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April 27, 2010

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

Current Market Analysis

The first four months of the year are almost over, and it has been a wild ride for the stock market. First, the Dow Jones Industrial Average hit an intermediate high of 10,725 on January 21. Interestingly, that was the exact midpoint of the move from the low of 7,286 after the tech crash to the high of 14,164 set in October 2007. From there the market plunged over 800 points during fourteen trading days, falling to a low of 9,908 on February 8. Since then, the market has gone almost straight up, surpassing the old high of 10,725 as it blew right past the psychological barrier of 11,000. Just yesterday we had another Dow Theory bullish signal as the Industrial and Transportation Averages made new highs at the same time. Couple that with the fact that the market is now trading well above the 50% level of 10,725 and it would seem that, at least for now, it remains "all clear ahead."

The economic statistics that I talk about below continue to improve. Even the housing and financial sectors have broken out of long trading patterns and moved higher. The one key domestic laggard is the labor market. If our economy can begin to generate a meaningful amount of new jobs (more than 150,000 per month), then the overall picture would brighten considerably. Now, my greatest worry is our debt, and the debt of other troubled nations (see: Greece, Spain and Portugal). Should sovereign debt across the globe be called into question it could have a catastrophic effect on currencies and interest rates. Which is another good reason to own gold.

So what do the charts tell us now? The Industrial average is right on track and making new highs almost daily. Last month I suggested that the market was due for a bit of a correction and some profit-taking. That hasn't really happened yet. And volume still isn't as strong as I'd like, but as I've been saying on Twitter for weeks, I would not short this market.

The Transportation average has traced a bumpier path than the Industrials, but it too has achieved new highs. And it too is likely due for a breather. But as long as it remains above its rising trendline, it remains bullish.

Since last May, the yield on the 10-year treasury has traded between 3% and 4%. In November I wrote that "I still expect yields to remain in the 3% - 4% range for the remainder of [2009] before heading inevitably higher sometime beginning in 2010." Since December, rates have been trading at the higher end of the range, suggesting that rates could break above 4% in the near future. So far, each attempt to move above 4% has failed. For our economy, let's hope that this continues.

Last Month's Results

As always, I provide the following chart to show the raw results for the preceding month, the quarter-to-date and the year-to-date, not including dividends. The equity markets enjoyed broad and very strong growth in March, continuing the gains enjoyed in February. As is often the case, the gains were led by technology and growth stocks. The MSCI EAFE index continues to pull up the rear so far this year with a nominal gain so far. There are two more months until we are advised to "sell in May and go away". We'll see what happens next. 

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

  • According to the Department of Labor, the most recent figure for seasonally-adjusted initial jobless claims for the week ended April 17 was 456,000, an decrease of 24,000 from the prior week. The four-week average was 460,250. There was an even bigger drop in the non-seasonally adjusted number of initial jobless claims. We're still waiting for these numbers to drop in a meaningful way.
  • Non-farm payroll employment rose by 162,000 jobs in March, due in large part to the government hiring people for the census. January and February job losses were both reduced after revisions. Average hourly wages for blue collar workers fell a bit to $18.90, while the average work week increased slightly to 33.3 hours. There is certainly no inflationary pressure in wages right now.
  • In March, the total number of workers counted as unemployed rose to 15.0 million, while the unemployment rate remained unchanged at 9.7%. The more comprehensive U-6 rate was 16.9%, up from 16.8%. There were 6.5 million people who have been unemployed longer than 27 weeks. This number keeps increasing. The seasonally adjusted number of people who could only find part-time work jumped to 9.1 million and the number of marginally attached workers slipped to 2.3 million. The number of people holding multiple jobs dropped slightly to 7.06 million. Overall, the employment picture remains poor.
  • The Congressional Budget Office (CBO) estimated that on a net present value basis, the Treasury reported a federal budget deficit of $62 billion in March, leaving us with a deficit of $714 billion for the first six months of fiscal 2010, which is $67 billion less than the record shortfall from 2009. The March deficit was $129 billion less than last year, mostly due to the accounting for the TARP payments.
  • The Census Bureau reported that the U.S. had a trade deficit of $39.7 billion in February, up from $37.0 billion in January. The trade gap with China dropped to 41.5%. Smoothing these figures out over a few months shows very little real change in the trade deficit. And this modest deficit really doesn't worry me too much. 
  • The Census Bureau reported that privately owned housing starts increased 1.6% in March after gaining 1.1% in February, and was 20% higher than a year ago, to a seasonally adjusted annual rate of 626,000 units. New building permits were up 7.5% from last month and were up 34% from last year. If this is not simply a one month aberration due to the expiration of tax credits this could be the start of a very positive trend.
  • The National Association of Homebuilders/Wells Fargo Confidence Index increased to 19 from 15 in April, matching the 19-month high set last September. Again, we'll see if this is simply a one month aberration or the start of a real recovery in new construction.
  • The Census Bureau reported that on a seasonally adjusted annualized basis, sales of new homes in March exploded by 26.9% from the prior month, and were almost 24% higher than the same period last year, to 411,000 units. The estimate of homes for sale is 228,000, which represents "only" 6.7 months at the current rate of sales. The median sales price fell to $214,000, which is slightly below the 12-month moving average price of $217,667. The sales totals for the prior three months were all revised slightly higher. Again, beginning of the recovery or a government fueled aberration?
  • The National Association of Realtors reported that on a seasonally adjusted annualized basis, sales of existing homes in March rose 6.8% from February, and were 16.1% higher than a year ago, to a projected 5.35 million units. The estimate of homes for sale, at 3.58 million, represents a shrinking 8.0 months of supply at the current rate of sales. The median sales price rose to $170,700, which is slightly lower than the 12-month average of $172,583. Distressed home represent about 35% of all sales.
  • 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, decreased fractionally in January for the fourth month in a row, to 157.89, following five consecutive months of increases. Given the number of distressed sales nationally, this shouldn't be a surprise. But the "rate of change" is improving. We'll see.
  • According to RealtyTrac, the number of foreclosures in March surged 19% from February, and were 8% higher than a year ago. This is the highest monthly total since they began tracking foreclosures in January 2005. The only good news is that it seems the pipeline of foreclosures is being worked through, so maybe things could improve later in the year.
  • The Institute for Supply Management (ISM) index of manufacturing activity was 59.6 in March. This marked the eighth month in a row in which the manufacturing sector expanded, and the growth is accelerating. The ISM index of non-manufacturing activity was 55.4, marking the sixth time in the last seven months that the service index indicated moderate growth.
  • The Federal Reserve reported that capacity utilization in the industrial sector increased for the ninth straight month, to 73.2% in March. Capacity utilization now remains only 7.4% below the average level of the period from 1972 through 2008, but 3.7% higher than a year ago. Like the ISM numbers, this is another good indication that the economy is getting stronger, at least in the industrial sector.
  • The Conference Board reported that it's index of Leading Economic Indicators rose by 1.4% in March, following a 0.4% increase in February and a 0.6% increase in January. "The indicators point to a slow recovery that should continue over the next few months. The leading, coincident and lagging series are rising. Strength of demand remains the big question going forward. Improvement in employment and income will be the key factors in whether consumers push the recovery on a stronger path."  
  • According to the Bureau of Economic Analysis, the "third" estimate of GDP growth in the fourth quarter was a very strong 5.7%, slightly lower than the second estimate of 5.9%, but much higher than the 2.2% growth recorded in the third quarter. More than 50% of the growth was due to businesses replenishing their depleted inventories. While this is a short term boon, it is not sustainable. We'll see what happens in Q2.
  • The Federal Reserve reported that in February the amount of outstanding consumer credit decreased by an annualized rate of 5.5% from the prior month, to $2,448 billion. The amount of consumer credit has declined steadily for the past year and a half and is now around it's lowest level since July 2007. The amount of revolving credit is falling particularly quickly.
  • According to the Census Bureau, retail trade and food service sales increased 1.4% in March, and the February numbers were revised up to 0.5%. Maybe consumers will start to spend a bit more. The employment numbers will lead the way.
  • The Federal Reserve reported in that in March the supply of M-2 decreased slightly from the prior month but was up 1.4% during the prior six months. The supply of M-1, on the other hand, rose a more robust 6.2% over the same six months. It seems like the Fed may finally be tapping the monetary brakes in advance of the inevitable rate increases later this year or early next year, now that the economic expansion is building.
  • The Conference Board Consumer Confidence Index rose again in April to 57.9 from 52.3 in March. Consumers remain concerned about the job market and their near term financial situation but their outlook clearly is improving.
  • According to the BEA, disposable personal income fell again in February, which caused the personal savings rate to fall from 3.4% to 3.1%.
  • According to the FDIC, 57 banks have failed so far this year, through April 23. 140 banks failed in 2009 and were either closed or merged into healthier banks. By comparison, 26 failed in 2008 and only 3 failed in 2007.

Trends To Watch

For the past few months I've written that I expected the dollar to rally due to being "relatively" better than other currencies, like the Euro. Thanks to struggling countries like Greece and Portugal, this is exactly what's come to pass as the dollar index has surged above both the 50-day and 200-day moving averages. In addition, the 50-day average has moved above the 200-day average, which is bullish for the dollar. The next resistance level, as you can see below, looks to be between 82-83. We'll see if the dollar can continue to rally and crest that level. While I remain convinced that ultimately, the dollar will roll over and head inevitably lower, I would not be short the dollar right now.

I've been saying for the better part of eight years (and investing accordingly), that the price of gold would go inevitably higher, but that this upward move would not happen in a straight line. I've said many times that there will be corrections and profit-taking, but that investors should not get scared out of their positions. Indeed, those corrections could be used to add to your holdings. The latest correction was about 15% over two months, and part of that is clearly due to the strength in the dollar. Yet now gold is rising along with the dollar, which demonstrates the interest in gold. I would look for gold prices to eventually rise above $1,200 again and head towards the high of $1,226

I believe that silver continues to be in a stealth bull market, and is very undervalued right now relative to gold. I expect the price of silver to eventually move out of its trading range and trade above $20 per ounce.

The price of West Texas Crude is heading for a major breakout, one way or another. The trading range pictured below cannot last much longer. It will have to break out one direction of the other. My money is betting that it breaks out higher.

The chart of the price of copper shows a tremendous rise, followed by a big break, followed by a strong recovery. I've shown, with the red lines, a pretty clear looking inverted head and shoulders pattern. Since last month it appeared that the bullish trend would continue. But it isn't yet clear. The picture will likely become more clear in the next few weeks.

After being in a holding pattern for almost a year, the financial sector, as represented by the XLF, finally broke out above the trading range. This is very bullish, and to be honest, very surprising to me. I've had a negative outlook on the financial sector for years. The accommodate monetary policies of the Federal Reserve have finally allowed the domestic banking sector to get healthier, in spite of themselves. As I've been saying, the past year has been the best possible scenario for banks: they pay nothing on deposits yet lend at 5%, thereby making tons of money on the spread. It's almost impossible not to make money under these conditions.

The housing market too has finally broken above a year-long trading range. After reading all of the positive statistics that I listed above, this should come as no surprise. It seems a bottom has finally been made in residential housing and things may be improving. So I suppose I've been proven wrong here too.

Developed foreign markets, as represented by the MSCI EAFE index, remain range bound. The index has managed to rise above the moving averages, which is bullish. So we just continue to watch and wait for something to happen. The sovereign debt problems in Europe could drag this index lower.

The Chinese market has traded sideways since last July. It is now sitting almost exactly in the middle of the range, and slightly below both moving averages. Fascinating. To me, this is a very dangerous point and it could go either way. I wouldn't want to try to call this trade. Should the Chinese market roll over and head lower, it could have very negative implications for the global economy.

Not surprisingly, the Baltic Dry Index has been trading in a range right along with China, the country with the largest influence on the index. The question is does China lead the BDI or does the BDI lead China. I think it's probably the former. As China goes, so goes global commerce.

After showing nothing but optimistic charts, I'm going to close with two that are more worrisome to me. The NYSE Bullish Percent Index represents the percentage of stocks listed on the NYSE that signal a buy. Contrarians would argue that extreme levels of exuberance is a bearish indicator, and vice-versa. This chart shows an almost extreme amount of bullishness, which suggests trouble ahead. RSI is almost off the charts and bullish sentiment is near a high. This portends a pullback is coming.

Finally, let's take a quick look at the volatility index, also known as the "investor fear gauge". Right now, investors are showing almost no fear. Like prior chart, this is a contrary indicator and suggests trouble on the horizon. Too much investor complacency points to an upcoming pullback in the market.

What I'm Thinking and Doing

I am neither a trained economist nor a trained stock analyst. But I have been observing the stock market for almost 20 years now and I've been managing money professionally for over 13 years. I certainly don't always get the trends right, and I'm often a little off on my timing. But over the past seven years I think I've gotten it right more often than not. I was particularly on target with my calls on oil, gold and unemployment. I also managed to get out of all real estate holdings well before the crash. I'm afraid we could be headed for a double-dip recession sometime in 2011 or 2012. I think it's inevitable due to the high levels of unemployment, the lousy residential and commercial real estate markets, the out-of-control federal deficit and the massive tax increases that are headed our way over the next few years. This is a recipe for disaster. I really hope I'm wrong, and I suppose things could change over the next year or so. But I'm worried that our elected officials just don't get it. I'm keeping a close eye on interest rates and the dollar. Any hint that the Fed is preparing to raise rates, which isn't likely right now, or that the market is demanding higher rates for our debt, which is more likely, will spook the equity markets.

Now that I've given you the Gloomy Gus view, let's review the optimistic outlook. The industrial side of the economy is clearly expanding. Corporate profits and dividend payouts are rising. M&A activity is stirring and the IPO market is beginning to show signs of life. Importantly, the housing sector may finally have bottomed out. I'm not ready to declare all is clear in housing yet, but some signs are appearing. What remains stagnant is the unemployment picture. If businesses finally start hiring then the positive effects would spread throughout the entire economy.

And I still think the mid-term elections in the Fall will likely go strongly to the Republicans. More and more prominent Democrats are reading the same tea leaves and refusing to even run for re-election. Should the Republicans recapture the House, and maybe even the Senate, a divided Congress could prevent the President or Congress from doing anything too stupid. Then maybe we can have a real debate on more constructive tax policies for 2011 and beyond.

I've been saying for months now, both in this newsletter and on my daily Tweets (@gwerlinich) that this market is in a strong bull cycle and wants to go higher. Over the past two months I have put my money where my mouth is by spending more than $1.5 million in cash on new equity positions. This has reduced my cash from almost 12% to about 6.5% of my holdings. I plan to further spend down that cash to around 5% before I write to you next month.  

Personal News and Notes

The big news is that the kids and I have finally moved into my new house! A lot of blood, sweat and tears (and money) have been expended but the place looks amazing. I've worked my butt off over the past two weeks and all the boxes are gone and everything has been put away. Now I can take my time and fill in the missing furniture over the next few months. And I couldn't have done any of it without my fantastic design team of Jenni and Pia at Cashmere Interiors. If anyone in the New York area needs some help with their home I can highly and enthusiastically recommend them.

Nola has completed her three fencing competitions for the season. She made tremendous progress from the first to the last. I love the fact that she's so into it. Lily has begun her spring softball season. She scored the winning run in the final at bat on Saturday. She's like a little Jose Reyes. Ezra is also fencing and playing tennis. Amazingly, there are only two more months until summer camp and teen tours begin. We're in the home stretch!

On Friday I leave for a long weekend in Myrtle Beach to recharge the batteries. A few rounds of golf and a few days on the beach. Just what the doctor ordered. Any readers in the area? If so, join me for a beer. 

Don't forget that you can friend me on Facebook, connect with me on LinkedIn, or follow me on Twitter. I try to "tweet" something about the market every day or so, so if you follow me, you'll get a quick update on what's going on almost every day. It's a very easy way for you to receive updates from me in between my newsletter. I've been using these three sites because I'm actively seeking to make new business connections as well as maintain contact with friends old and new. So please look for me out in Cyberspace, and ask your colleagues, friends and family members to do the same.

That's it for this month. I thank you, my readers, and remind you that this newsletter is for you. If you have any thoughts or suggestions on how to make it better, please let me know. And if you'd like to speak with me about your investment needs, I'd be pleased to be of service. Simply give me a call or drop me an email.

Best regards,

Greg Werlinich

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