Current Market Analysis

The stock market has been of mixed bag since I wrote to you last month. After rallying strongly in the end of March and April, then extending those gains in early May, the broad averages plunged last week in the face of sour economic news and record high oil prices. The good news is that it's normal for the market to settle a bit after such a strong rally. The Industrial and Transportation averages remain well above their March and January lows. Indeed, it wouldn't surprise me to see this pullback extend a bit longer before leveling out a bit. My feeling is that, as we head towards the typical summer doldrums in the market, the market will likely trade sideways for the most part, with small swings up and down, but no really decisive moves in either direction. The market must continue to digest the lousy housing market, slowly recovering credit markets, surging oil prices, an anemic economy and an uncertain political landscape. I wouldn't try to trade this market (not that I would ever try to trade any market). I would though use short-term market weakness to continue to build positions in solid companies.

Talk is cheap; let's see what the markets are telling us. Below is a chart of the Industrial Average in 2008. The most important thing to notice is that the current price is about 700 points above the closing low set in early March. It wouldn't surprise me at all to see the Industrials trade between 12,000 and 13,000 for the next few months as the market digests all of the disparate economic, political and weather-related news making headlines today and in the months ahead. If that happens, it could set the stage for a nice rally later in the year.

The Transportation average continues to lead the market this year, which is really quite remarkable given the high price of oil and the sorry state of the airline industry. Amazingly, the Transports just hit a new high before falling a bit during the selloff last week. Last month I wrote that "it wouldn't surprise me to see a little correction and consolidation before it attempts to revisit the high set last summer." Well, we did in fact beat that high, so now I think we'll get that correction and consolidation. Either way, this remains a very bullish chart.

I think the S&P 500 has entered a trading range, shown in between the blue lines below. As long as the index remains above 1,256, this chart will remain generally bullish. It would be very bullish if the rally could extend above 1,450 and head back above 1,500. 

Why should bond yields be immune from trading ranges? As you can see below, yields have been bound this year between 3.28% and 4.0%. I would expect this to continue as equities trade sideways a bit. At some point in the future, yields will have to rise to stave off inflationary pressures, but I don't think we're there yet. When that time arrives, bond investors should beware.

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 situation for the financial sector continues to be shaky, at best. I don't think the financials are out of the woods yet. More write-downs, already in the hundreds of billions, continue to be announced almost every week. I wrote last month that "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 write-downs and losses continue." That is happening as we speak, so we'll see if the March low holds. 

The housing picture is very interesting. I've been writing for months that I don't believe the worst is over yet. I've also written about the many "false bottoms" that have occurred over the past year or so. I'm not yet convinced that the bottom has truly been made in housing yet. As I wrote last month, my feeling is that the next move is likely to be lower as the housing market continues to get worse.

Last month I wrote that the brief from March was over as the price of oil had recovered to hit a new high of almost $120 per barrel. Since then the surge has continued as the price of West Texas Crude has soared to an almost unimaginable $135 per barrel. Now the talk is of $150 oil, or higher! Before we get there though, I expect the price to correct back below $120. Unfortunately, I can't see any reason for the price of oil to end its inevitable march upward.

The price of gold continues to consolidate between $850 and $1,000. Barring some unforeseen event, I expect the price of the yellow metal to remain in this range for at least the next few months. Remember, I don't recommend that you attempt to trade gold. It's better to establish a position and simply sit with it. Part of why we own gold is for "portfolio insurance". And part is to protect us against rampant inflation and the debasement of our currency. If I'm wrong about the general upward trend of gold, it will likely mean the stock market is headed much higher, and we would be more than compensated for our "losses" in our gold positions by higher equity prices.

After a five-month rally (the March plunge notwithstanding), the price of copper has rolled over a bit in th past two months. Is this foreshadowing poor economic times ahead, or is it simply a natural correction and profit-taking after a strong run? Has a dangerous double-top formation been drawn? We'll know in another month or so. For now, I would like to see the price remain above the 200-day moving average. Stay tuned.

I wrote last month that "I believe that the recent bump in the dollar is a false rally and will likely peter out before any real gains are made." So far, that has proven correct as 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 haven't shown in a while; it's the index of Europe, Asia and the Far East. In other words, it's a proxy for the action in the rest of the world. It seems like the rest of the world is doing just fine, thank you. I would like to see the 50-day moving average move above the 200-day to confirm the bullish trend, and that could happen within the next week or so.

The Shanghai Index, which I use as a proxy for China, has recovered a bit after its nearly 49% plunge over the prior six months. I'm not sure if this rally has legs though. It doesn't look like a convincing rally just yet. I'm still not ready to put any money to work in China based on this chart.

Last month I suggested that the Federal Reserve "should do nothing, but may cut a maximum of 25 basis points." Chairman Bernanke did in fact announce the 25 basis point cut that the market had demanded, but suggested in his commentary that there would be no more cuts forthcoming due to inflationary concerns. Excuse me while I stifle a sarcastic laugh. My guess is that there will be no changes to interest rates for the remainder of the year as the Fed would not want to be seen as impacting the election one way or another. But I believe that whenever the next change is made to interest rate policy, it will be to increase, not decrease, them.

What I'm Thinking and Doing

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Greg Werlinich
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