Current Market Analysis

What a difference a month, or in this case, a few weeks makes. After hitting an intra-day high of 11,670 on May 10, which left it only 80 points below its all-time high, the Dow Jones Industrial Average plunged almost 630 points in eight trading days to a low of 11,040 before closing yesterday at 11,125. Interestingly, as you can see from the chart below, the Dow is very oversold technically right now, and is therefore due for a rally. And while it has broken well below its 50-day moving average, it is still trading above its 200-day moving average and within a trading "channel" that has been formed over the past nine months or so. To violate this channel the Dow would have to drop below 11,000, which would also be psychologically damaging as well.

I wrote last month that as long as the Dow remained above both the the 50- and 200-day moving averages, the positive momentum should continue. The near term action on the Dow is now less clear to me. Overseas markets have have dropped precipitously recently in sympathy with US markets, and in fear of burgeoning worldwide inflation. This could all just be profit taking, or it could be prelude to a massive sell-off across global markets. Unfortunately, we only know which scenario is correct when viewed in the rear-view mirror, so stay tuned.

The chart on the Dow Jones Transportation Average, not surprisingly, looks very similar. After a rise that paralleled the ascent of the Industrials, the Transports had a similar blow-off recently. The difference is that the fall just barely pierced the 50-day moving average and hasn't come close to the 200-day average. So I'd say that we're due for a little bounce here too.

The chart of the yield on the 10-year Treasury could be the most important one in this newsletter, and it could portend the most trouble for investors going forward. The yield on the 10-year Treasury has moved increasingly higher and has pierced 5% for the first time in almost four years. As I have been predicting, this is causing problems in the housing market, as demonstrated by the ugly chart of four of the leading US homebuilders. As is quite evident, these stocks are in free-fall right now. 

The spread between the 10-year Treasury and the TIPS is now 2.72%, an increase of about 0.2% in the past few weeks. This suggests that the bond market is growing more concerned about inflation. I continue to believe that the inflation is being caused by the loose monetary policy of the Fed (and the other central bankers around the world) as it prints enough money to continue the profligate spending of our government. Without the additional hundreds of billions in new dollars being printed every year, neither the government, nor its citizenry, would likely be able to repay its mammoth, and growing, indebtedness. So I expect the inflationary forces to continue.

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. April was a mixed bag with the Dow and the S&P leading the way domestically, but still training the MSCI EAFE by a mile. Tech stocks were weak, as evidenced by the small loss in the NASDAQ. After leading the way for the past few months, growth had taken a back seat to value. After the first four months of the year, most investors were probably sitting on modest profits, regardless of their investment methodology. Unfortunately, as we have seen above, those good fortunes have changed quickly. And as we have entered the market's "worst six months" (May to October), there could be further trouble ahead.

What I'm Doing Now

May has been a very...difficult month, and an instructive one too in once again proving that nothing goes up in a straight line. With almost no exceptions, all of my key sectors have taken a beating this month. This is very similar to what happened to me in February. So what have I done? Or more importantly, what haven't I done? I didn't panic. I didn't sell anything. I took a few deep breaths, looked at my core holdings, and decided that my reasons for owning them were unchanged. Then for my new clients, and for existing clients with some cash, I stepped up and bought more of my favorite securities. It's easy to be a buyer when everything is going up. It's much harder to buy when everyone else is selling. But that's when strong profits can be earned. Invariably, panic selling is done at exactly the wrong time. So now, I'll watch and wait and see what happens next.

Statistics To Watch

• The most recent four-week average for initial jobless claims rose sharply to 332,000 after the week of May 22 reported a big increase to 36,000. We'll have to see if this trend continues.
• There was a very tepid increase of only 138,000 non-farm jobs in April, after an only slightly better March. Average hourly wages jumped to $16.61 from $16.49. The average workweek edged up to 33.9 hours. The number of people holding multiple jobs fell to 7.36 million from 7.59 million. So fewer people are working a little longer and making a little more. This is potentially inflationary.
• The number of unemployed workers inched up to 7.1 million in April. The seasonally adjusted number of people, who for economic or business reasons could only find part-time work, remained steady at 4.0 million. The number of marginally attached workers fell to 1.3 million. My adjusted Comprehensive Labor Index™ fell to 8.6% while the official unemployment rate reported by the government inched remained steady at 4.7%. Please note, starting this month, I have adjusted my part-time worker figures. In earlier months I was double counting certain numbers. I have corrected this mistake dating back to my January newsletter.
• The University of Michigan Consumer Confidence Index in April fell slightly to 87.4.
• According to the CBO, the government generated a surplus of $120 billion in April, which brought the deficit for the seven-month period to $182 billion, or $53 billion less than for the same period in fiscal 2005. About half of the surplus is due to the effects of timing on certain payments. Overall tax receipts are much higher this year. Anecdotal evidence indicates that the tax cuts have caused the overall tax receipts from wealthy Americans to increase.
• According to the Census Bureau, the U.S. trade deficit in March fell to $62.0 billion from $65.7 billion in February, which is down from the record high of $68.5 billion set in January. This two-month decrease can probably be attributed to a weaker dollar.
• The Labor Department reported that on a seasonally adjusted basis, the CPI for all urban consumers advanced 0.6% in April, as rising energy prices boosted costs across the board. The "core" CPI, which excludes food and energy, remained steady at 0.3%. I would expect the CPI figure for May to be a bit lower as energy prices have decline somewhat.
• The Federal Reserve reported that total outstanding consumer credit remained steady in March at $2.16 billion, which continues to be at all-time high levels. Consumer credit increased at an annualized rate of 2 3/4% in the first quarter.
• According to the Census Bureau, retail trade and food service sales rose 0.5% in April. Gasoline stations and non-store retailers made the biggest gains in the month.
• The Census Bureau reported that privately owned housing starts fell 7.4% in April, and 11.1% from the same period last year, to a seasonally adjusted annual rate of 1.85 million. This is the lowest monthly figure for housing starts since November 2004.
• The Census Bureau reported that on a seasonally adjusted annualized basis, sales of new homes rose 13.8% in March to a projected 1.21 million units. The estimate of new homes for sale continues to rise, and at 555,000 represents 5.5 months of supply at the current rate of sales. The average sale price plunged in the month from $300,400 to $279,100, the lowest average price in more than 15 months.
• The National Association of Realtors reported that on a seasonally adjusted annualized basis, sales of existing homes rose a meager 0.3% in March, after a 5.0% gain in February, to a projected 6.92 million units. Of greater concern is that the estimate of homes for sale, at 3.2 million, represents 5.5 months of supply at the current rate of sales and is the highest level recorded in years. And after peaking at $275,000 in June 2005, the average price of homes sold has fallen to $266,000.
• The Institute for Supply Management (ISM) index of manufacturing activity measured 57.3 in April, up a bit from March. This marks the 35th consecutive month in which economic activity in the manufacturing sector is reported to have grown. Anything above 50.0 is considered to be an indication of growth.
• According to the Bureau of Economic Analysis, the "advance estimate" of the annualized rate of GDP growth for the first quarter of 2006 is 4.8%. Keep in mind that this figure will be revised two more times in coming months.
• Also according to the BEA, personal savings was ($32.5) billion in March, as compared with a revised ($58.3) billion in February and ($60.6) in January. This makes at least eight straight months of negative personal savings. This cannot last forever and has negative implications for the retail sector.
• The Fed increased M-2 by $21.3 billion, or 0.3%, in April. The supply of M-2 has increased by 3.6% in the last three months and 4.9% in the last twelve months as the Fed continues to prime the monetary pump.
• Foreigners now hold $1.624 trillion in US debt, another new record.

Trends To Watch

One of the most important trends in the market right now continues to be the movement on the Dow Jones Industrials, which I wrote about earlier in this newsletter. It will be important for the Industrials to remain above 11,000 and above its 50-day moving average. While the overall bullish trend hasn't been completely violated, it is certainly in danger of doing so.

The price of West Texas Crude remains a very important trend in the market. I think it is very instructive to note that the price of oil is making higher lows with each correction. With the price now right at its 50-day moving average, and still comfortably above its 200-day moving average, there is no question that the bullish advance in oil prices continues. It would take a drop below $64 per barrel to change that. And just eyeballing the admittedly inexact chart below, I'd say that the next big move in oil prices could take us to $100. Please, don't have a heart attack. I don't expect this to happen right away. I do however think it will happen sooner than most people expect. I have been consistently bullish on oil prices for over four years, far longer than most of the "experts" out there. And I have not wavered in my belief that the price is likely to remain in this general uptrend for quite a while. I also said last month that "nothing goes straight up, so it wouldn't surprise me at all to see a period of retreat and consolidation. Prices are clearly overbought right now and could retreat to about $63 per barrel without violating the general trend." Well, the correction is underway. We'll see where it takes us.

Yikes!! After an incredible two month surge that took the price of gold from about $530 to $730 an ounce, the correction has finally come. The price of gold has plunged a heart-stopping $65 per ounce in just over one week and is now severely oversold. The price of silver and other metals have had similarly steep corrections. I'm sure this has caused many faint-hearted investors and traders to bail out of their positions in gold; not so for me. For the past year gold has reached higher highs after each correction and I'm confident that it will be no different this time. I've used this pullback to add to my positions. Next stop: $750 and beyond.

The chart on the US dollar looks terrible. I've maintained my annotations from last month to show how the price fell below the support level I drew at about $85.50. The dollar is now well below both moving averages and continues to draw a classic "head and shoulders" formation. On a purely technical basis, it could easily fall as low as 80 on this move. And while that helps the trade deficit by making imports more expensive and exports cheaper, it will likely drive interest rates and the price of gold higher, and ultimately do more damage than good to our economy.

Finally, let's look at the yield curve below (the green line is the current one, showing that rates are higher today than yesterday). Right now, the Fed Funds lending rate is 5.00%. 6-month t-bills yield 5.01%, 2-year Treasuries yield 4.96%, 10-year Treasuries yield 5.07% and the 30-year Treasury yields 5.16%. So we have a very mild inversion between 6 months and 5 years before the curve returns to its normal upward path as the duration heads out to 30 years. If the Fed tightens again at their next meeting, the entire curve could again invert. Otherwise, long rates would have to continue going up, which would further damage an already weakened housing market.

Personal News and Notes

I have a book signing event coming up at the Culinary Institute of America on June 20th as part of the Annual Conference of the National Association of College Auxiliary Services - East. If you would like more information, please let me know.

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