Current Market Analysis

The stock market looks much better today than when I last wrote to you. As I've been writing for the past couple of months, I believe the overall picture has brightened a bit. Indeed, the "second half rally" that I've been predicting may end up being a "second quarter rally" instead. It appears as though the market has discounted all of the bad news and in the face of the "worst economic picture since WWII", has climbed a wall of worry and resumed its long-term rise.

I wrote this last month but I think it bears repeating: "It's interesting how market sentiment works. The more bearish investors and pundits get, the more likely it is that things are already getting better. The best investors usually trade opposite the crowd because that's how the big money is made. When everyone is saying the same thing it's usually time to look the other way. So when investors are putting all of their money in cash and bonds, even when those instruments are yielding less than inflation, and the experts are predicting the end of the banking system as we know it, smart investors are putting their money back to work in equities." Add to all the negative sentiment is the startling high short-interest building right now. Eventually, those short-sellers will be forced to close losing short positions, adding strong buying power to a rising market.

Talk is cheap; let's see what the markets are telling us. On Friday, a very important thing happened: both the Dow Jones Industrial and Transportation Averages surpassed old support levels. According to Dow Theory, this suggests that even better times are ahead for the broad stock market. This would confirm what I've been feeling and writing about, although it is contrary to much of what is being written and spoken of in the popular press. The market is telling us that while the worst of the economic news may not have happened yet, it has in fact been anticipated and discounted. If this is the case, the next support level on the upside to surpass would be around 13,500 (a 5% increase from current levels).

The Transportation average has really been one of the bellwethers of the stock market so far this year, as you can see in the chart below. And this overall strength has been presented in contrast to the weakness of the airline and trucking segments that are part of the larger average. Last month I wrote that "should this index manage to move above support at 5,000, [it] would be very bullish." It has now done so, and it is very bullish. Also bullish is the fact that the index is now above both moving averages. It wouldn't surprise me to see a little correction and consolidation before it attempts to revisit the high set last summer.

The S&P 500 is also showing some strength as you can see below. The index has risen towards the upper boundary of its four-month trading range. I would deem it bullish if it were to surpass 1,400.

As the equity markets cratered, the bond market boomed, reducing yields on the 10-year Treasury to historic lows. Conversely, as stocks have rebounded, bonds sold off, which increased yields almost 60 basis points. And even though the recent rise in yield surpassed the trading range, it has not yet broken the almost perfect series of lower highs and lower lows. This suggests that the trend might not be over yet.

Last Month's Results

• According to the Department of Labor, the most recent four-week average for seasonally-adjusted initial jobless claims, for the week ended April 12, was 376,000, an increase of about 11,000 from the prior week. These numbers continue to increase slowly but surely.
• Non-farm payroll employment fell by 80,000 in March. This was the third month in a row that payrolls dropped, as 76,000 jobs were lost in February. These statistics continue to be revised lower and the current numbers will likely end up being far worse than the current estimates. Average hourly wages grew a bit to $17.86 while the average workweek inched up to 33.8 hours.
• The number of unemployed workers reversed last month's anomalous drop by rising to 7.8 million, the highest number since January 2005, leading to an unemployment rate of 5.1%. The number of unemployed people is estimated to have risen by 1.1 million since last year. My guess is that the true number is probably closer to 2 million. The seasonally adjusted number of people who could only find part-time work held steady at 4.9 million and the number of marginally attached workers fell to 1.4 million. The number of people holding multiple jobs inched lower to 7.5 million. My Comprehensive Labor Index™ rose to 10.23%.
• According to the CBO, the government posted a budget deficit of $47 billion in March, which was $50 billion less than a year ago. This was partly a factor of timing, as certain outlays happened in February rather than March. The deficit for the first six months of the fiscal year is running about $51 billion more than a year ago.
• According to the Census Bureau, the U.S. trade deficit in February was $63.3 billion, up from a revised higher $59 billion in January. I'm surprised that the weak dollar and the weak economy didn't help lower the trade deficit.
• The Census Bureau reported that privately owned housing starts plunged 11.9% in March, after a small decrease in February, and was down 36.5% from a year ago, to a seasonally adjusted annual rate of 947 million units. New building permits were down 5.8% from last month and down 40.9% from last year, which suggests that the outlook for future housing starts remains bleak and continues to worsen. Housing starts and permits are below 1991 levels.
• The Census Bureau reported that on a seasonally adjusted annualized basis, sales of new homes in February fell 1.8% from the prior month and 29.8% from the same period last year, to a projected 590 million units. That is the lowest figure in the four plus years I've been tracking new home sales. The estimate of homes for sale is now 471,000, which represents a whopping 9.8 months of supply at the current rate of sales. The median sales price rose to $244,100 and is up from revised higher figures.
• The National Association of Realtors reported that on a seasonally adjusted annualized basis, sales of existing homes in March fell 2.0% from the prior month, and were down 19.3% from the same period last year, to a projected 4.93 million units. The estimate of homes for sale, at 4.05 million, represents 9.9 months of supply at the current rate of sales. The median sales price rose to $200,700, which remains below the falling 12-month average of $212,817, and was down 7.7% from a year ago.
• According to RealtyTrac, foreclosures increased 4.9% in March to 234,685 after a surprising decrease in February. Foreclosures are still 57% higher than a year ago. Nevada, California and Florida, respectively, reported the highest foreclosure rates in the country.
• The Institute for Supply Management (ISM) index of manufacturing activity was 48.6 in March, marking the third out of the past four months in which the manufacturing sector failed to grow. The ISM index of non-manufacturing activity increased to 49.6. So both the service and manufacturing sectors are still contracting.
• The Conference Board reported in March that it's index of Leading Economic Indicators rose 0.1%, breaking a string of five consecutive months that the index had declined. The leading index fell 1.6% for the past six months, or 3.2% annualized. Big surprise, the economy remains weak.
• According to the Bureau of Economic Analysis, the "final" estimate of GDP growth in the fourth quarter was 0.6%, in line with the "preliminary estimate". This allows the pundits to claim that the US was not in recession in the fourth quarter. I don't buy this at all because I don't think the way they calculate GDP growth is realistic. That being said, I expect the first quarter figure to be lower.
• The Federal Reserve reported that the amount of outstanding consumer credit increased by 0.2% from the prior month in February, to $2,539.8 billion. The rate of growth is slowing as the consumer may finally be closed to being tapped out.
• According to the Census Bureau, retail trade and food service sales rose 0.2% in March after declines in both January and February, and remained a meager 2.0% better than a year ago. Retail sales are holding up, but just barely.
• The Fed increased M-2 by a large 1.0% in March, one of the largest single month increases I can remember. The supply of M-2 has increased by a massive 12.6% in the last three months and 7.0% in the last twelve months. According to John Williams on his website "Shadow Government Statistics" (www.shadowstats.com), the increase in M-3 now approaches 17% as the Fed tries to inflate us out of this recession.
• The Conference Board Consumer Confidence Index, which had declined sharply in February, fell further in March. The Index now stands at 64.5 (1985=100), down from 76.4 in February. According to the American Bankruptcy Institute, lenders continue to be swamped by delinquent mortgages. Food, gasoline and commodity prices are rising out of control. In other words, the economy is in terrible shape. Indeed, things could be just about as bad as they're going to get. I look for things to start improving in the next few months.

While the situation has improved somewhat, at least as far as the action in their stocks is concerned, I don't think the financial sector out of the woods yet. The writedowns, already in the hundreds of billions, are likely to continue for another quarter or two. It's really hard to make a strong case for buying the bank stocks just yet. I think that while a bottom MAY have been made in March, I think they'll likely fall again as the writedowns and losses continue.

While the picture for the housing sector looks a little better, I'm still not convinced that the worst is over. I have long been bearish on housing as there have been many false "bottoms" that have sucked investors back in, only to leave them with big losses as the sector continued its downward spiral. We've now had the rally I called for two months ago. For this rally to have some legs, I'd like to see the index cross north of 155 and move higher. My feeling is that the next move is likely to be lower as the housing market continues to get worse.

At least for now, the selloff in oil is over! The price of West Texas Crude has surged to almost $120 per barrel! Last month I wrote that I didn't believe that we'd seen the high price for oil this year. I just didn't expect it to move so high so quickly. Oil prices are now oversold and should therefore correct and consolidate a bit. As long as prices stay north of $95 per barrel, the upward trend will continue.

As I've suggested, the price of gold is now consolidating after hitting an all-time high in March. I've traced a trading range between $1,050 and $850. I expect the price to remain there for a while before continuing its inevitable upward march.

Dr. Copper tells me that the economic outlook is not nearly as dire as the Talking Heads would have us believe. If this was indeed the worst economy since the Great Depression, how could copper, and almost all commodity prices, remain so stubbornly high? The answer is that they wouldn't. One concern would be that it looks like the chart is forming a double-top formation. That could auger negative things ahead. This will bear watching. Otherwise, things look pretty good.

I believe that the recent bump in the dollar is a false rally and will likely peter out before any real gains are made. In fact, it looks as though the rally has already ended. Given the extremely lax monetary policy, it's hard to imagine a scenario in which the dollar has any lasting strength. I still believe the long-term trend for the dollar is lower.

Below is a chart I've never shown before. This chart shows the percentage of stocks trading on the New York Stock Exchange that are in bullish trends. You can clearly see the big increase over the past few months. This is a good sign.

When I wrote in February, the Shanghai Index, which I use as a proxy for China, had dropped about 30% from the October peak. By last month, the decline had increased to 42%. Now the index has plunged a total of 49%! The next support level is about 2,500. So much for making easy money in China.

The yield curve continues to steepen as the spread between the 2-year and 30-year notes widens. This suggests a stronger economic outlook. It will be very interesting to see what the Fed does at their meeting next week. They could do nothing or cut rates as much as 50 basis points. My feeling is that the Fed should do nothing, but may cut a maximum of 25 basis points. If they do nothing the dollar will rally a bit. If they cut, it will sink further. Either way, it won't have much of an impact on the economy.

What I'm Thinking and Doing

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Greg Werlinich
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