NEWS AND VIEWS

Werlinich Asset Management, LLC
400 Columbus Ave.
Valhalla, NY 10595
914-741-6839
800-746-6926
Email: greg@waminvest.com
URL: www.waminvest.com

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Market Analysis...A Strong Finish, but a Bad Beginning
What I'm Doing Now...Holding Firm
Statistics...Mostly Good
Forecasts...Look Back and Look Forward
Monthly Tip...Life Coach
Personal News and Notes

Current Market Analysis...A Strong Finish but a Bad Beginning

The amazing year-end "election rally" provided a nice finish to an otherwise difficult year for most investors. In fact, the gains achieved in November and December turned most of the broad averages from negative to positive for the year. The market managed to turn a blind eye to all of the problems that took the market lower as the Dow surged to a new post-crash closing high of 10,854.54 on December 28, 2004. When the Dow moved above 10,400, it broke the pattern of lower highs and lower lows that I had written about for much of last year, allowing the Dow to soar to that new high. That's the good news. The bad news is that the market has not extended that rally. In fact, the Dow has tumbled quickly, falling 486 points in the past three weeks as it has retraced all of December's, and part of November's, gains. If it continues to fall, and moves below both of it's moving averages, that would be a very negative signal. As it is, the "Santa Claus Rally" was a total bust and the negative "first five trading days" of the year portends a gloomy year ahead.


I wrote in December that I felt that the action of the Dow was becoming very closely tied to the changing price of oil. This linking seems to be holding true so far this year. As oil prices have risen back to almost $50 per barrel, the Dow has slumped. Should oil prices again crest $50, I would expect the Dow to fall further.

Also, pay close attention to the dollar and the deficits. While the dollar is enjoying a modest revival, it is still very weak and likely to become weaker still as our budget and trade deficits grow ever larger. If that happens, interest rates should increase, which would likely drive the market lower.

Speaking of interest rates, the strength in the bond market continues to surprise many market observers, myself included. Since my December newsletter, the yield on the benchmark 10-year treasury bond has fallen from 4.39% to 4.12%. We are again closing in on the magic 4% that ignited the housing boom not so long ago. It is counter intuitive to me to have rates this low with so many factors arrayed to drive rates higher. This suggests that there are problems on the horizon that are not being discussed today. Maybe the threat of inflation is not so imminent. Rather, maybe the bond market sees the chance of a recession on the horizon. Or maybe there are other economic fears, nationally or internationally, which is causing a flight to bonds, even at these low yields. This certainly bears further scrutiny.

Index

Dec

QTD

YTD

Description

S&P 500

3.25

8.73

8.99

Large-cap stocks

Dow Jones Industrial Average

3.40

6.97

3.15

Large-cap stocks

Nasdaq Composite

3.75

14.69

8.59

Large-cap tech stocks

Russell 1000 Growth

3.44

5.05

2.29

Large-cap growth stocks

Russell 1000 Value

3.35

10.38

16.49

Large-cap value stocks

Russell 2000 Growth

3.59

17.08

14.31

Small-cap growth stocks

Russell 2000 Value

2.39

24.15

22.25

Small-cap value stocks

MSCI EAFE

4.39

15.36

20.07

Europe, Australia, Far East

Lehman Aggregate

0.92

0.95

4.34

US government bonds

Lehman High Yield

1.49

4.58

11.13

High-yield corporate bonds


What I'm Doing Now...Holding Firm

As I look forward to the balance of 2005, my investment stance remains unchanced. I continue to invest first for the preservation of capital, then to create a reliable stream of current income, and then to capture a reasonable amount of growth where possible. For the past two-plus years, my sector holdings have changed very little. I continue to overweight energy, natural resources, precious metals, defense, diversified financials, specialty retail, dollar hedge products and to a lessor extent, pharmaceuticals. Iin addition, I own a basket of small- or micro-cap stocks. This portfolio mix has performed exceedingly well for the past two years and I see no reason to make any substantive changes right now. 

That being said, should circumstances warrant a change on my part, I won't hesitate to pull the trigger on whatever trade is necessary to protect my portfolios.

Statistics to Watch...Mostly Good

  • A modest 157,000 new jobs were created in December, which barely keeps pace with population growth. Average hourly wages continued to rise a penny at a time, reaching $15.86. The average workweek remained steady at 33.8 hours.
  • The White House expects the non-farm payroll numbers to rise by 2.1 million jobs in 2005, or 175,000 per month.
  • The number of unemployed workers remained steady at just over 8 million. Similarly, the number of part-time workers has also held firm at around 4.5 million and the number of "marginally attached" workers is holding at about 1.5 million. My "underemployment rate" is holding at around 9.5%, while the official unemployment rate reported by the government is fixed at 5.4%.
  • There are now 7.8 million people holding more than one job, an increase over the prior year of 574,000.
  • The four-week average for initial jobless claims rose slightly to 345,750.
  • The University of Michigan Consumer Confidence Index rose from 92.8 to 97.1. Americans continue to shop and go further into debt.
  • According to the Congressional Budget Office (CBO), the federal deficit for the first quarter of fiscal 2005 was $114 billion through December.
  • According to the Census Bureau, the U.S. set a new record federal trade deficit in November of $60.3 billion, beating the old record of $56.0 billion set in October. After 11 months, the US had already established a new record accumulated annual deficit of $561.3 billion.
  • The Labor Department reported that the Consumer Price Index, which measures changes in the prices paid by urban consumers for a representative basket of goods and services, rose 3.3% in 2004, while the "core" CPI, which excludes food and energy, rose 2.2%.
  • The Federal Reserve reported that total outstanding consumer credit fell slightly in November to a still staggering $2.085 trillion.
  • The American Association of Individual Investors' (AAII) bullish sentiment has plunged from 57.70% at the end of November to 33.8% last week. The average investors appear less sanguine about the market than the "experts".
  • The Census Bureau of the Department of Commerce reported that seasonally adjusted estimates of U.S. retail and food services sales for December increased 1.2% from November and 8.7% from December 2003.
  • The Census Bureau reported that on a seasonally adjusted annualized basis, sales of new homes were about 1.125 million in November, down about 12% from October, but still up from a year ago.
  • The National Association of Realtors reported that on a seasonally adjusted annualized basis, sales of existing homes were about 6.94 million in November, up 2.7% from October.
  • The Institute for Supply Management (ISM) index of manufacturing activity for December was 58.6, up from 57.8 in November, which marked the sixth consecutive month that the index remained below 60.0. So the economy continues to grow, but grow slowly.
  • In December a NYSE seat sold for $1 million, a nine-year low and a drop of $500,000 from the prior year. In January, the next seat sold for $975,000. That is a very bearish barometer for the health of the stock market.

So what does all this mean to you? It means that jobs are being created, albeit too slowly. It means that people are working as much as they can and but spending almost every penny they earn. It means that regular investors are growing more cautious while the pros continue in their unwavering optimism. It means the right now, the economy seems to be doing well but that there are some warning signs. It means that I am maintaining my "cautious pessimism" from last year.

Forecasts...Look Back and Look Ahead

In my January 2004 newsletter, with the Dow trading at about 10,500 (which was, by the way, more than 100 points higher than it is right now), I wrote that it was important for the Dow to remain above 10,000 in any pullback and break above 11,000 in a rally. I suggested that if neither barrier was breached, "we might just stay in a trading range of plus or minus 5% for most of the year." While the Dow did briefly fall below 10,000, it never did scale 11,000, and did in fact trade in a 5% range for the entire year.

I was wrong when I predicted that the Fed would probably not raise short-term interest rates last year. They raised the rates by 1.5%. I was far more accurate in my prediction that 10-year treasury rates would trade between 4% and 5%, with rates averaging 4.5%.

In January I expressed a near-term optimism for the market which held true as the 2003 rally extending into February before beginning its eight month descent. That drop ended on Election Day with a rally that raised the Dow by almost 1,100 points in less than two months. For the year I expected a "flat to slightly higher stock market" in 2004. That is pretty much what we got.

Gold spent most of 2004 trading sideways after more than two years of rising prices. This consolidation was not a bad thing. It sets things up for the next leg of the ascent which I still believe is coming.

A year ago the four week moving average for initial jobless claims was 355,750. Today that average is slightly lower at 345,750. The reported unemployment rate dropped during that period from 6.2% to 5.7%. It seems to me that most of the people that are no longer reported as "unemployed" have just given up looking.

Some of my clients, while very pleased with the excellent results that we've achieved over the past few years, are quick to ask me what my plans are for this year. My response is simple: I plan to follow the same strategy that has worked so well for the past two and a half years. I will continue to invest according to a sector-based strategy that overweights the areas in the market that offer the best protection, income and chance for reasonable growth.

So what are my forecasts for 2005? I'm glad you asked.

  • I believe that 11,000 will continue to be the ceiling for the Dow. I think Dow 10,000 will again be breached with 9,750 being an important support level. I think we'll have one more rally sometime in the first half of the year before a second half decline which will leave the Dow down 5-7% for the year. Like last year, I suspect we'll trade in the 5% range for most of the year.
  • I think the Fed will raise short-term interest rates to between 3% and 3.5% by the end of the year.
  • I think that the yield on the 10-year treasury will again trade between 4% and 5%, and end the year little changed from its current position.
  • After a brief rally, the dollar will continue its slide until it gets to 1.45 - 1.50 to the Euro.
  • I expect oil prices to stay north of $40 per barrel for the entire year, and spend some part of the year above $50. Natural gas prices will exhibit the same trend as it recovers to around $8 MCF.
  • Gold prices will eventually begin to rise again as the dollar weakens. Gold prices should eventually break above $450 an ounce and attempt to set new highs.
  • The economy should stay on trend in the first quarter, or even the first half of the year, which means GDP growth of about 3.5% before slowing in the second half. Similarly, job creation will be stronger in the first half. At the same time, the trade and budget deficits will probably widen, notwithstanding the admininstration's attempt to rein in spending.

Monthly Tip - Life Coach

This month's tip will be a little different than usual. Jennifer Emrich, C.E.C., will discuss steps that each of you can take in order to make a happier you.

CHANGE YOUR LIFE: Practical Steps to a Happier You

How many times have you found yourself wishing your life was better? Maybe you hope for a career that excites you, a stronger financial situation, richer personal relationships or a more fulfilling life. How many times have you dreamed about making a change in your life, something exciting and challenging, only to moments later list all the reasons why that dream is unattainable?

Now, if you are like many of us, you have heard those inner nay-saying voices and just accepted them as fact. But what if you took the time to evaluate the possibilities and allowed your dreams to live for a bit without instantly shutting them down? What if by uncovering what is stopping you from moving forward you could actually create powerful change in your life -- change that allows you to move towards your goals with excitement and confidence? The key is in understanding our fears as well as what drives us.

Below are five questions designed to help you tap into what motivates you and what holds you back. Take some time to write down your answers because they can provide some great insight into you and your goals. You may be surprised with some of the answers you uncover.

  • What is one goal that you have always wanted to accomplish but never have?
  • What are the benefits of taking action and making that goal a reality?
  • What might be the downsides of not achieving your goal?
  • What are the benefits of staying exactly where you are?
  • What are the downsides of achieving your goal?

The last two questions are the most difficult because they really require some soul searching. These questions give you the best understanding of why you donít take action. Look at question number fourÖletís say for example your goal is to take charge of your finances. What could be some benefits of not taking control of your money? Sounds like a trick question but there are always payoffs to our actions. One benefit might be that you can shop Ďtil you drop. If you ignore your financial situation, you donít have to feel bad about spending. Maybe by shopping you feel more secure about yourself and how you look. Or for those who feel itís easier not having to learn about investment options, stock portfolios and the like, a perceived emotional benefit might actually be a more carefree life. The truth is we gravitate to what feels good and ďchangeĒ takes us out of our comfort zone.

What about question number five? What would be the downside to managing your finances? For one, it would require that you actually look at your financial picture, and maybe you are in debt. That could mean putting yourself on a budget which might mean denying yourself a lifestyle you enjoy. Or maybe it would mean educating yourself about investing and you find that completely overwhelming. These are just a few examples, but they illustrate how even someone who really wants to take charge of their finances might cling to the comfort of their current situation. The bottom line is they donít have to expend the energy or deny themselves anything that they may want in the short term. It becomes clear why people with the best intentions often donít want to do the hard work it takes to change, because inaction can be a heck of a lot easier!

So whatís the bottom line here? The bottom line is you can have whatever life you want, itís all up to you! The key is retraining your mind to focus on the rewards associated with taking action and the pain of inaction rather than the payoffs of staying where you are. The rewards are all the benefits you can reap by achieving your goals. So in the example of finances, the rewards might be a stronger financial future, security for your family or a better retirement plan, all of which lead to less stress. By uncovering these, it starts to put into perspective what you are missing out on by not taking the reigns. Give yourself the freedom to imagine what your life would feel like if you stepped outside your comfort zone and really went after your goals. Change can be frightening and sometimes even risky, but it can open up your life to possibilities and rewards richer than you ever imagined.

Jennifer Emrich, C.E.C., is the owner of Envision Coaching and a Certified Life Strategy & Career Coach. To find out more about how coaching can help you create a better life, or for a complimentary coaching session, call (914) 674-0790 or email envisioncoach@optonline.net.

Personal News and Notes

It's hard to believe but The Black Book on Personal Finance has been completed, is now at the printer and should be in bookstores in March. In the meantime, the e-book of my chapter on Sector Rotation Investing is also complete and available for sale. The publisher's suggested retail price for the e-book is $19.95. As a special accomodation to my readers, I have negotiated a 10% discount off the list price. As soon as my publisher's web site is up and running, you will be able to buy and download the e-book. I hope many of you will be kind enough to buy and read it. I believe that you will find the content to be interesting and informative. The ideas and concepts that I discuss are the exact ones that I am currently using to manage more than $35 million in family and client money.  

2004 was a very good year for WAM and its clients. For the second consecutive year, the returns on our clients' portfolios exceeded our expectations. If the returns on your investments haven't been similarly strong, or if you are ready to change the way your money is being managed, now is a good time to talk to us. For a limited time, I'm offering a FREE 30-minute consultation or porfolio review (a $50 value). In addition, if you then choose to become a client, you will receive a complementary copy of The Black Book on Personal Finance. The initial consultation is completely free and without any obligation, so you have nothing to lose and potentially much to gain. I look forward to hearing from you.

As always, I thank you for your interest and consideration, and invite you to write or call me if you have any questions, or if I can be of service to you in any way.


Best regards,


Greg Werlinich
President

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