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.

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.

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.

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.

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