

Russell 2000 Value

6.4

6.4

21.7

Small-cap value stocks

MSCI EAFE

5.3

5.3

10.0

Europe, Australia, Far East

Barclays Aggregate

0.1

0.1

-2.3

US government bonds

Barclays High Yield

1.9

1.9

3.3

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 August 9 was 320,000, a decrease of 15,000 from the prior week's revised figure. The four-week average of 332,000 is about 20,000 higher than the tally from a month ago. The four week average has decreased by 42,000 since the beginning 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 has gotten a bit better, stoking fears that the Fed may begin to remove the stimulus as early as September.
  • The non-farm payroll employment report in July was a disappointment. The establishment survey reported that a meager 162,000 jobs were added in the month, while the figures for May and June were both revised lower, subtracting 26,000 jobs. The household survey reported that the unemployment rate fell to 7.4%. The 11.5 million workers counted as unemployed was fewer than last month while the labor force participation rate dipped lower to 63.4%.
  • The more comprehensive U-6 "underemployment" rate fell from 14.3% to 14.0%. While a slightly smaller 4.2 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 remained at 8.2 million and the number of marginally attached workers fell to 2.4 million. Those numbers are a bit better. The number of people holding multiple jobs fell to 6.9 million. The average hourly wages for blue collar workers remained at $20.14 while the average work week was a slightly shorter 33.6 hours. Overall, the picture continues to be muddled at best.
  • The Congressional Budget Office (CBO) estimated that on a net present value basis, the Treasury reported a federal budget deficit of $96 billion in July, a little worse than the same period last year, but that's mostly because of quirks in the calendar. That leaves a deficit of $608 billion for the first ten months of fiscal 2013, almost $370 billion less than the record figure reported for the same period of fiscal 2012.
  • The Census Bureau reported that the U.S. trade deficit of goods and services was $34.2 billion in June, the smallest monthly deficit since October 2009. US manufacturing is on a rebound, led by the petroleum industry.
  • The National Association of Homebuilders/Wells Fargo Confidence Index increased for the fourth straight month in August, rising to 59. This is the highest level in almost eight years as minimal inventory is driving more business to the builders. 
  • The Census Bureau reported that privately owned housing starts increased 5.9% in July to a seasonally adjusted annual rate of 896,000 units, leaving them 20.9% higher than a year ago. New building permits rose 2.7% from the prior month and remained 12.4% higher than the year before.
  • The Census Bureau reported that on a seasonally adjusted annualized basis, 497,000 new homes were sold in June, an 8.3% increase from May, and a whopping 38.1% higher than a year ago. The estimate of number of homes for sale remained at 161,000, which represents a minuscule 3.9 months of inventory at the current rate of sales. The median sales price dropped to $249,700, which fell below the 12-month moving average price of $255,367. That's two months in a row of falling prices. Another month and I'll start to get worried.
  • The National Association of Realtors reported that on a seasonally adjusted annualized basis, 5.08 million existing homes were sold in June, a decrease of 1.2% over May but still 15.2% higher than a year ago. The estimate of homes for sale held steady at about 2.2 million as rising prices and higher mortgage rates have spurred more homeowners to put their homes up for sale over the past few months. The median sales price increased to $214,200, about $9,000 higher than the prior month, and far above the rising 12-month average of $201,092. The picture in existing homes seems to better than in new homes.
  • According to the Institute for Supply Management (ISM), economic activity in the manufacturing sector expanded in July for the second straight month as the index increased to 55.4, the highest reading of the year. On the other hand, the ISM index of non-manufacturing activity was 56.0, which marked growth in the service sector for 43 consecutive months. We'll see if the growth continues in August.
  • The Conference Board reported that it's index of Leading Economic Indicators was unchanged in June following a small increase in May. Says Ataman Ozyildirim, economist at The Conference Board: "The U.S. LEI was flat in June. Declines in building permits, new orders and stock prices were offset by gains in consumer expectations, initial claims for unemployment insurance, and other financial indicators. However, the LEIís six-month growth rate remains positive, suggesting the economy will continue expanding through the end of the year." Says Ken Goldstein, economist at The Conference Board: "Some segments of the economy are turning around faster than others, resulting in positive but moderate growth. The biggest uncertainties remain the pace of business spending, the improvements in consumer spending power and the impact of slower global growth on U.S. exports"
  • According to the Bureau of Economic Analysis, the "first" estimate of GDP growth for Q2 2013 was only 1.7%, a paltry improvement over the meager 1.1% growth (revised downward) generated in Q1 and the anemic 0.4% growth in Q4 2012. For comparison, growth was 3.1% in Q3, 1.3% in Q2 and 2.0% in Q1. These tepid numbers aren't likely to stir the Fed to reduce their policy of monetary expansion in the near future.
  • The Federal Reserve reported in that in June the amount of total outstanding consumer credit continued to grow, reaching $2.85 trillion, up from the prior month and growing at a healthy 6% annualized rate. Once again, this is the highest figure I've noted since I first started reporting this statistic in 2007. What's troubling is that this increase in consumer credit is barely registering in the retail sector.
  • The Conference Board's Consumer Confidence Index dipped to 80.3 in July after a surge in June. Says Lynn Franco, Director of The Conference Board Consumer Research Center "Consumer Confidence fell slightly in July, precipitated by a weakening in consumersí economic and job expectations. However, confidence remains well above the levels of a year ago. Consumersí assessment of current conditions continues to gain ground and expectations remain in expansionary territory despite the July retreat. Overall, indications are that the economy is strengthening and may even gain some momentum in the months ahead." A weakening stock market in August will likely result in weakened confidence next month.
  • According to the FDIC, no banks failed in July, leaving the total for the year at 16, versus 39 through the same period last year. My target of 25 bank closings for the year looks about right.

Trends To Watch

The dollar index has gyrated wildly recently. It has made two failed attempts this year to pierce and remain above resistance around 84.5. It has now fallen to the midpoint of the trading range (red dotted line). The weakness in the dollar has fueled increases in precious and base metals, and other commodities like petroleum. Still, the greenback remains solidly in the middle of the trading range and retains its status as a "safe" and desired currency, notwithstanding the efforts of our Federal Reserve to destroy its value.

It look more and more like the floor was indeed made in the price of gold when it bottom around 1,200 at the end of June. Not surprisingly, that dovetailed almost perfectly with the day the dollar hit its high. The more the dollar weakens, the greater the gains for the price of gold (among other commodities). Last month I said  I  picked up a few shares of one of the leading gold miners at dirt cheap prices. That looks more and more like a good buy. Recently the price rose above resistance at $1,350. The next barrier looks to be around $1,400.

The price of West Texas crude continues to hold strong and steady. After surging out of its primary trading range (dotted green line) in July its made three failed efforts to break through major resistance at $110. I think the index could hold between $100 and $110 for a while before making a move in one direction or the other.

The bull market in the financial sectors continues. It's interesting that the index has basically climbed along the 50-day moving average, which it's kissing right now. If the index dips a bit closer to the trendline, it could provide another entry point for investors looking to climb on board the train.

The housing sector doesn't look so good. Rising interest rates appear to be hurting the sector. The current price of the index has fallen below both moving averages, which look like they could be forming a "death cross". If that happens, and if the index falls below support around 155, it could be time to bail on the sector.

The index for the developed international markets have again moved up to challenge resistance around 63.5. The current price is solidly above both moving averages. Money appears to be leaving the developing markets, which are being hard hit by rising rates, and heading back to the "slow growth" developed world. This would be a "flight to safety" in the equity markets. Makes sense to me; I eliminated all of my developing market exposure months ago.

Could there be some life in the Chinese stock market? The Shanghai index, a proxy for the Chinese economy, has again bounced off major support and is rising toward interim resistance (green dotted line). Should the index break through this resistance and head higher it would breath much needed life into the base metal sector which relies so heavily on Chinese demand.

The NYSE Bullish sentiment index is bullish right now, but not overly so, as it has recently turned lower. It's been nine months and counting since the index has fallen below 60. Given this demonstrated history, I would expect the index to fall a bit more before again heading up. If so, it could provide a nice buying opportunity.

Right now only about 41% of stocks traded on the New York Stock Exchange are currently trading above their 50-day moving average, down from 72% only a month ago. This is right on the border of bearish territory (green dotted line). RSI is bumping against oversold territory. This could suggest a buying opportunity coming up.

Finally, as you can see, the VIX, or the "fear index", has recently moved out of "complacent" territory and into the "normal" zone. That doesn't bother me one bit. In fact, if it were to move a little higher, in conjunction with the two charts above hitting a "buy" signal, I think it would be time to step up and put some money to work.


What I'm Thinking and Doing

"Fed watch" is picking up speed. The questions are will Chairman Ben Bernanke begin to taper off quantitative easing before he leaves the Fed by the end of the year, and if so, when will he begin to do it? Perhaps more important is what will happen if market forces continue to drive rates higher, independent of the Fed's actions? Will that put the brakes on the budding, but unsteady economy? And if the economic growth begins to slow, or if the housing markets turns down, what will the Fed do then? These are a few of the key questions I've been pondering.

I have to admit that I'm also very curious as to whether the recent 4% drop in the market is simply a natural pause in an unusually long bull run or is it the beginning of something worse. Whether you're a professional or amateur investor, this is one of the fundamental questions that we all have to answer: whether a downturn is cyclical or secular; short-term or long-term. We can look at charts, listen to the pundits, read earnings reports or simply rely on experience and instinct. Or we can use some combination of all of the above. No way is right and no way is wrong. My instincts tell me that this downturn is temporary and that by the end of the year, the market will be higher than it is today.

I have almost completed the massive portfolio reorganization that I began towards the end of last year. Over the last nine months or so I have eliminated over two dozen positions. In doing so I have dramatically cut back on my commodity holdings and many energy stocks. I even sold a few of my smaller precious metals positions. I've eliminated laggards and small positions. I have done all of this in an effort to focus on my core holdings and position the portfolios to benefit from the growing sectors of the market. I have used the cash from all the selling to add to my positions in housing, pharmaceuticals, finance and consumer staples. I've even taken small positions in a few oversold tech stocks. For the most part I've emphasized strong companies with excellent competitive positions that pay above average dividends. In the 401k accounts that I manage for select clients I've also done a lot of rebalancing, reducing bond and international exposure while increasing the allocation to domestic equity. I feel very comfortable that our portfolios are constructed in such as way as to allow us to benefit from the majority of future gains while giving us some modest protection against potential losses.

News and Notes

On a personal note, my family, as well as two of their friends, enjoyed a wonderful week on Cape Cod recently. We had wonderful weather, ate great seafood, enjoyed lengthy bike rides and warm afternoons on the beach. It was a great final family vacation before we send Nola off to college. It's hard to believe that we will be dropping her off at Wesleyan University next week. I am so excited for her as she prepares to begin the next phase of her life. Good luck sweetheart.

Last week I hosted the 2nd annual summer pool party and BBQ for my networking group, the Rising Tides Alliance. We enjoyed a great afternoon of wonderful food and drinks and even better friendships and relationship building. If you'd like more information about the group, or if you'd like to join us for our next event in September, please let me know.

I recently gave a lengthy interview that will appear in the November edition of The Suit Magazine. As soon as the article appears on their website, I'll let my readers know. I hope you enjoy it.

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
President

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