Current Market Analysis

Welcome to a New Year and a new decade, both for us and for the stock market. I was very pleasantly surprised by the out-sized gains enjoyed by the market in 2009. And yet even those outsized gains did not come close to recovering the losses endured in 2008. After the Bear Markets of 2000-2002 and 2008, the past ten years have been dubbed the "Lost Decade", as the average investors are worse off today then they were more than ten years ago. The Dow Jones Industrial Average closed 8.25% lower than it did 10 years ago, S&P 500 closed 23% lower, and the NASDAQ closed a stunning 44% lower. Hopefully the next ten years will be more profitable.

Notwithstanding the decline in the market yesterday, the new year has picked off right where it left off last year; it continues to go up. We had our most recent Dow Theory confirmation (when the Dow Jones Industrial and Transportation averages hit new highs on the same day) on January 11. Since then the Industrials have made new highs three additional times, most recently on January 19, when it hit 10,725.43. If the Transports don't confirm with its own new high shortly, that would be a cause for concern. But for now, it appears to be all clear ahead. I've been telling you for months that I don't see anything in the immediate future that will derail the rally, and I continue to feel that way.

Notwithstanding my short-term bullishness about the market, I continue to be bearish on our government and our economy. As much as our government would have you believe otherwise, the "Great Recession", which is already more than two years old, is not even close to being over. Unemployment is still way too high, the federal deficit is still growing, our trading partners are growing increasingly disenchanted with the weakened dollar and the American consumer remains tapped out. While the economy appears to be improving, as I'll talk about below, we still have a long way to go before any intelligent person can declare that we are in anything resembling a robust recovery. I also believe that there are some very dark storm clouds headed our way again in the not-too-distant future. But that's a story for another day.

I've said this before but I think it bears repeating; please remember not to confuse a short-term, or cyclical" trend with a long-term, or "secular" trend. I believe, until proven otherwise, that this is a cyclical bull market, and will stay that way until it doesn't. At that point, we'll have to re-evaluate everything.

So what do the charts tell us now? Well, they continue to show good times. The Industrial average, like many of the charts you'll see below, shows the "V" shaped recovery that the experts have been "predicting". I have to admit, I didn't see it coming. But as long as the rising uptrend continues, it's all good. And I'm pleased to see the trading volume increase recently. 

The chart of the Transportation average roughly mirrors the Industrials, but there is a slight divergence recently that I'd like to see corrected. I'm also a little concerned about the lagging trading volume. Finally, it's important that the index price remains above it's 50-day moving average. To fall below would be a bearish indicator.

Since May, the yield on the 10-year treasury has traded between 3% and 4%. In November I wrote that "I still expect yields to remain in the 3% - 4% range for the remainder of [2009] before heading inevitably higher sometime beginning in 2010." If you look at what happened in December when rates briefly rose above 3.9%, you'll see that we may already be headed in that direction.

Last Month's Results

• According to the Department of Labor, the most recent figure for seasonally-adjusted initial jobless claims for the week ended January 9 was 444,000, an increase of 11,000 from the prior week. The four-week average declined to 441,000. The problem is that while it seems there is some modest improvement in jobless claims, the less publicized non-seasonally adjusted number of initial jobless claims was staggering 801,086. That's a huge difference from the "adjusted" number.
• Non-farm payroll employment was discouraging in December after a surprisingly good November, falling by 85,000 versus a revised 4,000 jobs gained in November. Average hourly wages inched up to $18.77, while the average work week remained steady at 33.2 hours.
• In December, the total number of workers counted as unemployed remained at 15.4 million, up from 7.5 million only two years ago, which kept the unemployment rate at 10.0%. There are 6.1 million people who have been unemployed longer than 27 weeks. The seasonally adjusted number of people who could only find part-time work held at 9.2 million and the number of marginally attached workers held at 2.3 million. The number of people holding multiple jobs fell to 6.9 million. My Comprehensive Labor Index™, which is much more representative of the real unemployment situation, fell to 20.6%.
• The Congressional Budget Office (CBO) estimated that on a net present value basis, the Treasury reported a federal budget deficit of $92 billion in December, leaving us with a deficit of $390 billion for the first fiscal quarter of 2010, which is $56 billion more than the record shortfall from 2009.
• The Census Bureau reported that the U.S. trade deficit of $36.4 billion in November, up from a revised lower $33.2 billion in October. The trade gap isn't really a big problem at this point, except for the fact that more than 55% of the gap is with one country - China.
• The Census Bureau reported that privately owned housing starts increased 8.9%% in November after falling 10.1% in October, but remained 12.4% lower than a year ago, to a seasonally adjusted annual rate of 574,000 units. New building permits were down 6.0% from last month and were only down 7.3% from last year.
• The National Association of Homebuilders/Wells Fargo Confidence Index dipped a bit in December to 16, from 17 in November. The 16-month high of 19 was set last September.
• The Census Bureau reported that on a seasonally adjusted annualized basis, sales of new homes in November fell 11.3% from the prior month, and remained 9% lower than the same period last year, to 355,000 units. The estimate of homes for sale is up to 235,000, which represents 7.9 months at the current rate of sales. The median sales price rose to $217,400, which is just below the 12-month moving average price of $219,633. There simply is no clear trend yet in new home sales.
• The National Association of Realtors reported that on a seasonally adjusted annualized basis, sales of existing homes in November increased 7.4%, and were also up a huge 44.1% from a year ago, to a projected 6.54 million units. The estimate of homes for sale, at 3.52 million, is the smallest figure since January and represents only 6.5 months of supply at the current rate of sales. The median sales price fell to $172,600, which is still slightly lower than the 12-month average of $173,433. Existing home sales continue to be paced by foreclosures which depress home values.
• The S&P/Case-Shiller Home Price Index, which uses a three-month moving average to track the value of home prices across the US, increased In October for the sixth straight month, to 158.82.
• According to RealtyTrac, the number of foreclosures in December increased 14% from November, after four straight months in which foreclosures decreased. For the year, the number of foreclosures increased by 21% over 2008. It could have been much worse if not for government intervention. Unfortunately, there are still high levels of delinquencies which will likely result in large numbers of foreclosures again in 2010.
• The Institute for Supply Management (ISM) index of manufacturing activity was 55.9 in December, continuing the general uptrend in place so far this year. This marked the fifth month in a row in which the manufacturing sector showed signs of growth. The ISM index of non-manufacturing activity was 50.1, marking the third time in the last four months that the index indicated moderate growth.
• The Federal Reserve reported that capacity utilization in the industrial sector increased for the sixth straight month, to 72.0%. in December. It should also be noted that utilization for the five prior months were all revised upward. Capacity utilization now remains only 8.9% below the average level of the period from 1972 through 2008.
• The Conference Board reported that it's index of Leading Economic Indicators rose by 0.9% in November, following 0.3% and 1.2% in October and September, respectively. After peaking in July 2007, the LEI fell for 20 months in a row. This is now the eight monthly increase in a row. Most indicators suggest that the recession may have bottomed out.
• According to the Bureau of Economic Analysis, the "final" estimate of GDP growth in the third quarter was 2.2%, lower that the "advance" estimate of 3.5% and the "second" estimate of 2.8%. Even with the lower revisions, this was far better than the "final" estimate of -0.7% GDP growth in the second quarter. Please keep in mind that these gains are thanks in part to gimmicks like "cash for clunkers" (which added more than 1.5% to GDP), credits for first time homeowners and massive government spending. I expect the 4th quarter GDP numbers to be lower.
• The Federal Reserve reported that in November the amount of outstanding consumer credit fell by an annualized rate of 8.5% from the prior month, to $2,465 billion. Consumer credit has declined in fourteen of the last sixteen months, and is at it's lowest level since April 2008. This is good for consumers, but ultimately bad for the economy as consumers spend less money.
• According to the Census Bureau, retail trade and food service sales decreased 0.3% in December, but was 5.4% below the levels from the year before. Retail sales also fell 0.2% in November. To have retail sales fall in the holiday season is not good news.
• The Federal Reserve reported in that in December the supply of M-2 dipped slightly from the prior month and up only 0.9% during the prior six months. The supply of M-1, on the other hand, rose a more robust 5% over the same six months. The overall rate of monetary expansion definitely appears to be slowing. The Fed is using other tools, like purchasing bonds and mortgages, to create a stimulative monetary policy.
• The Conference Board Consumer Confidence Index rose in December, following an increase in November, to 52.9 from 50.6. Don't be mislead by these increases; consumers remain very pessimistic about their present economic situation.
• According to the BEA, disposable personal income inched up again, which caused the personal savings rate to move back up to 4.7% in both November and December.
• According to the FDIC, 140 banks failed in 2009 and were either closed or merged into healthier banks. By comparison, 26 failed in 2008 and only 3 failed in 2007. 3 more have failed already this year.

In November I wrote that "In the short-term, I wouldn't be surprised to see the dollar rally a bit, but longer term, the dollar is headed lower." Those were prescient words as the dollar surged almost immediately thereafter. I believe that left to its own devices, the dollar would sink like a stone under the weight of the massive government deficits and unfunded obligations. But "relative" to the currencies of other countries, the dollar is still the world's reserve currency. Therefore, the dollar could rally further before it inevitably rolls over and tests the 72 level.

To put the action of the dollar index into some context, I'm showing you a chart of the past 22 years. You can clearly see that the dollar is off of its second lowest level ever, and isn't that fall off its historical low of 70.70. It's been quite a drop from a high of 121 only seven years ago. And unfortunately, I don't think we've nearly seen the worst of it.  

The price of gold continues to surge to unprecedented heights. But that upward move is never in a straight line, as was demonstrated in December. Remember, I've said many times that there will be corrections and profit-taking, but don't get scared out. I am firmly convinced that this is not the top; this is just a point along the way in an upward trend to a much higher level.

The stealth bull market in silver silver continues unabated. The gain in the price of silver over the past year has dwarfed that of gold, yet it has happened almost in a media vacuum. Investors who have put some money in silver are doing very well, and will likely continue to reap the rewards going forward.

After breaking above $80 per barrel, the price of West Texas Crude is consolidating a bit right now. This is totally normal. I won't get concerned unless the price falls below $75, and violates the rising blue trend line. I still believe that the price of oil will be back above $100 per barrel before we see $60 again.

The rising price of copper continues to be a good indicator of growing worldwide economic strength. And while I believe much of this increase is due to activity in China, it's still positive. As with any commodity, there will be a period of consolidation or correction ahead, but the current trend is very bullish. And like silver, there is very little discussion in the press about this upward trend.

The financial sector, as represented by the XLF, has been in a holding period for almost half a year. The XLF been unable to break through a major resistance level at $16. And now it is trading dangerously close to its 50-day moving average, which is ominously converging with the 200-day average. Should the 50-day move below the 200-day, it will be time to bail from the financial sector. The past year has been the best possible scenario for banks: they pay nothing on deposits yet lend at 5% of so, making tons of money on the spread. If interest rates rise, this spread will invariably tighten, ending this perfect money-making environment. I think the banking industry is heading toward very rough waters again.

The housing market has also been treading water for the past half year. Remember, housing is clearly linked to the labor markets, interest rates and the overall economy. It wouldn't take much to knock housing back down. The first danger sign would be if the index falls below the 50-day moving average or the rising trend line. Like the financials, I think the housing market is headed for more problems.

Foreign markets, as represented by the MSCI EAFE index, are looking a bit troubled as they have traded sideways since October. The index is basically sitting on the 50-day moving average and the trend line. I drop below 55 could be dangerous.

Like the developed markets, the Chinese market has traded sideways for a couple of months and is now actually trading below the 50-day moving average and is basically resting on the trend line. RSI has also fallen below 50. There could be a problem here.

The Baltic Dry Index has been on a wild roller coaster with huge swings up and down. Based on the chart I would bet that we're due for another jump up, possibly to as high as 5,000.

The NYSE Bullish Percent Index represents the percentage of stocks listed on the NYSE that signal a buy. Contrarians would argue that the extreme levels of exuberance noted in the chart suggest a bearish indicator because there is little room left to the upside. This chart looks neither overly bullish or bearish to me. But with RSI highly overbought, I wouldn't be surprised to see this head down, which suggests a market pullback might be coming.

Finally, we can take a quick look at the volatility index, also known as the "investor fear gauge". Clearly there is very little fear in the market right now. Indeed, investors may be a bit too complacent. This could be a contrary indicator for an upcoming pullback in the market.

What I'm Thinking and Doing

Personal News and Notes

Greg Werlinich
President

"News and Views", Copyright©, Werlinich Asset Management, LLC and www.waminvest.com. All Rights Reserved.