March 16, 2007

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

After feeling for months like Chicken Little, or the Boy Who Cried Wolf, my warnings about an impending market swoon finally came to pass, even as I was just beginning to believe that, at least on a technical basis, things were looking better than ever in the markets. The question now is how long will this correction last, and how severe the downward action will be. Will this just be a normal correction in a continued bull market, leading to even greater heights, or is this the beginning of a new bear market? Unfortunately, we can only know the answer to those questions after the fact. So for now, we watch and wait for more clues.

For the first time in almost a year, the current market analysis is very different this month. As of trading this morning, the Dow Jones Industrial Average is down about 5% from the high set about three weeks ago. The swoon was apparently precipitated by a trading crisis in China that knocked 9% of the value of their stock market in one day. In addition, the sub-prime lending market in this country is in death-spiral right now, and the full effects of this crisis are just beginning to trickle into the rest of the financial markets. Layer on to this concerns about our economy needs additional rate hikes to ward off inflation, a tight labor market, further weakness in the dollar and renewed concerns about the housing market and one could speculate that the market has a greater risk to the downside than opportunity to the upside right now.

I wrote last month, while the Dow was trading at about 12,740, that "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." Well take a look at the chart below and you can see the beginnings of a correction with the Dow now around 12,140. I also wrote that "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." So now that the trading range has clearly been broken, what's next? We still haven't had a 10% correction, which is long overdue. And we also haven't pierced the 200-day moving average. Of note is that the Dow has experienced three 90% down days, which are days when more than 90% of the trading action is to the downside. This generally portends more trouble down the road. To quote myself one final time from last month: "A correction of some magnitude is coming; it's just a question of time and degree."

After finally finally powering past 5,000 and setting a new high, the Transports plunged in sympathy with the rest of the market, and on a percentage basis, the Transports took a much bigger hit.

Next I want to show you two charts of the S&P 500. The first is a daily chart of the past two years and the second is a monthly chart of the action so far this decade. In the daily chart, you'll notice that even with this latest hiccup, the S&P is still in a solid upward trend, and has about 100 points to the downside before it violates this trend.

In the monthly chart, you can see that the recent action is barely a blip in the trend. It is worrisome that the RSI was very oversold, and continues to be oversold today, even after the drop. It would also be very bearish if the MACD drops below zero.

So what is the bond market telling us? It looks like a buying frenzy in Treasuries resulting from a "flight to quality" as investors flee equities and take shelter in the bond market. This action shaved a half a point off yields in about six weeks. It's interesting that much of the bullish movement in bonds preceded the stock selloff. So did the bond market see the correction coming, or was something else going on? Where was the buying coming from? It could simply be a case of excess worldwide liquidity looking for a safe place to go. To be honest, I don't know the answer. The good news is that the lower rates might provide some support to the mortgage and housing markets.

So, the upward trend has been pierced. Is this just a momentary respite in the running of the bulls, or are the bears ready to come out of hibernation? Time will tell, but the bears have been asleep for a long time and they are probably hungry, so watch out.

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. February was looking like a very good month, right up until two days before month-end, when a 415-point one day plunge ruined the party for everyone. Surprisingly, the worst performing index with the Dow. Small-cap stocks held up much better than large-cap, which is almost counter-intuitive to me. Not surprisingly, bonds were the best performing asset class.

Name of Index	Feb	QTD	YTD	Description
S&P 500	-2.18	-0.81	-0.81	Large-cap stocks
Dow Jones Industrial Average	-2.80	-1.56	-1.56	Large-cap stocks
NASDAQ Composite	-1.94	0.04	0.04	Large-cap tech stocks
Russell 1000 Growth	-1.88	0.64	0.64	Large-cap growth stocks
Russell 1000 Value	-1.56	-0.30	-0.30	Large-cap value stocks
Russell 2000 Growth	-0.32	1.54	1.54	Small-cap growth stocks
Russell 2000 Value	-1.23	0.25	0.25	Small-cap value stocks
MSCI EAFE	0.82	1.51	1.51	Europe, Australia, Far East
Lehman Aggregate	1.54	1.50	1.50	US government bonds
Lehman High Yield	1.40	2.53	2.53	High-yield corporate bonds

What I'm Doing Now

I haven't bought any new positions since I wrote to you last month, which in hindsight, was a very good decision. And while I'm always looking for an interesting security to buy, I'm perfectly content to sit tight right now and see what develops in the market before putting an meaningful cash to work.

At the same time, I haven't really sold anything meaningful either. While I am very content to stand pat with my core holdings, I have culled a couple of small, poor-performing stocks in order to raise additional cash. I will likely continue this until these small holdings have been fully liquidated for all of my clients. I'd like to have some "attack capital" available for some opportunistic purchases.

Statistics To Watch

The most recent four-week average for initial jobless claims, for the week ended March 10, rose to 329,250 from 326,250 four weeks ago.

According to the Department of Labor, non-farm payroll employment rose a modest 97,000 in February, which was a disappointing number, although the figures for the prior two months were again revised upwards. Average hourly wages rose to $17.16 from $17.09 as wages continue to rise slowly but steadily. The average workweek fell slightly to 33.7 hours. The number of people holding multiple jobs rose slightly to 7.75 million.

The number of unemployed workers fell to 6.9 million in February. The seasonally adjusted number of people, who for economic or business reasons, could only find part-time work, fell to 4.2 million and the number of marginally attached workers fell to 1.5 million. My Comprehensive Labor Index™ fell 40 basis points to 8.6% while the unemployment rate reported by the government fell to 4.5%.

The Conference Board reported that it's index of Leading Economic Indicators increased 0.1% in January after strong growth in December. Overall, the Leading indicator is lower than a year ago but suggests slow to moderate economic growth in the near future.

The University of Michigan Consumer Confidence Index fell back in February to 91.3 after surging to 96.9 in January. The greatest part of the loss of confidence came from lower income households in the midwest, who fear job losses from the manufacturing sector.

According to the CBO, the government posted a budget deficit of $123 billion in February. That resulted in a deficit of $165 billion for the first five months of the fiscal year, which was $52 billion better than a year ago. An increase in tax receipts was offset by a growth in Social Security, Medicare and Medicaid payments and tax refunds.

According to the Census Bureau, the U.S. trade deficit in January fell slightly to $59.1 billion in January, down from $62.1 billion in December. The weakening dollar will certainly help reduce our trade deficit.

The Labor Department reported that on a seasonally adjusted basis, the CPI for urban consumers rose 0.4% in February while the "core" CPI, which excludes food and energy, rose 0.2%. Rising energy, food and beverage and healthcare costs fueled most of the gain in CPI. The compounded annual growth rate in CPI for the past three months is 4.0%, which is higher than the Fed must be comfortable with. These numbers could stoke inflation concerns.

The Federal Reserve reported that the amount of outstanding consumer credit rose again in January, at a 3.25% annualized rate, to another new high of $2.41 billion. There seems to be no end to the appetite for spending with the American consumer.

According to the Census Bureau, retail trade and food service sales rose a paltry 0.1% in February from the prior month, and were up 3.2% from a year ago. Sales from the last three months were up 3.7% from the same period a year ago.

The Census Bureau reported that privately owned housing starts plunged 14.3% in January, and were down a massive 37.8% from a year ago, to a seasonally adjusted annual rate of 1.41 million units. The West and South were hit the hardest. Building permits were also down, but not quite as drastically.

The Census Bureau reported that on a seasonally adjusted annualized basis, sales of new homes in January dropped 16.6% from revised December levels, and were down 20.1% from the same period last year, to a projected 937 million units. The estimate of new homes for sale continues to drop, and is now down to 536,000, which represents 6.8 months of supply at the current rate of sales. The median sale price has firmed up at $239,800.

The National Association of Realtors reported that on a seasonally adjusted annualized basis, sales of existing homes in January rose 3.08%, but was 4.3% lower than the same period last year, to a projected 6.46 million units. The estimate of homes for sale, stable at 3.55 million, represents 6.6 months of supply at the current rate of sales. The median price of homes sold fell to $210,600, it's lowest figure in more than a year. The growth figure is therefore misleading, as that growth was simply brought about by sellers lowering their prices.

According to the Mortgage Bankers Association, the delinquency rate for mortgage loans on one-to-four-unit residential properties stood at 4.95% of all loans outstanding in the fourth quarter of 2006 on a seasonally adjusted basis, up 28 basis points from the third quarter, and up 25 basis points from one year ago. The foreclosure continues to grow at the same time.

Also according to the Mortgage Bankers Association, the most recent four-week average for mortgage loan application volume is up 2.0%. The recent decrease in interest rates may be spurring the growth in mortgage applications.

The Institute for Supply Management (ISM) index of manufacturing activity was 52.3 in February, up from 49.3 in December. Anything above 50.0 is considered to be an indication of growth. I'm not going to get too excited about one month. Let's see if this is the start of renewed growth or just a momentary burst of strength in a generally fading manufacturing sector.

The Bureau of Economic Analysis announced that the "preliminary estimate" of GDP growth for the fourth quarter of 2006 is 2.2%, versus the "advance estimate" of 3.5%. This brings the current GDP numbers much more in line with the 2.0% reported for the third quarter. With one more revision coming, my forecast of 1.5% no longer looks so bad.

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 0.4% in February after a 0.9% increase in January. The supply of M-2 has increased by 7.7% in the last three months and 5.6% in the last twelve months as the Fed continues to flood 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.

I really think that the overall economic picture is deteriorating slowly but surely. The manufacturing sector is tepid, housing is plunging, the yield curve is growing more inverted, inflation is likely much greater than is being reported, oil prices are firming and the Fed is manipulating the money supply to keep everything afloat. Other than that, everything is great. I continue to feel as though I'm spitting into the wind here as I appear to be one of the very few people concerned about that true state of our economy. Last month I said we were in a "Goldilocks economy" where the market was "priced for perfection, and it wouldn't take much to knock it off its lofty perch." I don't really believe that everything is "just right", but I'm clearly in the minority. Let's see if the picture becomes any clearer over the next few months.

Trends To Watch

The "Big Picture" of the market, represented by the Wilshire 5000, looks like the other major averages. After briefly breaking out of its strong trading range, the index has dropped right back into the thick of it. And while it got very close, the index never did reach its all time high of 14,991, set in early 2000. So again, the battle between the bulls and the bears is joined.

The price of a barrel of West Texas Crude has again dropped below $60, after rising as high as about $63 per barrel a week ago and is now trading right on its 200-day moving average. The trading in oil is again looking a little frenetic. The bottom line to me is that while the price can do virtually anything in the short run, I remain convinced that the price of oil will likely head inexorably higher, barring a worldwide recession. And while I cannot completely discount that possibility, even that would be just a temporary speedbump in the longer trend.

Since breaking out of the classic declining triangle pattern, which I show again in the first chart below, gold peaked just below $700 per ounce and is now consolidating. As the Fed continues to destroy the value of the dollar, and and as events around the world grow more uncertain, gold looks 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. The second chart, which shows the weekly movement of gold over more than four years, shows the unmistakable upward trend which isn't close to being violated. Don't try to trade this move; just build a position and sit with it.

Now let's take a look at the Dow Jones Commodity Index (which represents 19 physical commodities). The commodity index managed to briefly break above trend before falling back. It's important to note that it did not manage to surpass the December high during the rally, so 175 is still an important target. As I've said before, regardless of the short-term movement, I believe that commodities are in the midst of a long-term bull market.

After consolidating around 85, the dollar again appears to be weakening a bit. As the index makes ever lower lows and lower highs, things don't look good for the immediate future of the dollar. I do believe though that over time, the dollar will trend lower.

After being dead wrong about the action of the housing market, I was truly beginning to think I missed the boat on this trend, even though it made absolutely no sense to me that housing stocks would rally for any reason other than a "dead cat bounce". Maybe I wasn't so dumb after all. Granted, it's only been about six weeks of downward action after a seven month rally, things don't look so good. Some of this poor action can likely be attributed to the problems in the sub-prime lending market. But I think more importantly, investors are taking a hard look at the fundamentals of this sector and seeing that a lot of problems still remain. I wouldn't be at all surprised to see all of the gains lost as this index falls to new lows over the next few months.

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 5.11% (down slightly from 5.14% last month), 2-year Treasury yields have moved down to 4.58%, 10-year Treasury yields are now 4.54% while 30-year Treasury yields are down to 4.69%. So the inversion remains, and has gotten wider since last month. The spread between the 10-year Treasury and the 10-year TIPS is holding steady at around 2.35%, suggesting very little fear of inflation in the bond market.

Monthly Tip - Preventing Identity Theft

A friend of mine passed along this information to me a few weeks ago because he felt that it would be a great topic for my newsletter, and I agreed. The following are some tips, written by an attorney, that we can all use to help prevent identity theft. I hope you find this useful.

Do not sign the back of your credit cards. Instead, put "PHOTO ID REQUIRED".
When using checks to pay your credit card bills, DO NOT put the complete account number on the "memo" line. Instead, just put the last four numbers. The credit card company knows the rest of the number, and anyone who might be handling your check as it passes through all the check processing channels won't have access to it.
Put your work phone # on your checks instead of your home phone. If you have a PO Box use that instead of your home address. If you do not have a PO Box, use your work address. Never have your SS# printed on your checks. You can add it if it is necessary but, if you have it printed, anyone can get it.
Make a photocopy of the contents of your wallet. Copy both sides of each license, credit card, etc. Then you will know what you had in your wallet as well as all of the account numbers and phone numbers needed to call. Obviously, keep the photocopy in a safe place. It's also a good idea to carry a photocopy of your passport whenever you travel.

Even if you take every reasonable precaution, someone may still steal your identity. So here are some tips as to how to limit the damage in case this happens to you or someone you know:

We all know that if they are lost or stolen, we should cancel our credit cards immediately. But the key is having the toll-free numbers and your card numbers handy so you know whom to call.
File a police report immediately in the jurisdiction where your credit cards, etc. were stolen. This proves to credit providers you were diligent, and this is a first step toward an investigation (if there ever is one).
Most importantly, call the 3 national credit reporting organizations immediately to place a fraud alert on your name and also call the Social Security fraud line number. The alert means that any company that checks your credit knows your information was stolen, and they have to contact you by phone to authorize new credit.

Now, here are the numbers you always need to contact about your wallet, etc, has been stolen:

Equifax: 1-800-525-6285
Experian (formerly TRW): 1-888-397-3742
Trans Union : 1- 800-680-7289
Social Security Administration (fraud line): 1-800-269-0271

Personal News and Notes

That about wraps things up for this month's newsletter. Mother Nature has thrown us quite a curveball this week. After teasing us with temperatures close to 70 degrees only two days ago, the Northeast is now being slammed with a severe snow and sleet storm. I am SO ready for spring.

On a happier note, I am celebrating the 10th Anniversary of WAM this month. It's hard to believe that I formed my company ten years ago this month, then started taking clients in September. From those meager beginnings WAM now works with about forty clients and manages more than $55 million. I want to thank all of my current, and future, clients from the bottom of my heart. It has been a great first ten years, and I'm looking forward to an even better second ten.

I started writing my newsletter almost four years ago. I sent my first effort out to a few dozen people. Today, News and Views goes out to over 1,100 readers. I hope you enjoy reading it each month and that you learn something every now and then. Thank you for your continued interest and I look forward to being of service to you sometime soon.

Best regards,

Greg Werlinich
President