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

Current Market Analysis

This month's newsletter is earlier than normal as I will be out of town for the next week and a half. Therefore, some of the normal economic statistics may be missing as they are reported later in the month. Also, there is no Tip this month as I don't have any good content to pass along. I hope to have an interesting article to include next month.

This current market analysis this month is very similar to the market analysis for the past nine months or so - party on!! The broad averages continue to power ahead to new highs. The Dow Jones Industrial, Transportation and Utility Averages are all making new highs. The S&P 500 is very close to besting the old record set in late 2000. Only the tech heavy Nasdaq Composite remains almost 50% below its historic high. Almost every indicator seems to be flashing "full steam ahead" so, for now, I expect the good times to keep rolling on.

Not only has the Dow Industrials remained well above 12,000, but it appears to making a strong run at 13,000 with nary a backwards look. As I write this on a stormy day in New York, the Dow is trading for about 12,740 , or about 180 points higher than only three weeks ago. I am still very concerned by the almost vertical rise in the Dow since last summer. What goes up must eventually come down, right? You can't have a 2,000 point gain without a large correction somewhere down the line.

The parabolic ascent by the Dow is clearly shown in the chart below. The only thing that concerns me, other than the length and breadth of the ascent itself, is that the trendline seems to moving to the lower end of the trading range, suggesting a greater chance of a breakdown. The RSI is also moving toward a overbought territory. The market MUST take a breather sooner or later. According to Ned Davis, on January 30 we had experienced 978 trading days without the Dow dropping by at least 10%, which was the second longest period in history. And we had gone 135 trading days without at least a 2% drop, the longest such period since 1958. A correction of some magnitude is coming; it's just a question of time and degree.

As I mentioned earlier, the Dow Jones Transportation Average finally break through to set a new high. This is a very positive technical indication and very bullish.

And what is the bond market telling us? It looks a bit confusing to me. In only two months, yields had risen about 50 basis points, from 4.4% to about 4.9%. Recently, rates have backed off to yield about 4.75% today. Is this a "flight to quality" buying spree driving yields down? Is it the bond market declaring that inflation is dormant? Is it foreign buyers coming back into the market at the dollar has strengthened? Are the petroleum producing countries buying again as oil prices have firmed? Is it simply just too money money flooding world markets with liquidity that needs somewhere to go? It could be all of the above, any of the above, or any number of other reasons. All that matters though is that rates have come down, which is generally good for business and good for consumers.

So as I said last month, until the trend is broken, it appears the market will continue to move higher, at least for now. Just beware the inevitable slowdown or correction.

Last Month's Results

As always, I provide the following chart to show the raw results for the month, the quarter-to-date and the year-to-date. The results for January were solid across the board with growth finally leading the way, after being a laggard for much of the past few years. This market is a perfect example of a rising tide lifting all boats.

What I'm Doing Now

In the past few weeks I put of some of my cash to work buying two new positions: a leading energy company that had been beaten up due to lower oil prices and a very high yielding specialized REIT. The yield on the latter security is more than 10% which provides a very nice income stream. In the meantime, I continue to look for interesting opportunities to buy good securities at good prices and hold them for extended period of time, which is the best way to build wealth.

Please remember that wealth is created over time, by following an intelligent investment philosophy, being patient and compounding your income. Wealth is rarely generated by rapid trading or following some hot get rich scheme. If the "secret strategy" or "can't lose methodology" were so great, the people behind that scheme would use it to enrich themselves, not offer to sell it to every Tom, Dick or Harry in the world. Talk to your advisor before making any rash decisions that you may come to regret; remember, it's your money.

Statistics To Watch

• The most recent four-week average for initial jobless claims, for the week ended February 10, rose to 326,250 from 308,250 three weeks ago.
• According to the Department of Labor, non-farm payroll employment rose a modest 111,000 in January, which was a disappointing number, although the figures for the prior two months were revised upwards. Average hourly wages rose to $17.09 from $17.06. The average workweek fell slightly to 33.8 hours. The number of people holding multiple jobs dropped to 7.50 million.
• The number of unemployed workers rose to 7.0 million in January. The seasonally adjusted number of people, who for economic or business reasons, could only find part-time work, rose to 4.6 million and the number of marginally attached workers rose to 1.6 million. Not surprisingly, my Comprehensive Labor Index™ rose to 9.0% while the unemployment rate reported by the government inched up to 4.6%.
• The University of Michigan Consumer Confidence Index surged to 96.9 after falling slightly in December, thanks to strong employment numbers and falling energy prices.
• According to the CBO, the government posted a budget surplus of $40 billion in January, following a revised surplus of $45 billion in December. That resulted in a deficit of $40 billion for the first four months of the fiscal year, which was $58 billion better than a year ago. January is often a good month for revenues thanks to the receipt of estimated tax payments. The CBO is now projecting a full-year deficit of $200 billion.
• According to the Census Bureau, the U.S. trade deficit in December rose to $62.1 billion, breaking the string of three straight months in which the trade deficit fell. The deficit for the year was $763.6 billion, almost $50 billion more than the prior year.
• The Federal Reserve reported that the amount of outstanding consumer credit rose again in December, as I predicted, to a new high of $2.40 billion. That is up from $2.30 billion just one year ago. The ability of the American consumer to take on more personal debt is seemingly endless.
• According to the Census Bureau, retail trade and food service sales rose 0.7% in January from the prior month, and were up 2.3% from a year ago. These are relatively modest results.
• The Census Bureau reported that privately owned housing starts continued their modest rebound in December, rising 4.5% from November, but were still down 18% from the same period last year, to a seasonally adjusted annual rate of 1.64 million units. Similarly, building permits were down 24% from last year. I think the increase in starts can be largely attributed to the unseasonably warm weather across the country, but especially in the Northeast, which showed a 25% increase in starts from November.
• The Census Bureau reported that on a seasonally adjusted annualized basis, sales of new homes in December rose 4.8% from revised November levels, but was down 11.0% from the same period last year, to a projected 1.12 million units. The estimate of new homes for sale has fallen slightly to 537,000, which represents 5.9 months of supply at the current rate of sales. The median sale price dropped to $235,500.
• The National Association of Realtors reported that on a seasonally adjusted annualized basis, sales of existing homes in December fell 0.8%, and was 7.9% lower than the same period last year, to a projected 6.22 million units. The estimate of homes for sale, down to 3.5 million, represents 6.8 months of supply at the current rate of sales. The median price of homes sold rose slightly to $222,000.
• In their latest US Foreclosure Market Report, RealtyTrac reported that 130,511 properties nationwide entered some stage of foreclosure during January, a 19.0% increase from December and a 25% increase from a year ago. This was the sixth straight month that foreclosures exceeded 100,000, the longest stretch since they started reporting these figures in January 2005.
• According to the Mortgage Bankers Association, the most recent four-week average for mortgage loan application volume is down 1.1%. The increase in interest rates in December and January seemed to slow down mortgage application volume. I would expect it to pick up again now that rates have started to fall again.
• The Institute for Supply Management (ISM) index of manufacturing activity was 49.3 in January, down from 51.4 in November. Anything above 50.0 is considered to be an indication of growth. This is the second month out of the past three that the index fell below 50, suggesting that the manufacturing sector is slowing down.
• The Bureau of Economic Analysis announced that the "advance estimate" of GDP growth for the fourth quarter of 2006 is 3.5%, which is significantly higher than the 2.0% reported for the third quarter. This number will be revised two more times so we'll see what the final number looks like. Either way, it will likely be higher than my forecast of about 1.5%.
• Also according to the BEA, personal savings was estimated to be negative $116.6 billion in December, or 1.2% of personal disposable income. All twelve months in 2006 had a negative personal savings rate. That is not sustainable; sooner or later Americans must begin to save some money.
• The Fed increased M-2 by 0.6% in December, or a 7.2% annualized rate. The supply of M-2 has increased by 7.8% in the last three months and 5.3% in the last twelve months as the Fed is just flooding the market with money. Their stated concerns about inflation are laughable as they are inflating the money supply at a staggering rate. I'm certain this increase in the money supply is one of the key reasons for the rise in the stock market.

Trends To Watch

The "Big Picture" of the market, represented by the Wilshire 5000, looks even more bullish than ever. It appears that the index has just broken out above the already strong trading range and is rapidly approaching its all time high of 14,991, set in early 2000.

Last month I wrote that $50 per barrel provided an important support level for West Texas crude, and that the price seemed very oversold, which usually portends a rally. Indeed, a rally has occurred as the price has risen back to around $60 per barrel. The potential reasons for this gain include a vicious cold snap across most of the country, production cuts by OPEC, traders covering their short positions or just the basic laws of supply and demand. In any event, I remain confident in my long-held belief that oil prices are headed inexorably higher over time. In the short-term however, anything can happen. So, like you, I will watch with keen interest.

After forming a classic declining triangle pattern, gold has recently broken out to the upside as the price of gold soared to over $660 per ounce, up about $60 per ounce in less than six weeks. As the Fed continues to destroy the value of the dollar, and as interest rates rise, gold is looking better and better. As I write almost every month, regardless of the short-term moves, I believe the long-term action is going higher and as I consider my investments in gold to be partially "portfolio insurance" or hedges against "what if?", I'm perfectly happy to sit with my positions for the foreseeable future, regardless of the short- or medium-term moves.

Now let's take a look at the Dow Jones Commodity Index (which represents 19 physical commodities). Like gold and oil, the commodities index is rallying nicely from a deeply oversold position, although it is still within its trading range. It would be a bullish signal to break above 172, and even more so to better the previous high of 175. As with oil and gold, I believe that regardless of the short-term movement in the price of this index, we are in the midst of a long-term bull market in commodities, and therefore I expect that eventually this index will move much higher.

After a nice month-long rally, the dollar seems to be consolidating around 85. The price movement of the dollar index as formed a declining triangle pattern, which suggests possible strength ahead. With the price right around the moving averages and RSI and MACD appearing fairly valued, I don't have a strong opinion as to the near-term direction. I do believe though that over time, the dollar will trend lower.

The action of the housing index continues to be generally positive, notwithstanding a small selloff recently. The trend right now is clearly bullish as the index remains in an upswing and above its moving averages. Easy money and accommodative rates has helped ease the pain in housing. Although many of the companies in this sector have reported poor earnings and given poor guidance, the market seems to think that the worst is behind them and is bidding up their stocks. We'll see if the market is right.

Finally, let's look at the still inverted yield curve below. The Fed Funds lending rate is holding at 5.25%. 6-month t-bills now yield 5.14% (down slightly from 5.16% last month), 2-year Treasury yields have moved down to 4.87%, 10-year Treasury yields are now 4.73% while 30-year Treasury yields are 4.82%. So the inversion remains, and it has widened slightly since last month. The spread between the 10-year Treasury and the 10-year TIPS is now 2.35%, suggesting very little fear of inflation in the bond market.

Personal News and Notes

That about wraps things up for this month. Next week I will be in Costa Rica, enjoying a much-needed vacation with my family. It was been brutally cold in the Northeast for the past few weeks. I'm looking forward to some wonderful adventures in the sun.

Greg Werlinich
President

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