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

April 19, 2007

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

Current Market Analysis

Last month I asked "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?" The short-term answer seems to be not very long and not very severe and that the bull remains in charge. As of the close of trading yesterday, the Dow set a new closing high of 12,803.84, with an intra-day high of 12,838.46, breaking the previous high of 12,786 set less than a month ago. Most of the technical indicators appear favorable for the market to steam ahead to further highs. And although I remain leery about the future of the economy, I'm not willing to fight the tape. So for now, let's enjoy the gains.

When I wrote last month, the Dow had plunged nearly 700 points in a few weeks to a low of about 12,110 after its nearly parabolic rise to 12,795. Since then, the subsequent rise has been almost as swift as the decline and the Dow is again powering to new highs. So obviously my fears of a major market correction were, at best, premature and at worse, unfounded. At no time during the correction did the Dow fall below its 200-day moving average and the RSI was only barely oversold when the rally commenced. Since it does not yet appear oversold, RSI suggests that there may be some room left to run before this rally cools off.

Much like the Industrials, the Transports have recovered most of their losses during the recent rally. As long as both indices continue to move upward, the good times should continue.

Next I want to again 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 the S&P has not only recovered all of the losses from the correction and remains in a solid upward trend, but it has established a new high for the year. And like the Dow Industrials, the S&P remains above both moving averages and yet is not oversold according to its RSI. These are all good indicators.

In the monthly chart, you can see that the recent correction was barely a blip in the trend. While I'm concerned that the RSI remains oversold, the action on the MACD is less worrisome. Most importantly, the S&P appears poised to surpass its all-time high set in early 2000. That would be very bullish.

So what's happening in the bond market? Whereas February brought us a "buying frenzy" in Treasuries when investors fled equities, March turned those buyers into sellers as investors put their money right back into equities. The chart below clearly shows this whipsaw action. So what does this tell us? Honestly, I don't know. I do believe that over the long term (which in this case means by the end of the year) I expect Treasuries to be priced higher than they are today, which means that yields will be slightly lower, and will test the 4.4% low end of this trading range.

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. March proved to be a fairly good month, helping to erase some of the losses from the late February swoon. In fact, thanks to the rally, most of the major averages ended the quarter in positive fashion. Interestingly, the foreign markets continue to out pace the U.S. averages. 

Name of Index





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

Statistics To Watch

  • The most recent four-week average for initial jobless claims, for the week ended April 7, fell to 323,250 from 329,250 four weeks ago. This figure has held fairly steady so far this year.
  • According to the Department of Labor, non-farm payroll employment rose by 180,000 in March, which is better than the revised 113,000 number in February, but still less than robust. The service sector generated most of those gains. Average hourly wages rose to $17.22 from $17.16 as wages continue to rise slowly but steadily. The average workweek increased slightly to 33.9 hours. The number of people holding multiple jobs rose slightly to 7.81 million.
  • The number of unemployed workers fell to 6.7 million in March. The seasonally adjusted number of people, who for economic or business reasons, could only find part-time work, rose to 4.4 million and the number of marginally attached workers fell to 1.4 million. My Comprehensive Labor Index™ fell to 8.5% while the unemployment rate reported by the government fell to 4.4%.
  • The Conference Board reported that it's index of Leading Economic Indicators decreased 0.5% in February after a revised decrease of 0.3% in January. The Leading Index has been flat to declining in nine of the last twelve months, suggesting slow to moderate economic growth in the near future.
  • The University of Michigan Consumer Confidence Index fell to 88.4 in March from 91.3 in February. General concerns about price increases and the fragile health of the economy stoked most of the fears.
  • According to the CBO, the government posted a budget deficit of $95 billion in March. That resulted in a deficit of $257 billion for the first six months of the fiscal year, which was $46 billion smaller than a year ago.
  • According to the Census Bureau, the U.S. trade deficit in February was $58.4 billion in February, down slightly from $58.9 billion in January. I would expect to see this deficit reduce further as the dollar diminishes in value.
  • The Labor Department reported that on a seasonally adjusted basis, the CPI for urban consumers rose 0.6% in March while the "core" CPI, which excludes food and energy, rose only 0.1%. Rising energy costs fueled all of the gain in CPI.
  • The Federal Reserve reported that the amount of outstanding consumer credit rose by only 1.5% in February, to remain at about $2.41 billion. One month is does not make a trend, so we'll see what happens over the next few months to see if the American consumer is truly cutting back or not.
  • According to the Census Bureau, retail trade and food service sales rose a more robust 0.7% in March from the prior month, and 3.8% from a year ago. Sales from the last three months were up 3.2% from the same period a year ago. If the consumer credit numbers are to go down, these numbers will likely have to come down also.
  • The Census Bureau reported that privately owned housing starts inched up 0.8% in March from a revised lower February figure, but was still down 23% from a year ago, to a seasonally adjusted annual rate of 1.52 million units. New building permits showed very similar results.
  • The Census Bureau reported that on a seasonally adjusted annualized basis, sales of new homes in February dropped 3.9% from revised lower January levels, and were down 18.3% from the same period last year, to a projected 848 million units. This is the smallest number of new homes sold since I started tracking this statistic more than three years ago. The estimate of homes for sale is now 546,000, which represents a whopping 8.1 months of supply at the current rate of sales. The median sale price rose to $250,000.
  • The National Association of Realtors reported that on a seasonally adjusted annualized basis, sales of existing homes in February rose 3.9%, but was 3.6% lower than the same period last year, to a projected 6.69 million units. The estimate of homes for sale, up to 3.75 million, represents 6.7 months of supply at the current rate of sales. The median price of homes sold inched up to $212,800. Sales in the Northeast accounted for almost all of the gain.
  • According to RealtyTrac, foreclosure filings were up 7% in March from revised February figures, and a whopping 47% from a year ago. California, Florida, Texas, Ohio and Michigan accounted for 50% of the nation's total.
  • Also according to the Mortgage Bankers Association mortgage loan application volume continues to hold fairly steady.
  • The Institute for Supply Management (ISM) index of manufacturing activity was 50.9 in March, down from 52.3 in February. The trend of the last few months clearly shows that manufacturing activity in this country is slowing and that the economy is slowing along with it.
  • The Bureau of Economic Analysis announced that the "final estimate" of GDP growth for the fourth quarter of 2006 was 2.5%, versus the "preliminary estimate" of 2.2%, and the "advance estimate" of 3.5%. GDP growth in the third quarter was 2.0%. This means that the annual GDP growth in 2006 was 3.3%.
  • Also according to the BEA, personal savings was estimated to be negative $119.6 billion in February, or 1.2% of personal disposable income. Negative savings has now continued unabated since sometime before 2005. This is not sustainable; sooner or later Americans must begin to save some money.
  • The Fed increased M-2 by 0.8% in March after a 0.4% increase in February. The supply of M-2 has increased by a huge 8.4% in the last three months and 6.1% in the last twelve months as the Fed opens the monetary spigots even further. 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 very bullish. It has already exceeded the high of 14,828 from the last rally and appears poised to move above 15,000, which would surpass its all time high of 14,991, set in early 2000. As long as it remains above its 200-day moving average, and above the recent low, the bullish trend should remain in force, although RSI is approaching an overbought status.

Before I say anything, let me reiterate that I am very bullish on the price of oil, and on the energy sector in general. That being said, the chart below shows the price of West Texas Crude to be forming an inverted "head and shoulders" pattern (see the image formed where I've drawn the blue lines). If the right shoulder were to completely form itself, we could easily see prices again rise past $70 per barrel, which I expect to happen at some point in the not-too-distant future. While I expect prices to consolidate for a while, and possibly drop (which it could do to as low as $57 without violating the pattern), I believe that prices are heading inevitably higher.

Let's now take a look at gold. I started putting my clients into gold back in 2002, when the price was about $270 per ounce, and I have continued to add to this position at various times since then. I think the two charts below are very instructive. The daily price chart, shown immediately below, first shows gold breaking out of a classic declining triangle pattern (the blue lines) as it began a clear upward trend (the purple lines). While I'm sure that the price will consolidate and likely fall a bit near-term, I believe that over the long-term, the price of gold is headed 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 since the beginning of the decade, shows the unmistakable upward trend which isn't close to being violated. I find it very interesting to see how the price of gold has hugged its 50-day moving average for much of this period. As I've said before, don't try to trade this move; just build a position and sit with it.

Not surprisingly, with oil and gold (not to mention most other hard assets like silver and copper) in solid uptrends, the Dow Jones Commodity Index (which represents 19 physical commodities) is again moving higher. Like gold, it broke out of a declining triangle pattern and is now in a new uptrend and butting against the December high. I've also drawn lines at 1.0 and -1.0 in the MACD section. Each time the average hit those levels, the price reversed quickly and moved strongly the other direction. Just something to pay attention to. That being said, 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.

So how is the dollar doing? The answer is clearly not very well. For move than a year the dollar has been in a clear downtrend, making increasingly lower highs and lower lows. This is very good for the trade deficit (as our goods become cheaper to export) but bad for foreign investors (who continue to lose money on the dollar denominated investments). After consolidating at around 85, the dollar has steadily weakened. The RSI is right at the oversold level, suggesting that we could have a short-term rally. Ultimately, I do believe that the dollar will continue to trend lower.

So what is happening in housing? I'm sure that things will continue to get worse for a while before there is any meaningful improvement. The housing index has now re-traced about 50% of the gains from the last rally. This is an important spot. The right shoulder of a head and shoulders pattern may be forming right now. I said last month that "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." I'm sticking with that prediction.

Finally, let's look at the yield curve, which remains inverted. The Fed Funds lending rate is holding at 5.25%. 6-month t-bills now yield 5.04%, 2-year Treasury yields are 4.64%, 10-year Treasury yields are now 4.65% while 30-year Treasury yields are up to 4.82%. So the inversion remains, but has tightened a bit, especially on the long end. The spread between the 10-year Treasury and the 10-year TIPS remains steady at around 2.35%, suggesting very little fear of inflation in the bond market.

Monthly Tip - Saving For College (reprinted from October '03)

For many parents, paying for college education is one of the most daunting financial burdens they will bear. Fortunately, there are many options available now that provide incentives to save for college. Chief among these options, which include prepaid tuition programs, Coverdell Education Savings Accounts (formerly known as Education IRA's), classic and Roth IRA's and Custodial savings accounts (UGMA's and UTMA's), are the Section 529 Plans. These plans, modified by the Tax Relief Act of 1997 and further amended by the Economic Growth and Tax Relief Reconciliation Act of 2001, represent the best means by which to save money to pay for the high cost of college.

Potential Benefits

  1. Retain control: the person giving the money retains control of how the funds are invested and disbursed.
  2. Tax free distributions: distributions from 529 plans are exempt from federal income tax as long as they're used to pay for "qualified college expenses".
  3. Reduce estate taxes: gifts placed in 529 plans reduce the taxable estate of the donor.
  4. Retain access to tuition assistance: funds deposited in a 529 plan are disregarded for the purposes of determining a family's expected contribution towards the cost of college.
  5. Growth potential: a properly designed investment strategy can generate returns that exceed the cost of tuition inflation.
  6. Flexibility and simplicity: 529 plans are relatively easy to set up, inexpensive to maintain and simple to access. Additionally, account owners can change the beneficiaries as times and conditions change.
  7. Widespread acceptance: money invested in the plan can be used for any college in the country.
  8. Availability: the benefits of the plan are available to anyone in the country, regardless of income bracket.
  9. High contribution limits: only the current gift tax laws limit annual contributions. Currently, annual gifts are limited to $12,000 per person, or $60,000 up front credited over five years.
  10. Potential tax deduction:certain states allow a deduction from state income taxes for contributions made to plans within the state. Check local rules before determining which state's plan to invest in.

Potential Drawbacks

  1. Each state has a limited palette of investment options from which to choose.
  2. One can change the investment option more than once a year only by changing the beneficiary or by moving the account into another state's plan.
  3. A successful 529 plan may reduce your child's ability to qualify for financial aid on his or her own.
  4. There is no guarantee that these plans will retain their tax free withdrawal status in the future, although it is highly unlikely that Congress will take away this benefit.

If you have questions about 529 accounts, I suggest you visit Saving For College on the web and look through their site. Alternatively, if you think that you can benefit by opening a Section 529 account, and would like the investment choices to be professionally managed and monitored, simply call us on 800-PHON-WAM (800-746-6926). Ask us about the Activ529 or Valu529 options to find out which plan is best for you. We look forward to hearing from you.

What I'm Thinking and Doing

I continue to believe that the overall economic picture is deteriorating slowly but surely. The manufacturing sector is tepid at best. The housing market is hanging on by a thread. The yield curve remains inverted. The "real" inflation (meaning the prices that real people pay in the real world for health, education, food and energy) is much greater than the phony numbers being reported by the government. Just look at the rising price of precious metals and other hard assets and commodities for confirmation that inflation is on the rise. The price of oil at the pump is increasing quickly and may approach the highs from last summer. Thanks to the manipulations of the Fed, which is clearly manipulating the money supply, the value of the dollar continues to deteriorate, eroding the purchasing power of our money. And yet, according to the stock market, everything is just great. I keep saying that we are in a "Goldilocks economy" where the market is "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. In the meantime, I'm enjoying the gains like everyone else, but I'm keeping a close eye on things, looking for signs of the inevitable correction.

I've bought only three new positions so far this year as I'm having trouble finding new stocks, in sectors that I like, for prices that I'm willing to pay. I don't like buying stocks at their all-time highs, and with the market setting new highs, I'm happy to just sit with my existing holdings. Indeed, I've used the past few months primarily to fill in a few positions and sell off some under-performing or unimportant holdings. I am very comfortable holding my core positions and equally happy to raise some cash so that I have some "attack capital" available for some opportunistic purchases.

Personal News and Notes

That about wraps things up for this month. As I wrote last month, we were in the midst of a snow storm. This month, we are struggling to dry out from the massive rain storm that left much of the New York area under water. Many local communities declared a state of emergency and many people were left homeless, or facing tremendous losses. My heart goes out to all of those who have been affected by the storm.

I want to wish a very Happy Birthday to my wonderful girlfriend Shaena. I'm looking forward to celebrating with you this weekend, and for the next 50 years.  

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. If you enjoy reading it each month, please consider sharing the name and email address of a family member, friend or colleague so that they may enjoy the same benefits that you currently receive. As always, thank you for your continued interest and I look forward to being of service to you sometime soon.

Best regards,

Greg Werlinich

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