Current Market Analysis

My last newsletter preceded the recent low point of the market by only three days. And like the rest of the country, I was gloomy. The bad news was unceasing and the despair was almost palpable. Four weeks later, there are some glimmers of light and hope, manifested by the nice rally we've enjoyed over the past three weeks. The best way I can describe the current economic news is not good, but rather less bad, and that's progress. If the news can continue to be less bad, we may yet fight our way out of this recession by the end of the year.

According to Dow Theory, current rally notwithstanding, we are still in the midst of a Bear Market. This call was confirmed on March 9 when both the Industrial and Transportation averages broke to new lows at the same time. And yet, it is not incongruous to have multiple strong rallies while the Bear is still in charge. In fact, last month I wrote that "the market is so oversold, that we are due for a strong Bear Market rally. And that is exactly what has happened. The big question is will it have enough legs to break above the last peak just below 8,500, or will the momentum peter out, and allow the average to re-test the lows? Time will tell. In the meantime, let's see what clues, if any, the charts give us.

The big question on the minds of all market observers is whether the low of March 9 was "The Bottom". Unfortunately, only the passage of time will reveal the answer. Clearly, it will be important to remain above 6,469 on any retracement. Given the strength of the rally, it shouldn't surprise anyone to see a little profit-taking and some sideways trading for a little while. After that, I would love to see the Industrials try to surpass 9,000 on the next leg of the rally.

The monthly chart shows how dangerous and fragile the situation remains. And since the market remains oversold, there is potentially more room on the upside as investors put some cash back in the market and the short-sellers are forced to cover.

The Transportation average mirrors the action of the Industrial average. According to Dow Theory, the Bear Market will remain in place until both average break to new highs at the same time. On an interim basis that could mean about 8,470 for the industrials and 3,250 for the transports. Longer term, that would be about 9,100 and 3,740, respectively.

The bond market continues to be very erratic, hardly a safe haven. It's hard to predict the short-term movement for treasuries, but longer term, I expect yields to rise to more normal levels as money returns to the stock market and as concern about the financial health of the US government grows.

The yield on the t-bill remains absurdly low, suggesting that a lot of money remains parked on the sidelines. When deployed, that pile of cash will eventually power the market back up. When that happens, the t-bill yield will get back to more normal levels of 2-3%.

Last Month's Results

• According to the Department of Labor, the most recent figure for seasonally-adjusted initial jobless claims for the week ended March 27 was 669,000. A year ago that figure was only about 389,000. The four-week average is now 656,750.
• Non-farm payroll employment fell by a staggering 663,000 in March. The only good news is that this was better than the 741,000 lost in January, as that month was revised down for a second time. Average hourly wages grew fractionally to $18.50, but the average workweek inched lower to 33.2 hours, so real wages are stagnating.
• The number of workers reported in March as unemployed rose to 13.2 million, bringing the unemployment rate to 8.5%. This is the highest unemployment rate in 25 years. The seasonally adjusted number of people who could only find part-time work rose to 9.0 million and the number of marginally attached workers held steady at 2.1 million. The number of people holding multiple jobs rose to 7.72 million. My Comprehensive Labor Index™, which is much more representative of the real unemployment situation, rose to 18.27%. I've been saying for months that I expected to see my CLI™ at around 20% later this year. Given how the unemployment numbers are accelerating, we could surpass 20% in the next few months.
• 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 January was $36.0 billion, down a bit from $39.9 billion in December, as imports continued to fall faster than exports.
• The Census Bureau reported that privately owned housing starts surged 22.2% in February, following a 14.5% decline in January, but was still down 47.3% from a year ago, to a seasonally adjusted annual rate of 583,000 units. New building permits were up a smaller 3.0% from last month but down 44.2% from last year. Let's see if this is a one month anomaly or the start of a new up-trend for housing.
• In March, the National Association of Homebuilders/Wells Fargo Confidence Index, which was created in 1985, remained at 9, marking the fifth straight month in single digits. Essentially, home builders remain bleakly pessimistic.
• The Census Bureau reported that on a seasonally adjusted annualized basis, sales of new homes in February rose 4.7% from the prior month but was still down 41.1% from the same period last year, to a still meager 337,000 units. The estimate of homes for sale is down to 330,000, which represents 12.2 months, or more than a year of supply, at the current rate of sales. The median sales price fell to $200,900 and remained well below the steadily falling 12-month moving average price of $224,383.
• The National Association of Realtors reported that on a seasonally adjusted annualized basis, sales of existing homes in February increased 5.1% from the prior month, but were down 4.6% from the same period last year, to a projected 4.72 million units. The estimate of homes for sale, at a reduced 3.8 million, represents 9.7 months of supply at the current rate of sales. The median sales price fell further to $165,400, which remained well below the steadily falling 12-month average of $191,850.
• 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 158.04 in January, the lowest level since October 2003.
• According to RealtyTrac, foreclosures increased by 5.9% in February to 290,631, and remained 30% higher than a year ago. Nevada, Arizona and California, reported the highest foreclosure rates in the country while California, Florida and Arizona 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 fell 0.4% in February, while January was revised down and December was revised to a small loss from a small gain. The outlook for the economy continues to be poor.
• According to the Bureau of Economic Analysis, the "final" estimate of GDP growth in the fourth quarter of 2008 was -6.3%, worse than the "preliminary" estimate of -6.2% and the "advance" estimate of 3.8%, but is in line with analyst 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 January the amount of outstanding consumer credit increased by 0.1% from the prior month, to $2,564 billion. That means that consumer credit has declined in four of the last six months. That's good for consumers, bad for the economy.
• According to the Census Bureau, retail trade and food service sales dipped 0.1% in February, and was 8.6% worse than a year ago. This means that retail trade and food sales have fallen seven of the past eight months.
• 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 Federal Reserve reported in February that they increased the supply of M-2 by 15.2% and M-1 by 9.0% in the last three months. In the past six months, the rates of increase were 15.3% and 23.9%, respectively. While the rate of increase in M-1 is down a bit from last month, these numbers still show a tremendous amount of monetary expansion as the Fed desperately tries to resuscitate the economy and avoid a depression. For the first time, there are small indications that their efforts 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.

Notwithstanding the recent rally, the downward trend in the financial sector remains in force as the index continues to make lower highs and lower lows. To break the cycle, it would have to rise above $10.41, which would just about double the low.

The housing sector is also attempting to break out of the negative cycle, and its chart looks a little better than the financials. Two months ago I said that the rally in housing was premature and that I expected this sector to test the November lows before trying to rally above the recent high of around 94. Well, the low was indeed tested right before a big rally. We'll see if it makes it to 94.

All regular readers of my newsletter know that I'm an oil bull and I've been calling for higher oil prices. It's taken longer than I expected, but the price of West Texas Crude has moved back above $50 per barrel. After some consolidating, I expect the price to rise back towards $70 later this year.

It shouldn't surprise anyone that the price of gold soared while the equity market plunged. It is equally understandable that gold would fall in the face of a big stock market rally. I would expect the price of gold to trade between $850 and $1,000 for the next month or so before the inevitable breakout to new highs later this year.

There has been relatively little written or spoken about the recent gains in the price of copper. This is a very good indicator of growing economic strength. If this continues, we can all send our thank you notes directly to China.

Another example of increased worldwide economic activity is the increase in the price of 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. As demand continues to increase for bulk goods, this index will continue to rise.

Even after the big drop in early March, the dollar index to be in an almost year-long uptrend. In order to maintain this momentum, the index will have to rise above 90. If it doesn't, and instead falls below 82, the rally could be over. If so, watch for gold to take off.

Foreign markets, as represented by the MSCI EAFE index, finally managed to break out of the doldrums. The domestic and foreign markets are growing increasingly correlated so the rise is to be expected.

Another stealth rally is going on in China right now as the Shanghai Composite has moved higher for five months in a row. If China keeps going up, the price of raw materials will likely continue to rise.

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. Things are looking a lot more bullish right now. Amazing how 20%+ gains makes investors feel better.

The volatility index, also known as the "investor fear gauge", is falling back towards a more normal range. This would be a very positive development. The declining triangle pattern concerns me, but maybe we'll continue the downward move rather than bust out on the upside.

What I'm Thinking and Doing

Greg Werlinich
President

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