WAM, Werlinich Asset Management, Independent, Fee Only, Investment Advisor, Money Manager, RIA, Financial Planner

May 13, 2004 Comments | Refer A Friend | Sign Me Up

Market Analysis...More Slippage
What I'm Doing Now...Selling A Little
Current Trend...Interest Rates Are Going Up
Statistics...Looks Good, But...
Monthly Tip...Disability Insurance
Personal News and Notes

Current Market Analysis...More Slippage

The results from April were uniformly poor. The Dow Jones Industrial Average, S&P 500 and Nasdaq indices all continued their downward trend, leaving all three down for the year. The small-cap and growth indices were the worst performers in the month. So what does this tell us? It suggests to me that the market is worried. The stock market is a forecasting tool, and in spite of the seemingly positive economic news being released, the market is still going down. In fact, the rate of decline has accelerated so far this month, leaving the Dow Jones below the important 10,000 point level.

The stock market hates uncertainty, and there's a lot of uncertainty right now with Iraq, interest rates, China, the election, the Middle East, and the economy. I have warned my readers for months that Dow 10,000 is an important barrier. Take a look at the chart below. The first thing that jumps out at me are the two declining double-top formations. The first was in February when the Dow reached its peak at 10,753. It then dropped sharply the following month to 10,007. The second double-top was made in April when the Dow peaked at 10,570. We're now experiencing the decline from that top. Now that the 10,000 barrier has been breached, there aren't many support levels between here and the lows of March 2003, although 9,585 would be the next support level. If the pattern of increasingly weak rallies followed by lower lows holds, the Dow may rally to around 10,300 before establishing a new low. A second negative indicator is that the Dow has fallen below the level of its 200-day moving average. All of these factors bode ill for the future of the Dow, and the market in general.

The losses in the stock market have been matched by the losses in the bond market. Two months ago the yield on the 10-year Treasury bond was about 3.70%. Last month, the yield rose to 4.3%. As I write this, the yield is up to 4.85% That is more than a full 1% rise in yield in only two months. This tremendous drop in Treasury prices has been caused in large part by fears that the Fed will be forced to raise short-term interest rates in order to stave off inflation. Most of the recent economic news suggests that the Fed will begin to raise the Fed Funds rate in either June or August, and that once they start raising, they will continue to raise until the rate reaches a "natural" level of around 3.50% to 4.00%. If this comes to pass, it will prove wrong my prediction that rates wouldn't be raised until next year. As is often the case with Wall Street analysis, the majority opinion is often wrong. So I'll reserve judgement until the actual announcement of the rate hike hits the newswires.

There have been some very clear casualties from the rise in interest rates. Obviously, bonds and bond funds have taken a hit. In addition, mortgage lenders, homebuilders and REITs have suffered greatly. At the same time, the recent rise in the dollar has temporarily halted the bull market in precious metals and the announcement by the Chinese government that they will attempt to cool off their overheated economy sent commodity prices tumbling. There have been precious few safe havens over the past few weeks. The question still to be answered is whether this period of losses is just a pause in the bull cycle that began just over a year ago, or a return to the bear market that started in March 2000. Only time will answer that question.

Index

April

QTD

YTD

Description

S&P 500

-1.68

-1.68

-0.42

Large-cap stocks

Dow Jones Industrial Average

-1.28

-1.28

-2.18

Large-cap stocks

Nasdaq Composite

-3.71

-3.71

-4.15

Large-cap tech stocks

Russell 1000 Growth

-1.16

-1.16

-0.39

Large-cap growth stocks

Russell 1000 Value

-2.44

-2.44

0.51

Large-cap value stocks

Russell 2000 Growth

-5.02

-5.02

0.28

Small-cap growth stocks

Russell 2000 Value

-5.17

-5.17

1.39

Small-cap value stocks

MSCI EAFE

-2.18

-2.18

2.13

Europe, Australia, Far East

Lehman Aggregate

-2.60

-2.60

-0.01

US government bonds

Lehman High Yield

-0.68

-0.68

1.65

High-yield corporate bonds

What I'm Doing Now...Selling A Little

Earlier this week I eliminated my exposure to the REIT market and reduced my exposure to the financial services sector. I'm uncomfortable owning industries that are very interest rate sensitive. The proceeds from those sales will just stay in cash for the time being. I'm maintaining my positions in precious metals, commodities, oil and gas and drugs. While the precious metals and commodities sectors have experienced sharp losses in the past few weeks, I am very confident in their long term prospects. My oil and gas positions have been among my better performers recently as oil prices seem to go up almost every day. I expect to hold onto my drug positions for a very long time. My "special situations" holdings also remain unchanged. As I said last month, no advance or decline happens in a straight line. The stock market will always test your resolve and your patience.

Trend...Surging Interest Rates

Reacting to a chorus of strong economic and employment news that suggests an increase to the Fed Funds rate, the bond market has tumbled dramatically over the past five weeks, sending interest rates sharply higher. After their last committee meeting, Chairman Greenspan left the rates unchanged, but removed the pledge to be "patient" about raising rates. He said future rate increases would be "at a pace that is likely to be measured." That suggested to many observers that a rate hike was just around the corner. In a recent poll by the Wall Street Journal, 43 of 55 economists stated that the Fed would raise interest rates by 25 basis points in June and that the Fed Funds rate would be 3.5% by December 2005.

The bond market appears to agree with those economists. As I said earlier, the yield on the 10-year Treasury has risen from a low of 3.7% to its current level just above 4.8%. The chart below clearly shows the dramatic rise in yield. Watch carefully for an impact on the mortgage industry and the housing market. If rates rise too far and too fast, and the housing market takes a hit, that could prompt bond market intervention by the Fed. This economy cannot afford for deeply indebted homeowners, who are leveraged to the hilt with no money down adjustable rate mortgages, to realize losses on their homes.

So what does this mean to you? That depends. If you've already bought a house, refinanced one, or taken out a home equity line of credit, then you should be ok, as long as you have a fixed rate or an ARM that doesn't reset for a while. If you are thinking about getting a new loan, you might want to do so quickly. If you are highly leveraged to an adjustable rate loan, you might be in danger. Try to convert to a fixed rate and reduce your leverage. When interest rates rise, you want to have as little debt as possible and the debt you do have, make sure you can easily cover the payments. Those people who took out adjustable rate loans with little or no downpayment are at the greatest risk. Same for highly leveraged credit card borrowers. If you are in either of those categories, beware of the rate increases and pay attention to your monthly payments; don't let your debts get out of hand.

Statistics to Watch...Looks Good, But Do They Matter?

The labor department recently announced that 288,000 non-farm payroll jobs were added in April, which was much more than expected. They also revised the March numbers upward from 308,000 to 337,000. About 75% of those jobs were in the service sector. Hourly wages increased by $0.05 while the average hourly workweek remained unchanged. The average hourly workweek in manfacturing inched lower as did the amount of overtime worked in manufacturing.
Roughly 8.2 million people remain unemployed, down from 8.4 million. The number of part-time workers who would like full-time jobs fell from 4.75 million to 4.52 million. The number of "marginally attached" workers dropped slightly to 1.5 million. That means with a labor force of 138.6 million, my "underemployment" rate fell to 10.25% while the unemployment rate reported by the government held fast at 5.6%.
For the week ended May 8, new applications for unemployment dropped to 315,000, the lowest level since October 2000.
The Consumer Confidence Index surged in April from a revised 88.5 in March to 92.9. This survey of 5,000 households indicates that people are becoming more upbeat about the economy.
The federal budget deficit was a whopping $72 billion in March.
After narrowing slightly in February, the federal trade deficit set a new record high of $45.9 billion in March. 26% of that was a result of rising oil prices.
The Labor Department reported that the Consumer Price Index, which measures changes in the prices paid by urban consumers for a representative basket of goods and services, rose a greater than expected 0.5% in March, while the "core" CPI, which excludes food and energy, rose 0.4%.
The Labor Department also reported that the Producer Price Index (PPI), which measures the average change over time in the selling prices received by domestic producers for their output, rose 0.7% in April, due mostly to increase in the prices of food and energy. The "core" PPI, which excludes food and energy, only rose 0.2%.
The Labor Department reported that consumer spending was up 0.4% in March, which was the same level as February.
The American Association of Individual Investors' bullish sentiment rose from 31.5% for the week ended March 26 to 39% for the week ended May 8.
The University of Michigan consumer confidence index edged down slightly in April to 94.2 from 95.8.
Same store retail sales grew 4.4% in April, easily topping the concensus forecast.
According to the Census Bureau, sales of new single family homes in March rose 6.4% to a seasonally adjusted annual rate of 2.007 million units, a 6.4% increase over February. At the same time, it was reported that mortage demand is slowing in response to the rapid increase in mortgage rates.
The Institute for Supply Management (ISM) index of manufacturing activity stayed essentially flat in April as it fell to 62.4 from 62.5 in March. That figure still suggests an expanding economy.
According to the Big Money Poll in the May 3 issue of Barron's, 61.3% of institutional investors were bullish or very bullish about the market. 26.7% were neutral. 12% were bearish. Not one single person was very bearish. That level of bullishness, in the face of so many domestic and global problems, makes me very uneasy.

So what does all this mean to you? The current market activity suggests that those Big Money guys and gals may not be so smart. On the contrary, the market seems to be telling us that there is trouble ahead. Unfortunately, that squares with many of the fears that I've been expressing in these newsletters for the past ten months. If bond prices keep falling, it could drag the whole stock market down with it. On top of that are the legitimate fears of further terrorist attacks, the uncertain outcome of an increasingly hostile Iraq and the problem of growing deficits, not to mention the question of who will be our next president. I'm wary, and you should be too.

Monthly Tip - Disability Insurance

This month I've asked Gil Elmaleh of Northwestern Mutual to write about a very important topic - disability insurance. I hope his column will help clear up some misconceptions about this important component of your financial life plan.

Chances are you're probably covered by some sort of life insurance plan to protect your family and assets in case of accidental death. Yet surprisingly, many people have little to no insurance to protect them in the event of disability. Since many people rely heavily on their current earnings for support, some measure of disability income insurance is critical.

One reason for the lack of coverage could be the cost. The fact is, disability insurance can be expensive. Many people purchase group policies, which cost considerably less than individual policies but often provide less comprehensive coverage. It's the old adage "you get what you pay for." In the long run, low-cost coverage is more expensive if a disability from an accident or sickness is not covered or the benefits run out.

To be adequately covered, most experts agree that you'll need at least 60 percent of your gross income for as long as you can't work. (Disability benefits are usually tax-free.) When comparing policies, it's important to understand the differences between the following types of protection:

Total and permanent disability
Total disability, not permanent, that prevents you from performing the duties of any occupation
Total disability, not permanent, that could force you into another occupation
Total disability followed by partial disability
Partial disability that progresses into total disability
Short-term disability that could be total or partial
Full physical recovery after disability but not full financial recovery

Some policies will pay only if you can't work - total disability. The key is to find one that will also pay if you have a loss of income due to disability. A policy that has partial disability protection allows you to collect benefits even while working part-time - though beware of policies that require you to be totally disabled for a specified time period first. This protects you if you develop a degenerative disease that leads to partial disability and progresses into total disability.

The most comprehensive policies are non-cancelable and guaranteed renewable. This means the insurance company can't refuse to renew your policy if your health fails, and can't raise your premium until age 65. It costs more, but it's well worth the price. I suggest that you also consider puchasing an inflation-protection rider. Finally, look for future insurability, which allows you to increase your coverage regardless of changes in your health, activities or occupation. Keep in mind the new policy will be subject to the financial insurability standards of the insurance company.

Some companies also have transition benefits that help cover your financial loss even though you're no longer disabled. For instance, say you were out for eight months due to a heart attack. When you return, your income is down 30 percent because some customers have gone elsewhere. Many policies will pay a benefit proportionate to your loss of income, so if you're down 30 percent, you'll receive 30 percent of your benefit.

Once you've decided what type of policy you need, there are other features to consider that can affect your costs. One is the date upon which the benefit payments begin. The longer the wait, the less expensive the policy. Most planners recommend a 90-day period. By living off savings for four months (which includes the 30 days for the insurer to issue the first check), you can significantly reduce the cost of your disability policy.

Another variable is the length of the benefit period. You can buy a policy that will pay benefits for one, two or five years, until you reach age 65, or to age 70. The most common is to age 65, when retirement and pension income usually kick in.

Your last decision is how to pay for your policy. A level premium is a flat rate that remains the same for the life of the contract. A step-rate starts lower, but then jumps higher down the road. An annually renewable (or renewable term rate) policy starts low then increases each year. This benefit is relatively new and is becoming popular among professionals because it's essentially a "pay-as-you-go" policy, much like term life insurance.

Although you may feel you're adequately covered by your group plan, take some time to compare plans. An individual policy may consider all forms of income, including bonuses, overtime, and pension contributions while group plans usually include only base salary. Coverage from a group plan typically ends if you resign, whereas an individual policy remains in force. Insurance companies also reserve the right to raise premiums or even cancel coverage for group policies.

So whether you buy individual disability income insurance as your sole protection against disability or as a supplement to your group coverage, the important thing is to make sure you're covered. You must have good health and an income to purchase individual disability insurance, but if you wait until you need it, you may not qualify. So protect yourself now!

If you would like more information on disability insurance, you can email Gil at gil.elmaleh@nmfn.com or visit his website at www.nmfn.com/gilelmaleh. You also can call him directly at 914-989-7585. As always, if I can be of any assistance, don't hesitate to give me a call.

Personal News and Notes

Earlier this week I appeared on "Your World with Neil Cavuto". As sometimes happens with live television, my appearance was cut a little short due to the fighting in Iraq. Rather than discussing the latest events in the market, I was asked to comment on the war and its effect on the market. That, my friends, is a challenging topic. If you missed the show, I will have the video on my website next month.

Speaking of which, my new website is almost finished and I think it looks great! I hope to premier it by the end of the month. I'll let you know as soon as it's ready.

I'm making intermittent progress on the chapter that I'm writing for The Black Book on Personal Finance. While it appears that the book won't be published before the end of the year, I hope to have excerpts of my chapter, titled "Dynamic Sector Rotation Investing: How To Make Money In Good Times and Bad", available on my website next month. I hope to have e-books of the chapter available for sale at the same time. I'll let you know more next month.

I competed at the Masters National Swim Championships in Indianapolis three weeks ago. I managed a few best times and a few Top Ten finishes. I also watched one of my teammates win five races and establish a new national record. That was very exciting. With only six swimmers in attendance, my team (Badger Masters Swim Club) acquitted itself very well.

I'll be in California the week of May 16 - 23 visiting clients, companies and friends. If you live in or around LA or San Francisco and would like to schedule a meeting with me during that week, please let me know. I will be happy to work you into my schedule.

As always, I thank you for your interest and consideration, and invite you to write or call me if you have any questions, or if I can be of service to you in any way.

Best regards,

Greg Werlinich
President

Please click here if you no longer wish to receive this newsletter.

Copyright� 2004, Werlinich Asset Management, LLC and /, All Rights Reserved.