Current Market Analysis

The stock market certainly started 2010 with a bang. First, the Dow Jones Industrial Average hit an intermediate high of 10,725 on January 21. Interestingly, that was the exact midpoint of the move from the low of 7,286 after the tech crash to the high of 14,164 set in October 2007. From there the market plunged almost 800 points over two week to break below 10,000. From there we've now recovered about half of the correction. It has been a very impressive rally, and it continues today as I finish writing this. Last month I said that "it appears to be all clear ahead." Well, I was certainly wrong about the immediate action, but maybe I'll be proved correct as we look a little further into the future.

Notwithstanding my short-term bullishness, I continue to be bearish on our government and key areas of the 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 housing market is still in trouble, consumers are cutting back, the federal deficit is still growing, and massive tax increases loom in the non-too-distant future. Yes, the industrial side of the economy is clearly improving, as I'll talk about below, and sentiment is improving. But we still have a long way to go before any intelligent person can declare that we are in anything resembling a robust recovery.

So what do the charts tell us now? The Industrial average clearly broke down below the rising trendline in blue, and below the 5-day moving average. After the recovery, the current price has recovered right to that average. It would be very constructive for the Dow to rise back above the 50-day average and track back towards the recent closing high of 10,725. I would also like to see the volume increase, which would demonstrate more institutional buying.

To give you an even better perspective of the recent action on the Dow, take a look at the chart below. On this chart you can clearly see some support levels in blue. The good news is that the Industrials bounced off support at about 9,750 then rose right through resistance at 10,250. It looks to me that the next resistance would be around 10,500. After that, it would be straight to the high of 10,725.

The chart of the Transportation average roughly mirrors the Industrials. Like the Industrials, the Transports fell below the rising trendline and below the 50-day moving average before rising back up to almost meet the 50-day average. So we'll watch to see if the Transports can move up in lockstep with the Industrials and attempt to move above the intermediate high of 4,262.

Since last 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." Since December, rates have been trading at the higher end of the range, suggesting that rates could break above 4% in the near future.

Last Month's Results

• According to the Department of Labor, the most recent figure for seasonally-adjusted initial jobless claims for the week ended February 13 was 473,000, an increase of 31,000 from the prior week. The four-week average increased to 467,500. The silver lining is that the less publicized non-seasonally adjusted number of initial jobless claims was 476,730, which was virtually identical to the seasonally adjusted number. If the claims could now just start going down, this would be huge positive.
• Non-farm payroll employment was basically flat in January after a dismal December. About 20,000 jobs were lost in January after a losing 150,000 in December. And it was no surprise that after revisions (which got very little press), the economy lost a staggering 617,000 more jobs in 2009 than were initially reported. Average hourly wages for blue collar workers rose a bit to $18.89, while the average work week remained steady at 33.3 hours.
• In January, the total number of workers counted as unemployed fell to 14.8 million, which dropped the unemployment rate to 9.7%. The more comprehensive U-6 rate was 16.5%, down from 17.3%. There were 6.3 million people who have been unemployed longer than 27 weeks, up from 1.3 million when the recession began in December 2007. The seasonally adjusted number of people who could only find part-time work fell to 8.3 million and the number of marginally attached workers held at 2.5 million. The number of people holding multiple jobs fell to 6.75 million. Overall, the employment picture remains terrible.
• The Congressional Budget Office (CBO) estimated that on a net present value basis, the Treasury reported a federal budget deficit of $46 billion in January, leaving us with a deficit of $434 billion for the first four months of fiscal 2010, which is $40 billion more than the record shortfall from 2009.
• The Census Bureau reported that the U.S. had a trade deficit of $40.2 billion in December, up from $36.4 billion in November. The trade gap with China was actually down to "only" 45%. We'll see how long that lasts.
• The Census Bureau reported that privately owned housing starts increased 2.8% in January after falling 0.7% in December, and was 21.1% higher than a year ago, to a seasonally adjusted annual rate of 591,000 units. New building permits were down 4.9% from last month but were up 6.9% from last year.
• The National Association of Homebuilders/Wells Fargo Confidence Index increased to 17 in February, after falling one point in each of the prior months. The 18-month high of 19 was set last September.
• The Census Bureau reported that on a seasonally adjusted annualized basis, sales of new homes in December fell 7.6% from the prior month, and remained 8.6% lower than the same period last year, to 342,000 units. The estimate of homes for sale is down to 231,000, which represents a still daunting 8.1 months at the current rate of sales. The median sales price spiked up to $221,300, which is now higher than the 12-month moving average price of $218,817. There simply is no clear improvement yet in new home sales.
• The National Association of Realtors reported that on a seasonally adjusted annualized basis, sales of existing homes in December fell 16.7%, but remained 15.0% higher than a year ago, to a projected 5.45 million units. The estimate of homes for sale, at 3.29 million, is the smallest figure since last January and represents only 7.2 months of supply at the current rate of sales. The median sales price rose to $178,300, which is still slightly higher than the 12-month average of $173,458. 32% of January home sales were "distressed" sales.
• 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, decreased fractionally in November for the second month in a row, to 158.49, following five consecutive months of increases. Given the number of distressed sales nationally, this shouldn't be a surprise.
• According to RealtyTrac, the number of foreclosures in January decreased 9.7% from December, but still remained 15% higher than a year ago. The number of foreclosures has declined in five of the last six months. Unfortunately, the January figures could be misleading, with big increases coming in the next few months as lenders foreclose on delinquent properties that defy better solutions.
• The Institute for Supply Management (ISM) index of manufacturing activity was 58.4 in January (the highest level since August 2004), continuing the general uptrend in place from the end of last year. This marked the sixth month in a row in which the manufacturing sector expanded. This is a clear sign of economic growth. The ISM index of non-manufacturing activity was 50.5, marking the fourth time in the last five months that the service index indicated moderate growth.
• The Federal Reserve reported that capacity utilization in the industrial sector increased for the seventh straight month, to 72.6% in January. Capacity utilization now remains only 8.0% below the average level of the period from 1972 through 2008. Like the ISM numbers, this is another good indication that the economy is getting stronger, at least in the industrial sector.
• The Conference Board reported that it's index of Leading Economic Indicators rose by a slim 0.3% in January 0.9% after strong increases of 1.2% and 1.1% in December and November, respectively. After peaking in July 2007, the LEI fell for 20 months in a row. This is now the ninth monthly increase in a row.
• According to the Bureau of Economic Analysis, the "advance" estimate of GDP growth in the fourth quarter was a whopping 5.7%, much higher than the 2.2% growth recorded in the third quarter. I'm highly confident that after two more revisions, the final number will be much lower. 3.4% of the 5.7% was due to businesses replenishing their depleted inventories. It is unlikely that inventory expansion will be able to continue at this rate for very long.
• The Federal Reserve reported that in December the amount of outstanding consumer credit fell by an annualized rate of .75% from the prior month, to $2,457 billion. Consumer credit has declined steadily for the past year and a half and is now at it's lowest level since July 2007. 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 increased 0.5% in January after falling 0.1% December, and were 4.7% below than a year ago. The increase was spread evenly throughout many sectors of retail sales.
• The Federal Reserve reported in that in January the supply of M-2 dipped slightly from the prior month and was up only 0.6% during the prior six months. The supply of M-1, on the other hand, rose a more robust 3.2% over the same six months. The overall rate of monetary expansion is clearly slowing. Over the next few months, the Fed will likely cut back on tools, like purchasing bonds and mortgages, that it has been using to create a stimulative monetary policy as it prepares to eventually raise interest rates.
• The Conference Board Consumer Confidence Index rose in January, for the third straight month, to 55.9. On the whole, consumers view the present situation as better, but remain concerned about the future, especially their financial situation.
• According to the BEA, disposable personal income inched up again in December, which caused the personal savings rate to move up to 4.8%. I would expect to see the savings rate exceed 5% in the next month or so.
• According to the FDIC, 16 banks have failed so far this year. 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.

For the past few months I've written that I expected the dollar to rally due to being "relatively" better than other currencies, like the Euro. Thanks to struggling countries like Greece, this is exactly what's come to pass as the dollar index has surged above both the 50-day and 200-day moving averages, which have now converged. It would be even more positive if the 50-day average would move convincingly above the 200-day average. The next resistance level looks to be around 82-83. We'll see if the dollar can continue to rally and crest that level. All of that being said, I remain convinced that ultimately, the dollar will roll over and head inevitably lower.

I've been saying for years that the price of gold would go inevitably higher but that this upward move would not happen in a straight line. I've said many times that there will be corrections and profit-taking, but that investors should not get scared out of their positions. Indeed, those corrections could be used to add to your holdings. The latest correction was about 15% over two months, and part of that was clearly due to the strength in the dollar. I would now look for gold to continue its upward trajectory.

Not surprisingly, since the price of silver had posted a greater percentage increase than gold over the past year, the recent correction was a deeper 25%. And like gold, corrections in sliver should be used to add to positions.

During the correction, the price of West Texas Crude fell below it's 50-day moving average and moved to the 200-day average. It then bounced right off a major support level at $70 (green line) before moving back up again. We'll see if the price of "black gold" can move above the most recent high of $83.95.

The chart of the price of copper shows the same 15% correction as the other commodities. To resume the bullish trend, the price will have to rise above $350.

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 right on 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 since last August. 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, then below the 200-day average. Like the financials, I think the housing market is headed for more problems.

Foreign markets, as represented by the MSCI EAFE index, look troubled after trading sideways since October. The index fell below the 50-day moving average and bounced off the 200-day average. It appears that there is major support around 50; a drop below that would be very bearish.

The Chinese market has traded sideways since last July. It is now below the 50-day average and sitting right on the 200-day average. To me, this is a very dangerous point and it could go either way. I wouldn't want to try to call this trade.

Over the past year, the Baltic Dry Index has had two huge bullish moves followed by similarly large corrections. As the RSI is now very oversold but moving up, and the moving average is negative but moving up, I believe we're on the cusp of the next move up. If this happens, the rise should take the index above 4,700.

The NYSE Bullish Percent Index represents the percentage of stocks listed on the NYSE that signal a buy. Contrarians would argue that extreme levels of exuberance is a bearish indicator, and vice-versa. Therefore, given the general bearish sentiment evidenced below, especially in the RSI, it suggests a bullish move could be forthcoming.

Finally, we can take a quick look at the volatility index, also known as the "investor fear gauge". It is not surprising that during the correction there was a spike in the VIX as the complacency vanished. I mentioned last month that the complacency "could be a contrary indicator for an upcoming pullback in the market." That certainly proved true. With the VIX now in the midpoint of the normal range, it's hard to divine any near-term trend. The VIX around 20 or so works fine for me.

What I'm Thinking and Doing

Personal News and Notes

Greg Werlinich
President

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