Current Market Analysis

It has been a devastating five weeks in the economy and the stock market since I last wrote to you. The final bit of constructive market action, that the Dow Jones Industrial Average had held above the November lows, has been smashed as the Dow has plunged to levels not seen since 1997. Twelve years of stock market gains have been erased by the Bear. Confidence in the policies of the new administration is rapidly eroding. New scams like Bernie Madoff and Allen Sanford are popping up almost every day with investors losing untold billions of dollars. Consumer confidence is all but nonexistent and investors are fleeing the market in droves.

According to Dow Theory, we are now in the midst of a Bear Market with no discernible end in sight. This call was made recently when both the Industrial Average and Transportation Average broke to new lows at the same time. This weak action is reinforced by the lack of any real buying power in the face of unrelenting selling pressure, much of which by short-sellers. The one positive to point to, if it is a positive at all, is that things have gotten so bad, that the market is so oversold, that we are due for a strong Bear Market rally. So now let's look and and see what the charts tell us.

The daily chart of the Industrials shows the recovery from the November 20 low and the creation of a trading range between 8,000 and 9,500, or even 9,000 if you shorten the time frame. Then we see the painful drop over the past month, breaking below the November low and the 7,450 low of October 2002. In fact, we're now plumbing lows not seen since April 1997. And the problem is that, on a technical basis, as we can see more clearly on the monthly chart below, there is simply no immediate support level from this point.

The monthly chart shows the lack of any discernible support level from this point. The only "good news" is that the market is massively oversold, more so than any point in the past 16 years, and is therefore due for a bounce, and it could be a big one.

The Transportation average has confirmed the negative action of the Industrial average, and therefore according to Dow Theory, a Bear Market is ongoing. As the Transports are often viewed as a leading indicator of economic activity, it is also confirming the continuing recession.

It would appear that the "bond bubble" has indeed burst. If yields haven't fallen dramatically in the face of losses in the equity markets, then there must be something very wrong here. Treasury bond holders are experiencing painful losses on their positions so far this year. Over time, I expect those losses to grow as yields continue to rise.

Last month I suggested that one bit of good news was that the panicked "flight to safety" of t-bills was starting to abate. This month it appears that the panic is returning as the yield has fallen in half over the past month. While better than 0.0%, a yield of 0.125% is still absurdly low.

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 28 was 639,000. A year ago that figure was about 344,000. The four-week average is now 641,750.
• Non-farm payroll employment fell by a whopping 651,000 in February. The January and December losses were revised down an additional 161,000. In addition, the total jobs lost in 2008 were revised down by an additional 385,000, bringing the total number of jobs lost last year to 3.078 million. Average hourly wages grew fractionally to $18.47, and the average workweek remained steady at 33.3 hours, so real wages are stagnating.
• The number of workers reported in February as unemployed rose to 12.5 million, bringing the unemployment rate to 8.1%. This is the highest unemployment rate in 25 years. The seasonally adjusted number of people who could only find part-time work rose to 8.6 million and the number of marginally attached workers held steady at 2.1 million. The number of people holding multiple jobs rose to 7.68 million. My Comprehensive Labor Index™ rose to 17.34%. My CLI™ is much closer to the true unemployment number. I wouldn't be surprised to see the CLI™ at around 20% later this year.
• Calculating the federal deficit, already a quagmire, has gotten worse due to the Troubled Assets Relief Program (TARP). Now the CBO is reporting the deficit on a cash and adjusted basis. The CBO estimates that on a cash basis the Treasury will report a federal budget deficit of $563 billion for the first four months of fiscal year 2009, whereas adjusted for net present value the deficit would be $335 billion.
• According to the Census Bureau, the U.S. trade deficit in December was $39.9 billion, down a bit from $41.6 billion in November, as imports continue to fall faster than exports. The total deficit of goods and services for 2008 was $667 billion.
• The Census Bureau reported that privately owned housing starts dropped 16.8% in January, following a 15.5% decline in December, and was down a stunning 56.2% from a year ago, to a seasonally adjusted annual rate of 466,000 units. New building permits were also down 4.8% from last month and 50.5% from last year. The market must continue to clear out excess inventory.
• In February, the National Association of Homebuilders/Wells Fargo Confidence Index, which was created in 1985, inched back to 9, up from the all-time low of 8 set last month. Essentially, home builders remain bleakly pessimistic.
• The Census Bureau reported that on a seasonally adjusted annualized basis, sales of new homes in January fell 10.2% from the prior month and 48.2% from the same period last year, to a only 309,000 units. The estimate of homes for sale is down to 342,000, which represents an incredible 13.3 months, or more than a year of supply at the current rate of sales. The median sales price fell to $201,100 and remained below the steadily falling 12-month moving average price of $227,508.
• The National Association of Realtors reported that on a seasonally adjusted annualized basis, sales of existing homes in January decreased 5.3% from the prior month, and were down 8.6% from the same period last year, to a projected 4.49 million units. The estimate of homes for sale, at a reduced 3.6 million, represents 9.6 months of supply at the current rate of sales. The median sales price fell further to $170,300, which remains below the steadily falling 12-month average of $194,825.
• 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, fell to 162.17 in December, the lowest level since January 2004.
• According to RealtyTrac, foreclosures decreased by 9.6% in January to 274,399, but remained 18% higher than a year ago. Nevada, California and Arizona, respectively, reported the highest foreclosure rates in the country while California had the highest actual number of foreclosures.
• The Institute for Supply Management (ISM) index of manufacturing activity crept up to 35.8 in February. This was the thirteenth straight month in which the manufacturing sector failed to grow. Any number below 40 suggests a serious recession. The ISM index of non-manufacturing activity was a slightly better 41.6.
• The Conference Board reported that it's index of Leading Economic Indicators rose in January for the second consecutive month, but November and December were revised downward. The January increase of 0.4% was due in large part to the massive monetary stimulus. The outlook for the economy continues to be poor.
• According to the Bureau of Economic Analysis, the "preliminary" estimate of GDP growth in the fourth quarter of 2007 was -6.2%, which is much worse than the "advance" estimate of 3.8%, but is in line with the estimates of between -5% and -7%. GDP growth in the third quarter was -0.5%, down from 2.8% in the second quarter and 0.9% in the first quarter. The second quarter "growth" was an illusion thanks to a federal stimulus program.
• The Federal Reserve reported that in November the amount of outstanding consumer credit fell 0.3% from the prior month, to $2,562 billion. That means that consumer credit has declined in four of the last five months. That's good for consumers, bad for the economy.
• According to the Census Bureau, retail trade and food service sales rose 1.0% in January, bu was 9.7% worse than a year ago. This breaks a streak of six consecutive months in which retail trade and food service sales fell on a month-over-month basis. My guess is that this increase is primarily due to huge price reductions and rebates.
• Given the decreases in credit and retail sales, it should come as no surprise that the personal savings rate, which for a long time had been negative, was up to 5% in January.
• The Fed increased the supply of M-2 by 16.6% and M-1 by 27.1% in the last three months. While these numbers are down a bit from last month, they still show a tremendous amount of monetary expansion as the Fed desperately tries to resuscitate the economy and avoid a depression. So far, their efforts do not appear to be working.
• The Conference Board Consumer Confidence Index plunged from 37.4 to 25.0 in January, which marks a new all-time low. This lack of confidence is driving people to save rather than spend.

The downward trend in the financial sector remains in force as no amount of federal assistance seems to help the bank stocks. Citigroup is trading for $1.00!! The index continues to fall to increasingly lower lows while rallying to increasingly lower highs. This is very bad action. I would avoid this sector like the plague until the trend is broken.

Last month I said that the rally in housing was "premature" and that I expect this sector to test the November lows before rallying above the recent high of around 94. The housing numbers are so bad, it's hard to make a bullish case for the sector just yet." Well, the housing index is indeed testing those November lows. I expect new lows to be made before I write to you again next month.

Don't look now, but the price of West Texas Crude is beginning to firm up. After bottoming at the end of last year we've entered a new range between $35 and $45. If the price can rise above $46 per barrel, it will break the trend of lower high prices, setting the stage for the rally I've been waiting for. The slightest increase in demand could set off a strong price increase thanks to a dramatic reduction in supply.

Last month I said that the price of gold was quietly trending higher and could test the $1,000 level. As you can see, gold did in fact trade over $1,000 per ounce, albeit briefly, before falling back to almost $900. While the price call fall a bit further before consolidating for a while, I believe the long-term trend will take the price even higher.

Don't look now, but copper prices are rising again. After plunging almost 70%, Dr. Copper appears to be on the mend. We'll see if this is a short-term correction or a glimpse of better news in the future as demand from China begins to rebound.

Another example of worldwide economic activity is the Baltic Dry Index. The BDI measures the demand for shipping capacity versus the supply of dry bulk carriers and indirectly measures global supply and demand for the commodities shipped aboard dry bulk carriers, such as cement, coal, iron ore and grain. After a horrific plunge of more than 90%, the index has more than tripled over the past two months, suggesting that global commerce is beginning to pick up again.

As conditions around the world deteriorate even faster than our own moribund economy, the dollar continues to be a "safe haven". Amazingly, the dollar has risen to a three-year high. In the short-run, I expect this trend to continue. Longer-term, I expect the dollar to head back down.

Foreign markets, as represented by the MSCI EAFE index, continue to be very weak, with no end in sight. The U.S. markets continue to outperform their foreign counterparts.

While most of the rest of the world markets head lower, the Shanghai Composite has actually moved up over the past four months. Maybe the Chinese government could teach the Obama administration a thing or two about how to implement a stimulus program.

The NYSE Bullish Percent Index was invented in 1955 by a group now known as Investors Intelligence. The index is calculated by reading either a buy or a sell signal from the point and figure chart of each of the 2800+ stocks on the New York Stock Exchange each evening. The value of the index represents the percentage of stocks listed on the NYSE that signal a buy. Right now, not surprisingly, the index does not suggest much bullishness.

After almost returning to a "normal" range at the beginning of January, the VIX, or "investor fear gauge", is again rising to very fearful levels. We simply need the markets to calm down.

What I'm Thinking and Doing

Greg Werlinich
President

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