Werlinich Asset Management, LLC
400 Columbus Ave.
Valhalla, NY 10595

June 22, 2006 Comments   |   Refer A Friend   |   Sign Me Up   

The Black Book on Personal Finance, which I co-authored with a chapter entitled "Sector Rotation Investing", can be purchased at or Barnes & The book is also available at selected bookstores around the country. 

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

Current Market Analysis

Look out below!! In the span of about five weeks, the Dow Jones Industrial Average dropped almost 1,000 points. Since falling to about 10,700 on June 13, the Dow has gained back about 400 points. So where are we headed from here? I honestly wish I knew for sure, although to be honest, I strongly suspect that we've already seen the highs for the year, whereas we have not yet seen the lows. The fact that the Dow did not set a new all-time high when it had the chance is not a good sign.

Last month I wrote that the Dow was very oversold technically and was therefore due for a rally. Well, the rally is on. The Dow is now trading right between the 50- and 200-day moving averages. Interestingly, the correction violated the trading channel that had been formed (shown below in blue) and the rally hasn't yet returned the Dow to that trading range. Indeed, there may now be a new downward sloping trend (shown in red). So let's see what happens next: either a return to the upward trend or a continuation of the downward trend. Again, I think there is a greater chance of the latter.

Last month I also speculated that the drop in overseas markets "could be prelude to a massive sell-off across global markets." That too has come to pass as shown in the following chart. Yet even with the recent plunge this overseas index has not really violated the 200-day moving average. So again, we just have to wait and see what happens next. That's the beauty of watching the stock market.

This month, rather than look at the Transports, I wanted to show the Wilshire 5000, which is the best way to look at the "whole market", as it actually is an index of about 6,000 stocks. And as you can clearly see, after topping out at 13,472, in a parallel with the Dow, the index has plunged below the 50- and 200-day moving averages on heavier volume. As with the other charts, it's hard to divine a clear direction but the trend does appear ominous.

The continuing increase of the yield on the 10-year Treasury could be the most important trend in the market right now, and is likely to portend the most trouble for investors going forward. I left the blue channel lines that I drew last month to show that the rising yield hasn't violated the trend yet, but does suggest a continued upward move. I think by next week the yield will be around 5.25%, which not coincidentally, will very likely match the Fed Funds rate after the next increase is announced on Wednesday.

The spread between the 10-year Treasury and the TIPS has fallen slightly to 2.58%, down from 2.72% last month. This suggests that the bond market is growing less concerned about future inflation. And since it seems as though the Fed is slowing down its policy of monetary expansion, this is no surprise.

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. As is clearly evident by the chart below, May was a bad month with growth and technology leading the way down. So far, the market's "worst six months" (May to October) have been bad indeed with June continuing the downward trend.

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

What I'm Doing Now

For the second consecutive month, all of my key sectors have taken a beating. It's important to understand that while this hasn't been pleasant, it was also not completely unexpected. After the incredible run enjoyed by most of my core holdings, it is normal to experience some profit-taking and consolidation.

Now, I can't lie to you - it's been a painful two months during which I have given back a lot of my year-to-date profits. The good news is that I expect all of my portfolios to remain in the black for the first half of the year, which will stand in stark contrast to most of the market.

So what have I done? Most importantly, I didn't panic. I didn't sell any core positions, although I did reduce my emerging market holdings and sell a couple of small, unimportant positions. I then evaluated my sector choices, looked at my holdings within those sectors, and decided that my reasons for owning them were unchanged. So not only didn't I sell any of those stocks, I actually made a few purchases at what seemed to me as firesale prices. As I said last month, 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.

Statistics To Watch

  • The most recent four-week average for initial jobless claims remained steady at 333,500 for the week ended June 9. 
  • For the third month in a row, there was a month-over-month drop in non-farm job creation as only 75,000 new jobs were created in May. Average hourly wages inched up to $16.62 from $16.61. The average workweek edged down to 33.8 hours. The number of people holding multiple jobs rose to 7.64 million from 7.36 million. None of this paints a rosy employment picture.
  • The number of unemployed workers inched down to 7.0 million in May. The seasonally adjusted number of people, who for economic or business reasons could only find part-time work, rose to 4.1 million. The number of marginally attached workers rose to 1.4 million. My adjusted Comprehensive Labor Index™ rose to 8.3% from 8.2% while the official unemployment rate reported by the government dropped to 4.6%.
  • The University of Michigan Consumer Confidence Index plunged in May to 79.1 from 87.4 in April.
  • According to the CBO, the government posted a budget deficit of $39 billion in May, which brought the deficit for the eight-month period to $222 billion, or $50 billion less than for the same period in fiscal 2005.
  • According to the Census Bureau, the U.S. trade deficit in April rose to $63.4 billion from $61.9 billion in March. $17 billion of that deficit was with China and another $7.8 billion was with Japan. 
  • The Labor Department reported that on a seasonally adjusted basis, the CPI for all urban consumers advanced 0.4% in May while the "core" CPI, which excludes food and energy, remained steady at 0.3%. As I forecasted last month, there was a drop in the May CPI figures thanks to temporarily lower energy prices.
  • The Federal Reserve reported that the amount of outstanding consumer credit increased by 0.5% in April to $2.17 billion, marking another new all-time high.
  • According to the Census Bureau, retail trade and food service sales rose a meager 0.1% in May. I'll want to see if this is just one bad month or the beginning of a more ominous trend.
  • The Census Bureau reported that privately owned housing starts rose 5.0% in May, but was still down 3.8% from the same period last year, to a seasonally adjusted annual rate of 1.96 million. I don't place much importance in this one month rise as it was still the second 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 4.9% in April to a projected 1.20 million units. More worrisome is the fact that the estimate of new homes for sale continues to rise, and at 565,000 represents 5.8 months of supply at the current rate of sales. The average sale price increased in the month from $279,100 to $298,300, bouncing off a 15 month low.
  • The National Association of Realtors reported that on a seasonally adjusted annualized basis, sales of existing homes fell 2% in April, after being flat in March, to a projected 6.76 million units. Of greater concern is that the estimate of homes for sale, at 3.4 million, represents 6.0 months of supply at the current rate of sales and is the highest level recorded in years. The average price of homes sold rose marginally to $269,000.
  • The Institute for Supply Management (ISM) index of manufacturing activity measured 54.4 in May, down considerably from April. This marked the 36th 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. But it does appear that activity is slowing.
  • The Bureau of Economic Analysis announced that the "preliminary estimate" of the annualized rate of GDP growth for the first quarter of 2006 was 5.3%, which was higher than the "advance estimate" of 4.8%. The final number will be anounced next month. The GDP in subsequent quarters is expected to be much lower.
  • Also according to the BEA, personal savings was estimated to be ($146.8) billion in April, as compared with a revised ($128.2) billion in March and ($116.4) in January. The April figure represents -1.6% of personal disposable income and makes at least eight straight months of negative personal savings. This can't last forever and has very negative implications for the retail sector.
  • The Fed decreased M-2 by a negligible $2.5 billion in May. The supply of M-2 has increased by a relatively small 2.1% in the last three months and 4.7% in the last twelve months as the Fed is dramatically slowing the rate of monetary growth. This is what will be slowing down "inflation".
  • Foreigners now hold $1.626 trillion in US debt, another new record. This is a broken record.

In my opinion, the overall economic picture is slowly eroding and that is why the stock market is heading down. Job growth is slowing, rates are rising, the housing market continues to erode and debts are rising. All of this is a prescription for big trouble in the not-too-distant future.

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 closed today at 11,019. It will be pyschologically important for the Industrials to remain above 11,000 and technically important to stay above its 200-day moving average and try to get back above the 50-day moving average. If the downtrend remains in force, we could be headed back to the mid 10,000's.

So what about oil? The rise is over and the price is headed lower, right? Isn't that what everyone keeps saying? Well let me tell you that unless the laws of supply and demand have been repealed, and unless there is a lot of cheap oil just sitting in some friendly country, waiting to be found, then the price of oil will not be dropping substantially any time soon. Just look at the chart. The price is making higher highs and higher lows. Even with the recent pullback, the price never really got below $70. As long as the price stays above $67 my trading range stays intact, and as long as the price remains above $65, it stays above it's 200-day moving average. So technically, there is no reason to see a drop, and geopolitically and economically, there is no reason to see a drop. Therefore, I'm not selling my oil stocks.

It may be a little too soon to call the bottom, but it appears that the correction in the price of gold may be done, at least for now. After falling almost $200 per ounce, and being WAY oversold on a technical basis, gold seems to be headed back up. The price touched, but never really violated its 200-day moving average. I expect that by the time I write this newsletter in September, the price of gold may be back in the mid-$600's. The next real upward move in the price after this consolidation is over, and that consolidation could take a few months, will likely bring the price to at least $800 per ounce.

The chart on the US dollar looks a little better, but not much. I've maintained my annotations from last month to show how the price fell below, then recovered to, the support level I drew at about $85.50. The dollar has now recovered to the 50-day moving average, but remains below the 200-day average. I think the latest recovery is because the Fed remains commited to raising the short-term interest rates. I also believe that the dollar is doomed to fall further over time. I still think the next dip will take the dollar index to around 80. I continue to look for ways to diversify my holdings out of dollar instruments.

I'm going to add a new chart showing a VERY important trend in the marketplace. That trend is the deterioration in the housing market. Last month I showed a compilation of homebuilders, showing their collective stock price losses of about 50%. This month I'll show you the Philadelphia Housing Index, and it isn't a pretty sight. The index is down about 31% from the high set almost a year ago. It is trading well below both moving averages, yet it isn't terribly oversold, which doesn't bode well for a recovery. This chart demonstrates what I've been talking about for months: the weakness in the housing sector. And it's going to get far worse before it gets better.

Finally, let's look at the yield curve below (the green line is the current one, showing that rates are higher today than yesterday). For now, the Fed Funds lending rate is 5.00%. It is going to be 5.25% next week. 6-month t-bills yield 5.26%, 2-year Treasuries also yield 5.26%, 10-year Treasuries yield 5.22% and the 30-year Treasury yields 5.26%. So for all intents and purposes, we have a completely flat yield curve. While this doesn't necessarily mean that we're headed for a recession, it also doesn't forecast a very healthy economy.

Monthly Tip - Tax Changes

This month I asked my associate Dennis Kremer to bring us up-to-date on some of the changes to current tax law that may affect each of us next Spring. I think these changes are mostly helpful to us; go figure.

Tax provisions affecting Individuals in the Tax Increase Prevention and Reconciliation Act

AMT Relief

Originally enacted to make sure that wealthy Americans did not escape paying taxes, the AMT, which is a parallel tax system which does not permit several of the deductions permissible under the regular tax system, such as state, local and property taxes, has started to affect more middle-income taxpayers. This is in part due to the fact that the AMT parameters are not indexed for inflation. In recent years, Congress has provided a measure of relief from the AMT by raising the AMT “exemption amounts” – allowances that reduce the amount of alternative minimum taxable income (AMTI), reducing or eliminating AMT liability. (However, these exemption amounts are phased out for taxpayers whose AMTI exceeds specified amounts.) For 2005, the AMT exemption amounts were $58,000 for married couples filing jointly and surviving spouses; $40,250 for single taxpayers; and $29,000 for married couples filing separately. However, for 2006, those amounts were scheduled to fall back to the amount that applied in 2000; $45,000, $33,750 and $22,500, respectively. This would have brought millions of additional middle-income Americans under the AMT system, resulting in higher federal tax bills for many of them, along with high compliance costs associated with filling out and filing the complicated AMT tax form.

To prevent the unintended result of having millions of middle-income taxpayers pay tax under the AMT rules, Congress has once again relied on a temporary fix to problem, this time a one-year extension of the 2005 AMT exemption amounts, increased slightly. Under the new law, for tax years beginning in 2006, the AMT exemption amounts are increased to: (1) $62,550 in the case of married individuals filing a joint return and surviving spouses; (2) $45,500 in the case of unmarried individuals other than surviving spouses; and (3) $31,275 in the case of married individuals filing a separate return.

Another provision in the new law provides AMT relief for those who have personal tax credits. The tax liability limitation rules generally provide that certain nonrefundable personal credits (including dependent care, elderly and disabled, and Hope Scholarship and Lifetime Learning) are allowed only to the extent that a taxpayer has regular income tax liability in excess of the tentative minimum tax, which has the effect of disallowing these credits against AMT. Temporary provisions had been enacted which permitted these credits to offset the entire regular and AMT liability through the end of 2005. The new law extends this temporary provision to tax years beginning in 2006.

Investor tax breaks extended

In 2003, Congress passed a measure to lower the tax rate on most dividends to 15 percent from as high as 38.6 percent, and to lower the rate on most capital gains from 20 percent to 15 percent. That measure was due to expire at the end of 2008, but the new law extends the favorable tax rates through 2010.

Income limitations on Roth IRA conversions eliminated, beginning in 2010

A taxpayer who makes deductible contributions to a regular individual retirement account (IRA) gets a tax break now for the dollars he puts in and his earnings grow tax free, but he pays ordinary income tax on every dollar he takes out, and withdrawals are subject to significant restrictions. In a Roth IRA, the taxpayer gets no tax deduction for contributions, but his money grows tax free and there’s no tax, and few restrictions, on qualifying withdrawals.

Under pre-Act law, only taxpayers with $100,000 or less in modified adjusted gross income can convert a regular IRA into a Roth IRA. A taxpayer making the conversion generally must pay tax on money he takes out of his regular IRA, but once it’s in his Roth IRA, he won’t pay tax on that money or the money it earns. Generally speaking, Roth conversions appeal to taxpayers who either think their tax rate will go up in retirement, or believe that the value of their account will rise significantly, and thus are willing to make an upfront tax payment when they convert in order to reap large tax savings in later years.

Under the new law, beginning in 2010, taxpayers with more than $100,000 of modified adjusted gross income also will be able to convert a regular IRA into a Roth IRA. To make such conversions more attractive in 2010, the new law permits taxpayers who convert in 2010 to spread the income and resulting tax payments on the converted funds over two years – 2011 and 2012.

Kiddie tax age limit raised from under 14 to under 18

At one time, wealthy parents could significantly lower their family tax bill by transferring investment assets to minor children. This tax technique, called income shifting, worked by taking income out of the parents’ higher tax bracket and placing it in the lower tax brackets of their children. To curtail the use of this tax technique, Congress enacted the “kiddie tax” rules, which said that children under 14 who had more than a small amount of unearned (investment) income had to pay at their parents’ marginal tax rate (the rate of tax on the last dollar earned). The threshold amount at which the kiddie tax kicks in is two times the amount allowed as a standard deduction for a dependent who has only investment income. For 2006, that amount is $850, so the kiddie tax begins to apply when the child has more than $1,700 in unearned income.

Under the new law, the age limit below which a child’s income from investments is taxed at the parents’ rates is raised from 14 to 18. The new law specifies, however, that the kiddie tax does not apply to a child who is married and files a joint return for the tax year. It also adds an exception to the kiddie tax for distributions from certain qualified disability trusts. The new provisions apply to tax years beginning after Dec. 31, 2005.

Dennis Kremer, CPA, CVA, CFE is partner in the accounting firm of William Greene & Company, LLP. He can be reached at (914) 232-8461 or by email at if you have any further questions.

Personal News and Notes

I participated in a wonderful book signing event at the Culinary Institute of America on June 20th for about 100 members of the East Regional Conference of the National Association of College Auxiliary Services. We had a very spirited discussion on interest rates, the economy, the stock market and retirement.

I hope you have been listening to my pod casts with Bobby Ilich for his program "Ahead of the Curve", on If you've missed any of these lively and informative broadcasts, I urge you to click on the link, and add it to your Favorite Places. These broadcasts typically run about 15 minutes and are a lot of fun. I hope you will listen in each week.

Summer is finally here. School is out and camp is around the corner. In fact, my daughter Lily leaves for her first sleepaway camp experience on Sunday while my son Ezra begins day camp on Monday. My eldest daughter Nola also has great travel and camping plans this summer. I'm headed up to Maine for the 4th of July weekend and I have a lot of swimming, golf and long bike rides in my future over the next couple of months. I hope you and your loved ones have an equally fun and exciting itinerary for the summer.

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

Best regards,

Greg Werlinich

Copyright© 2006, Werlinich Asset Management, LLC and All Rights Reserved.