Current Market Analysis

It is almost exactly two months since the stock market hit The (temporary?) Bottom. Since that time, the ensuing rebound has been so powerful and so widespread that many observers are calling an end to the recession and the Bear Market, have proclaimed a new Bull Market, and are practically singing "Happy Days Are Here Again". I'm not quite that optimistic, although I do believe this rally has legs. I just don't believe that's it's all clear ahead and that we've begun a new Bull Market. I think the Bear is simply napping right now, enticing investors who had been sitting on the sidelines to get back in the game.

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. Last week, both the Industrials and Transports made new recent highs at the same time, signaling a bull trend. The question is how long this trend can last. To help answer that question, lets take a look at some charts.

The Industrials have advanced about 2,000 points in the past two months. That's a move of about 31%. With that kind of move, it isn't surprising to see the talking heads on CNBC smiling a lot more and proclaiming a new Bull Market. If the Industrials can crest 8,500, there's no reason to think that 9,000 couldn't follow in short order. In prior Bear Markets, bull rallies have often retraced as much as one-half of the losses, suggesting that this rally could take us as high as around 10,000. If that were to happen, you wouldn't hear any complaints from me.

The monthly chart shows, which offers a much longer perspective, shows that even with the recent rally, we're barely above a hugely oversold position. This suggests again that the rally could have further to go.

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. While we are a long way away from those lofty levels, on an interim basis, the next levels appear to be about 9,100 and 3,740, respectively.

Bond yields continue to rise as investors trade out of bonds and into stocks. Even so, yields remain at relatively low levels. I would expect the Federal Reserve to use its balance sheet, if necessary, to purchase bonds in sufficient quantity to keep yields low enough to stimulate the mortgage market. They cannot allow mortgage rates to rise high enough to squash a housing recovery.

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 stock market even higher. 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 May 2 was 601,000. The four-week average has declined to 623,500.
• Non-farm payroll employment improved in April, falling by "only" 539,000 versus a revised 699,000 in March and 681,000 in February. Average hourly wages inched up to $18.51, but the average workweek remained at 33.2 hours, so real wages continue to stagnate.
• The number of workers reported in April as unemployed rose to 13.7 million, bringing the unemployment rate to 8.9%, its highest level since August 1983. The seasonally adjusted number of people who could only find part-time work held steady at 8.9 million and the number of marginally attached workers held steady at 2.1 million. The number of people holding multiple jobs rose to 7.78 million. My Comprehensive Labor Index™, which is much more representative of the real unemployment situation, rose to 18.66%. I've been saying for months that I expected to see my CLI™ at around 20% later this year. I still believe that's likely to happen.
• 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 $953 billion for the first six months of fiscal year 2009, whereas adjusted for net present value the deficit would be $803 billion. We are on track for an unimaginable $2 trillion deficit this year.
• According to the Census Bureau, the U.S. trade deficit in February was $26.0 billion, down sharply from $36.2 billion in January, as imports continued to plunge.
• The Census Bureau reported that privately owned housing starts dropped 10.8% in March, following a 17.2% increase in February, and was still down 48.4% from a year ago, to a seasonally adjusted annual rate of 510,000 units. New building permits were down 9.0% from last month and 45.0% from last year. It appears the February increases were simply a bump from abnormally low January numbers.
• In April, the National Association of Homebuilders/Wells Fargo Confidence Index, which was created in 1985, surged to 14 from 9 the prior month. This was the largest one month increase in six years. Is this an indication of a bottom in the housing market? I don't think so.
• The Census Bureau reported that on a seasonally adjusted annualized basis, sales of new homes in March were roughly the same as the prior month but were still down 30.6% from the same period last year, to 356,000 units. The estimate of homes for sale is down to 311,000, which represents a shrinking 10.7 months at the current rate of sales. The median sales price fell to $201,400 and remained well below the steadily falling 12-month moving average price of $222,942.
• The National Association of Realtors reported that on a seasonally adjusted annualized basis, sales of existing homes in March fell 3.0% from the prior month, and were down 7.1% from the same period last year, to a projected 4.57 million units. The estimate of homes for sale, at a reduced 3.7 million, represents 9.8 months of supply at the current rate of sales. The median sales price rose to $175,200, but remained well below the steadily falling 12-month average of $190,008.
• 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 154.70 in February, the lowest level since August 2003.
• According to RealtyTrac, foreclosures increased by 17.4% in March to 341,180, and remained 46% 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 increased to 40.1 in March, continuing the general uptrend in place so far this year. This was the fourteenth straight month in which the manufacturing sector failed to grow. The good news is the the trend is moving in the right direction and a number over 40 suggests the recession may be weakening. The ISM index of non-manufacturing activity was a similar 40.80.
• The Conference Board reported that it's index of Leading Economic Indicators fell 0.3% in March. It has been nine months since the index has moved up. The economy remains in poor shape.
• According to the Bureau of Economic Analysis, the "advance" estimate of GDP growth in the first quarter was -6.1%, after a similarly horrible -6.3% in Q4. There are still two revisions to come. The hope is that the first quarter will mark the bottom of the recession.
• The Federal Reserve reported that in February the amount of outstanding consumer credit fell by 0.3% from the prior month, to $2,564 billion. That means that consumer credit has declined in five of the last seven months. That's good for consumers, bad for the economy.
• According to the Census Bureau, retail trade and food service sales fell 1.1% in March, and was 9.4% worse than a year ago. This means that retail trade and food sales have fallen in eight of the past nine months.
• According to the BEA, even though disposable personal income continues to fall, the personal savings rate, which for years had been negative, was 4.2% in March, continuing a trend that shows Americans again saving money, rather than going deeper into debt.
• The Federal Reserve reported in March that the increase in the supply of M-2 was "only" 9.02% in the past three months, while the supply of M-1 actually fell by 8.3% in the same period. In the past six months, the rates of increase were 13.7% and 15.2%, respectively. It appears that the rate of monetary expansion is slowing a bit. We'll see if this trend continues.
• After hitting an all-time low of 25.0 in February, the Conference Board Consumer Confidence Index inched up in March, then jumped in April to 39.2. Consumers seem to think that the worst is behind us. Time will tell if they are correct.

Amazingly, the financial sector has finally broken out of the downward trading range with a powerful rally. It's been so long since I've written anything positive about this sector I'm honestly not sure what to say right now. The results of the government's "stress tests" have been announced. The prevailing wisdom is that things could have been worse. I believe that's the theme for the financials right now: things are less bad and could be worse. So until things get worse, the rally should continue.

Like the financials, the housing sector is attempting to break out of a seemingly never-ending cycle of negative news. A few days ago the housing index broke above a key resistance level of around 94. If it can remain above this level it would suggest this rally has further to go.

The price of West Texas Crude is moving steadily higher. As I write this, the current futures contract calls for a price of $57.44 per barrel. It's interesting that very few people are talking about this "stealth" price rise because everyone's attention is captivated by the rise in the market. I would expect the price to consolidate a bit before attacking the $60 level. After breaching that resistance, it's on to $70. At those prices, you'll begin to again hear the hue and cry from the politicians.

After a third attack at $1,000 in late February, the price of gold has again sold off and is now consolidating around $900 per ounce. It shouldn't surprise anyone that gold would fall in the face of a big stock market rally. I'm confident that gold will take another run at $1,000 before the year is over.

The rising price of copper continues to be a good indicator of growing economic strength. And while I believe much of this increase is due to economic activity in China, it is still a positive, at least until prices rise too far too fast as inflationary forces take hold later this year.

The dollar index is now looking very toppy and is in danger of falling lower as it has broken below its rising trendline. The index has also fallen below the 50-day moving average and is in danger of also dropping below the 200-day moving average. As the budget deficit grows to unprecedented levels and the economy remains weak, expect the dollar to fall further.

Foreign markets, as represented by the MSCI EAFE index, have staged a rip-roaring comeback of almost 50% after a dizzying plunge. International investors who held in there have begun to recoup some of their losses.

In China, the Shanghai Composite is up almost 70% over the past six months. They still have a long way to go before they make back everything they lost last year.

This chart has me feeling a bit nervous. The NYSE Bullish Percent 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. Amazingly, there is greater bullishness on the NYSE than at any other point in at least 16 months. The relative strength index is enormously oversold. One would expect the index to fall back to a more normal 40-60 range.

It is very good news to see that the volatility index, also known as the "investor fear gauge", has fallen back into the normal range, even if it is on the high end of the range. As the VIX continues to stabilize, the market will grow increasingly more calm, and be less susceptible to the wild swings of a panic.

What I'm Thinking and Doing

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Greg Werlinich
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