Werlinich Asset Management, LLC
400 Columbus Ave.
Valhalla, NY 10595

   March 4, 2005 Comments   |   Refer A Friend   |   Sign Me Up   

As promised, the chapter entitled "Sector Rotation Investing" that I contributed for The Black Book on Personal Finance has been completed and published and is finally available for sale. I invite you to read a short excerpt by going to the Personal Tip section below. Afterwards, please read the Personal News and Notes at the bottom for more information on how you can order either the ebook of the individual chapter, or the entire book. Thank you.

Market Analysis...Better Than Expected
What I'm Doing Now...Adding To Strength
Statistics...What To Believe?
Things To Watch
Monthly Tip...My Book Excerpt
Personal News and Notes

Market Analysis...Better Than Expected

The first two months of the year have defied both prediction and description. The strong gains in February almost wiped clean the losses from January. So where does that leave us? As I write this morning, the Dow is currently above the prior closing high of 10,854.54 set on December 28, 2004 and rising strongly. If it remains above that price at the closing bell, that would be a positive indication for the market. I would also like to see some of the other averages, like the Dow Transports and maybe the S&P 500 make similar highs. In any event, it would still be a fairly bullish indication.

At least temporarily, it appears that the linkage between the price of oil and the fortunes of the Dow seems to have been severed. Oil has surged to as much as $53 per barrel, yet the Dow continues to rise. My expectation that the Dow would fall if oil punched through $50 was wrong. We'll see what happens when oil gets to $60 per barrel. How well will the economy do when it costs over $50 each time you fill your gas tank, or when it costs twice as much to heat your house? We're going to find out in the not-too-distant future.

Let's not forget interest rates. I wrote last time about the strength in the bond market and my surprise that rates had again fallen so low. I suggested that "it is counter intuitive to me to have rates this low with so many factors arrayed to drive rates higher." Well, my thinking may yet prove to be correct. Take a look at the following chart of the yield on the 10-year Treasury bond. It shows that, in the past month rates have increased from just below 4.0% to about 4.35% today. That can't be good for the mortgage business, or by extension, the housing market. Yields have traded in a range of 4.0% - 4.5% since last August. Keep a close eye on these numbers to see if we break above this range.

As always, I provide the following chart to show the raw results for the month, the quarter-to-date and the year-to-date. What's instructive to notice is that growth, and it's primary proxy, the Nasdaq, is lagging behind the broader market and that the strongest areas are value and international. An environment of caution and concern would reasonably lead people to lean towards value and alternative investments.






S&P 500




Large-cap stocks

Dow Jones Industrial Average




Large-cap stocks

Nasdaq Composite




Large-cap tech stocks

Russell 1000 Growth




Large-cap growth stocks

Russell 1000 Value




Large-cap value stocks

Russell 2000 Growth




Small-cap growth stocks

Russell 2000 Value




Small-cap value stocks





Europe, Australia, Far East

Lehman Aggregate




US government bonds

Lehman High Yield




High-yield corporate bonds

What I'm Doing Now...Adding To Strength

At the risk of sounding like a broken record, my investment stance remains unchanged. In fact, after two and a half years of very strong results, I'm more convinced than ever that my investment posture is correct. In fact, I have been selectively adding to my positions in the energy, defense and commodity sectors over the past few months. As interest and dividends accumulate, I use that money to purchase other income producing securities, thereby increasing the overall yield on my investments. Don't forget that historically, dividends produced about 60% of the average annual return from owning stocks. It is very hard to compound your money with investments that produce no income.

Statistics to Watch...What To Believe?

  • January was another month of modest job creation, with only 146,000 new jobs created. That's less than the 175,000 per month average that the White House needs to hit its target of 2.1 million new jobs in 2005. Average hourly wages rose two pennies this month, to $15.88. The average workweek fell slightly to 33.7 hours.
  • The number of unemployed workers dropped significantly to 7.7 million. Similarly, the number of part-time workers dropped a bit to 4.4 million while the number of "marginally attached" workers rose to 1.8 million. These figures caused my "underemployment rate" to jump to 9.9%, while the official unemployment rate reported by the government fell to 5.2%. Personally, I don't trust the government figures at all. I think it substantially under reports the true number of people out of work.
  • There are 7.2 million people reported as holding more than one job, a small decrease from last month.
  • Not surprisingly, the four-week average for initial jobless claims has fallen significantly to 308,250.
  • The University of Michigan Consumer Confidence Index rose fell slightly to 95.5. The American consumer continues to "shop 'till they drop".
  • According to the Congressional Budget Office (CBO), the federal deficit for the first four months of fiscal 2005 was $106 billion after posting a small surplus in January.
  • According to the Census Bureau, the U.S. in December recorded another huge trade deficit of $56.4 billion. That is the second largest monthly deficit ever, surpassed only by December. That left the annual trade deficit at a whopping $617.7 billion. The deficit was only $496.5 billion in 2003.
  • 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 0.1% in January on a seasonally adjusted basis, while the "core" CPI, which excludes food and energy, rose 0.2%. You can be sure the CPI will rise faster in February due to rising energy costs.
  • The Federal Reserve reported that total outstanding consumer credit rose slightly in December to a mammoth $2.103 trillion. This matches the highest levels of consumer credit ever reported. In fact, there has been an increase of about $600 billion in consumer credit since December 1999.
  • Somewhat surprisingly in the face of a rising stock market, the American Association of Individual Investors' (AAII) bullish sentiment is at a very low 31.8%. The average investors continue to be less sanguine about the market than the "experts".
  • Retail same store sales were up 4.9% in February after being up 3.6% in January. These strong results are not surprising with low interest rates and the growing personal debt load. The question is how much longer this can continue.
  • The Census Bureau reported that on a seasonally adjusted annualized basis, sales of new homes were about 1.106 million in January, down about 9% from January, and down about 4% from a year ago. We'll see if this trend continues.
  • The National Association of Realtors reported that on a seasonally adjusted annualized basis, sales of existing homes were about 6.8 million in January, down 0.1% from December, but still up 13.7% from a year ago. Again, we'll see if this downward trend continues.
  • The Institute for Supply Management (ISM) index of manufacturing activity for January was 56.4, down from 58.6 in December. This marked the seventh consecutive month that the index remained below 60.0. So the economy continues to grow, but grow slowly.
  • After hitting a low price of $975,000 in January, the New York Stock Exchange reported that a membership seat was sold for $1.5 million this week. That's a bullish indicator.

So what does all this mean to you? Similar to last month, it means that jobs are being created, albeit too slowly. It means that people are working as much as they can but spending more than they earn. It means that regular investors remain cautious while the pros continue in their unwavering optimism. It means that while the economy seems to be doing well, thanks to the efforts of Greenspan and Co., danger signs lurk around the corner. Therefore, notwithstanding the fact that the Dow managed to close today at its highest level since June 2001, I continue to be "cautiously pessimistic" for the full year.

Things To Watch

I have spoken a lot about the trading range of the Dow. Today the Dow closed at 10,940 which is very close to 11,000. Let's see what happens next. This move could be very important.

4th quarter GDP growth was 3.1% on an annualized basis, down from 4.0% in the 3rd quarter. It will be interesting to see what the 1st quarter of this year looks like. Anything much below 3% will be worrisome.

The Labor Department reported that productivity growth in 2004 was 4.1%, down from 4.4% in 2003. As productivity declines, labor costs should eventually increase, reducing corporate profits.

A major theme for 2005, which I forgot to mention in my forecast issue in January, will be Mergers & Acquisitions and de-mergers. Watch for the big mergers (SBC-AT&T, Verizon-MCI, P&G-Gillette) as companies try to achieve economies of scale and use their cheap currency (cheap debt and overvalued stock) to buy revenues. Similarly, watch out for announcements of companies shedding non-core businesses (Citigroup is a prime example) in the hopes of increasing their margins and earnings growth. I believe the latter will be better for investors than the former, but time will tell.

I mentioned last month that "gold spent most of 2004 trading sideways and that 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." Well, it appears that the ascent may have begun. March gold is up to $435 an ounce. Let's see if this rally has legs.

After a sharp rally to about 1.27, the dollar has resumed its slide. Today it closed at 1.32 to the Euro and is not far off the lows set during the end of December.

Oil prices are also hitting new highs. April oil closed today at $53.78.

The yield on the 10-year Treasury closed at 4.31%.

All of these numbers tell me that we are in for trouble somewhere down the road in the not-too-distant future. But for today, "don't worry, be happy."

Monthly Tip - Book Excerpt

Thanks to a bit of shameless self-promotion, there will be no Tip this month. Instead, I will offer an excerpt of the chapter that I wrote for "The Black Book on Personal Finance". The chapter is entitled "Sector Rotation Investing" and describes my investment philosophy and methodology. I hope this little teaser will prompt you to purchase either the chapter or the entire book. Instructions on how to do so are given in the Personal News and Notes section below. In any case, I would love to hear your comments, so let me know what you think.

~ ~ ~ ~ ~ ~ ~ ~ ~ ~

"Set aside your pre-conceived notions of investing for the long run through traditional asset allocation models. As we have learned since the end of 1999, stocks don't always go up. Strategies like "buy on the dips" that worked for the prior 25 years are not appropriate in today's dynamic and volatile market. It's time for a new approach...

Rather than focusing on the hot trend or trying just to "beat the market," investors should concentrate their efforts on crafting an investment strategy that can yield appropriate real, or "absolute" returns, year in and year out...

Too often, investment professionals talk about their performance in relative terms...Even financial planners or investment advisors (like me), who try to focus more on long-term goals and objectives, are often judged by our clients on our short-term performance relative to a particular benchmark. The problem is that this methodology rewards relative, not absolute, performance, and this can lead to mediocrity...

At the end of the day, you should be more concerned with the absolute return on your investments...not whether you were able to beat some index that may or may not have any real bearing on your investment philosophy...

It's time to develop a new outlook and a new investment strategy that can make real money in good years and protect your from large losses in bad times. That strategy is dynamic sector rotation investing...

Broadly speaking, a sector is an industry classification. It describes the industry or country in which a particular company operates. Sectors can be country specific (like investing in China) or industry specific (like investing in oil and gas companies). Every publicly traded security...can be slotted into a sector...

When you are ready to develop a sector-based investment strategy, you must first choose the sectors in which to invest, then select the investments that will populate those sectors...With a sector-based approach, rather than maintain prearranged asset class weightings, you will invest the majority of your assets in those sectors of the market that you believe will generate positive results given the current market conditions...

The key to this form of investing is doing it properly. As with any strategy, be in market timing, indexing or classic asset allocation, if it isn't done well, your returns will suffer. Sector rotation investing requires the investor to be aware of the economic and political forces that shape the current and future investment climate and invest accordingly. These forces are dynamic. Therefore, the investment strategy must be similarly dynamic...

So why is this important to you? To be honest, in good times, it might not be so important. When the stock market is going up, a rising tide tends to lift all boats. On the other hand, this strategy gains in importance during the rough times that we face today and possibly for the next few years. We are talking about your money here. This is neither an abstract concept nor a theoretical discussion. These are the funds you are setting aside to pay for college, weddings, homes, vacations, health care, retirement, or future generations.

Let me be very clear: losses on paper are real losses. If you buy a stock at $50 and hold it while it drops to $25, you have lost 50% of your money, regardless of whether or not you sold that stock. You will still need to double your money just to get back to break-even.

Therefore, you need to take the steps necessary to avoid the big losses whenever possible. One way to do that is to invest in those sectors of the market that have the greatest chance of yielding positive returns at any given time and to also invest in other sectors that will offer the greatest protection during difficult times...

This uncommon approach puts me in the minority of professional investment advisors, most of whom adhere to the traditional asset allocation methodology. It is my experience that most individual investors do too. As I mention [earlier], there is nothing inherently wrong with a general asset allocation strategy because it's certainly better than no strategy at all and it can work fairly well in a bull market.

At its core, sector rotation investing is about being aware of the factors that shape the direction of the economy and the stock market, forming an opinion about the near- and long-term direction of the general market, forecasting sectors that will outperform during that period of time, then devising a strategy to profit from that anticipated movement. Simple, right? Not really; the devil is in the details."

~ ~ ~ ~ ~ ~ ~ ~ ~ ~

I hope this short excerpt has whet your appetite for the entire chapter. Please see below for details on how to purchase and download the ebook or order the entire "Black Book on Personal Finance".

Personal News and Notes

After months of waiting, The Black Book on Personal Finance is finally done. I actually have 500 copies of the book sitting in boxes in my office to prove it. In addition, my publisher promises me that their website is up and ready to take your orders. The suggested retail price for the e-book is $19.95. As a special accommodation to my readers, I have negotiated for each of you a 20% discount off the list price. To purchase the chapter, please click here to visit the publisher's website. When you are asked for a priority code, type in "WAM" (this must be in all caps). From there, just click the "buy now" button and follow the instructions. I am very pleased with the chapter and I'm confident that you will find reading it to be time and money well spent.

After two very good years in a row, 2005 has started out in spectacular fashion for WAM and its clients. 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. I will extend for one more month the offer of a FREE 30-minute consultation or portfolio review (a $50 value) that I made in my January newsletter. The initial consultation is completely free and without any obligation, so you have nothing to lose and potentially much to gain. The offer ends March 31. 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, feedback on "Sector Rotation Investing" or if I can be of service to you in any way.

Best regards,

Greg Werlinich

Copyrightę 2005, Werlinich Asset Management, LLC and All Rights Reserved.