Current Market Analysis

It's been three months since the stock market sunk to the March 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 and have proclaimed this to be a new Bull Market. I'm not yet sold on that theory, although I do believe this rally still 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 before returning from its nap.

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. It is not, though, incongruous to have multiple strong rallies while the Bear is still in charge. As I write this, the Industrials and Transports are close to making simultaneous new highs, signaling a continuation of the 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 2,350 points in the past three months. That's a move of about 36%. Last month I wrote that "if the Industrials can crest 8,500, there's no reason to think that 9,000 couldn't follow in short order." At around 8,800 right now, 9,000 is in sight. 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 movement of the Transportation average is mirroring the action of the Industrial average. According to Dow Theory, the Bear Market will remain in place until both averages 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 are 8,821 and 3,404, respectively. The clear Head and Shoulders formation shown below suggests that the Transports could be very close to breaking out to a new high.

Bond yields continue to rise as investors trade out of bonds and into stocks. Rates have soared almost a full 2% this year. Should rates increase too much more, it could threaten to choke off the economic recovery and any chance for the housing market to improve. Who will win this fight: the Federal Reserve trying to keep rates low or the free market recognizing that rates are destined to rise? I put my money on the market.

The huge increase on the yield of the 2-year Treasuries are another indication that higher rates are on the horizon. As the economic picture continues to improve, investors are increasingly taking money that they had parked in t-bills and short-term treasuries and are re-deploying those funds back into the stock market. There is also a growing fear that inflation may be returning in the not-to-distant future.

Last Month's Results

• According to the Department of Labor, the most recent figure for seasonally-adjusted initial jobless claims for the week ended June 6 was 601,000. The four-week average has declined to 621,750.
• Non-farm payroll employment improved in May, falling by 345,000 versus a revised 504,000 in April and 699,000 in March. Average hourly wages inched up to $18.54, but the average workweek fell to 33.1 hours, so real wages continue to stagnate.
• The number of workers reported in May as unemployed rose to 14.5 million, bringing the unemployment rate to 9.4%, its highest level since 1983. The seasonally adjusted number of people who could only find part-time work rose to 9.1 million and the number of marginally attached workers rose to 2.2 million. The number of people holding multiple jobs fell to 7.27 million. My Comprehensive Labor Index™, which is much more representative of the real unemployment situation, rose to a scary 19.53%. I've been saying for months that I expected to see my CLI™ at around 20% later this year. There is little doubt that this will happen sooner rather than later.
• The Congressional Budget Office (CBO) estimates that on a net present value basis, the Treasury will report a federal budget deficit of $984 billion for the first eight months of fiscal year 2009 as the May deficit of $181 billion was $15 billion worse than last year. TARP payments represent about $130 billion of that total. Next stop: our first $1 trillion deficit.
• The Census Bureau reported that the U.S. trade deficit in April was $29.2 billion, up from $28.5 billion (revised) in March. I think it's a slightly positive sign the the trade deficit is growing again as it demonstrates a general strengthening of the economy.
• The Census Bureau reported that privately owned housing starts dropped 12.8% in April following an 8.5% drop in March, and was down 54.2% from a year ago, to a seasonally adjusted annual rate of 458,000 units. New building permits were down 3.3% from last month and 50.2% from last year. While this isn't good news for homebuilders, it is good news for the overall housing market as the lack of new construction will ultimately help clear out the inventory of homes for sale.
• The National Association of Homebuilders/Wells Fargo Confidence Index increased in May for the second straight month to 16. This is the highest level since September 2008. The homebuilders must see something that I don't.
• The Census Bureau reported that on a seasonally adjusted annualized basis, sales of new homes in April were roughly the same as the prior month but were still down 34.0% from the same period last year, to 352,000 units. The estimate of homes for sale is down to 297,000, which represents a shrinking 10.1 months at the current rate of sales. The median sales price increased to $209,700 but remained well below the steadily falling 12-month moving average price of $219,850.
• The National Association of Realtors reported that on a seasonally adjusted annualized basis, sales of existing homes in April rose a modest 2.9% from the prior month, but were down 3.5% from the same period last year, to a projected 4.68 million units. The estimate of homes for sale, at almost 4.0 million, represents 10.2 months of supply at the current rate of sales. The median sales price rose fractionally to $170,200, but remained well below the steadily falling 12-month average of $186,983. Interestingly, there is a 40 month supply of homes priced over $750,000.
• 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 151.41 in March, the lowest level since June 2003.
• According to RealtyTrac, foreclosures decreased by 6.0% in May to 321,480, but remained 18% higher than a year ago. "May foreclosure activity was the third highest month on record, and marked the third straight month where the total number of properties with foreclosure filings exceeded 300,000 — a first in the history of our report,” said James J. Saccacio, CEO of RealtyTrac." Nevada, California and Florida, reported the highest foreclosure rates in the country while California, Florida and Nevada had the highest actual number of foreclosures.
• The Institute for Supply Management (ISM) index of manufacturing activity increased to 42.8 in May, continuing the general uptrend in place so far this year. This was the seventeenth straight month in which the manufacturing sector failed to grow. The good news is that New Orders are growing and the trend is moving in the right direction; a number over 40 suggests the recession may be weakening. The ISM index of non-manufacturing activity was a slightly higher 44.0.
• The Conference Board reported that it's index of Leading Economic Indicators rose a strong 1.0% in April, the first increase in seven months. Most of the components of the index gained sharply.
• According to the Bureau of Economic Analysis, the "preliminary" estimate of GDP growth in the first quarter was -5.7%, better than the "advance" estimate of -6.1%. This follows a horrible -6.3% in Q4 '08. There is still one revision to come. The hope is that the first quarter will mark the bottom of the recession.
• The Federal Reserve reported that in April the amount of outstanding consumer credit fell by 0.6% from the prior month, to $2,524 billion. That means that consumer credit has declined in seven of the last nine months. That's good for consumers, bad for the economy.
• According to the Census Bureau, retail trade and food service sales increased 0.5% in May, and April was revised upward to a decrease of only -0.2%. This improvement in retail sales dovetails with other coincident indicators that the economy is improving, albeit slowly.
• According to the BEA, even though disposable personal income continues to fall, the personal savings rate, which for years had been negative, was 5.7% in April, up from 4.5% in March, continuing a trend that shows Americans again saving money, rather than going deeper into debt.
• The Federal Reserve reported in April that the increase in the supply of M-2 was only 2.6% in the past three months, while the supply of M-1 rose by 4.1% in the same period. In the past six months, the rates of increase were 9.2% and 15.9%, 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, jumped in April to 40.8 then surged in May to 54.9. Consumers seem to think that the worst is behind us. Time will tell if they are correct.

I think it's time to admit that the financial sector has officially returned from the dead. The recovery in financial stocks has mirrored the recovery of the overall market. What is interesting to me is that the financials have really not participated very much in the rally over the past month as the sector has basically moved sideways. So has the rally petered out, or is it simply taking a breather? I think the financials will continue to rise along with the overall market, although probably not to the same extent.

The housing index has lost some steam over the past month as investors recognize that the sector remains in terrible shape. I think there will have to be some very good results from new and existing home sales later this month for the sector to regain any momentum.

The price of West Texas Crude continues to move steadily higher. As I write this, the current futures contract calls for a price of $72.48 per barrel, whereas it was $57.44 just one month ago. Interestingly, on CNBC the "experts" have noticed that the market is rising with the price of oil this year, suggesting that there is now a correlation. I would bet this correlation will suddenly disappear should the price of oil again approach $100. Last month I wrote that "I would expect the price to consolidate a bit before attacking the $60 level. After breaching that resistance, it's on to $70." Well, $70 has already been breached, and the rising triangle pattern shown below suggests the price will continue to move higher as traders jump on the bandwagon.

After a fourth attack on $1,000 early this month, the price of gold has again backed off a bit. It shouldn't surprise anyone that gold would fall in the face of a big stock market rally, or that it would fall prey to some profit taking after a solid rally. I'm confident that gold will take another run at $1,000 before the summer 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. On a purely technical basis, the fact that the 50-day moving average has crossed above the 200-day average is very bullish. I would expect prices to continue to rise.

Last month I wrote that "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." All of that remains true. The dollar is in big trouble. It's weakness is clearly a factor in the rising price of hard assets like oil, gold, copper, etc. If this rapid decline increases for too much longer, it could have a very negative impact on interest rates has bond holders will have additional incentive to get out of dollar-denominated debt.

Foreign markets, as represented by the MSCI EAFE index, have staged a rip-roaring comeback after a dizzying plunge. And technically, the moving averages are converging, which suggests further gains could be ahead.

The NYSE Bullish Percent Index represents the percentage of stocks listed on the NYSE that signal a buy. It has been about two years since there has been such bullishness for NYSE-traded stocks. That level of exuberance leaves me feeling very nervous.

The volatility index, also known as the "investor fear gauge", has fallen back into the normal range. As the VIX continues to stabilize, the market will grow increasingly more calm, and be less susceptible to wild swings of a panic. It also suggests a certain amount of optimism for the near-term future of the market.

What I'm Thinking and Doing

Personal News and Notes

Greg Werlinich
President

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