Werlinich Asset Management, LLC
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Rye Brook, NY 10573
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June 6, 2011

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

Current Market Analysis

When I last wrote to you in late April, the Dow Jones Industrial Average was at a three-year high around 12,505. After a small dip, the bull surge continued, bringing the industrial average to a closing high of 12,810 on April 29. Since then, it's been almost straight down, with five consecutive losing weeks, culminating with a closing price of 12,151 on June 3. The latest correction coincided with more dire announcements from some of the Euro-zone countries struggling with overwhelming debt burdens, and with the debt problems and economic malaise right here in the US.

Rather than simply succumb to the fear and blather shouted in the media, let's take a rational look at things. First of all, I believe that we are in the midst of a very normal correction in a large bull market. If you look at the chart below, you'll see that since last July, we've had four decent sized corrections. We dropped 10.2% last July, 7.8% last August, 7.2% this past March and 6% so far in our current pullback. Therefore, it stands to reason that we could drop a bit more before it's done, but then we can expect the market to turn around and head up to even bigger gains. The overall upward trend remains intact. My guess is that the bottom isn't too far off.

The transportation average is also down a little over 6% in the current pullback. On a technical basis, I want to see the index remain higher than its 200-day moving average. Then, on the next bull move, we will want the index to rise above 5,565 to prove that the bull market remains in force.

Just when many observers, including myself, were suggesting that it was time to abandon bonds, another disaster struck, pushing investors back to the relative safety of Treasuries. Then the equity markets sunk, providing further impetus for bond-buying. So now we're back to a 3.0% yield on the 10-year note. Looking at RSI, it would suggest that the bond trade may be just about done, which would coincide with a resumption of the equity bull market sometime soon.

Last Month's Results

As always, I provide the following chart to show the raw results for the preceding month, the quarter-to-date and the year-to-date, not including dividends. As you can see by the results below, the broad market averages were down a bit in May, but probably not as much as you may have thought given all the naysayers in the media. All the broad averages remain solidly in the black for the full year. The EAFE, not surprisingly, finished the month poorly thanks to the continuing problems stemming from the disaster in Japan as well as the debt crisis affecting most of the Euro-zone countries. Overall, the picture really isn't that bad.

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

Barclays Aggregate




US government bonds

Barclays High Yield




High-yield corporate bonds

Statistics To Watch

  • According to the Department of Labor, the figure for seasonally-adjusted initial jobless claims for the week ended May 28 was 422,000, a decrease of 6,000 from the prior week's revised figure. The four-week average was 425,000, slightly lower than a month ago, but still too high. The weekly numbers remain choppy, but the trend needs to improve.
  • Non-farm payroll employment increased by a meager, and very disappointing 54,000 in May, after averaging almost 220,000 over the prior three months. Job creation occurred in professional and business services, health care, and mining. Local government employment continued to trend down. Employment in other major industries changed little over the month.. The average hourly wages for blue collar workers actually inched higher to $19.43 while the average work week remained at 33.6 hours. It's possible that this was a one month anomaly following the earthquake and tsunami in Japan and horrible rains throughout much of the U.S. Next month will be very important.
  • The total number of workers counted as unemployed rose by about 200,000 to 13.9 million. Therefore the unemployment rate increased to 9.1%. The more comprehensive U-6 rate fell to 15.4%. 6.2 million people continued to be unemployed longer than 27 weeks. The seasonally adjusted number of people who could only find part-time work remained at 8.5 million and the number of marginally attached workers fell to 2.2 million. The number of people holding multiple jobs increased to 7.08 million. Overall, the employment picture is stagnating as QE2 failed to stimulate job growth.
  • The Congressional Budget Office (CBO) estimated that on a net present value basis, the Treasury reported a federal budget deficit of $41 billion in April, leaving us with a deficit of $871 billion for the first seven months of fiscal 2011, which is $70 billion more than the record levels from a year ago. The good news is that tax receipts were much higher than last year.
  • The Census Bureau reported that the U.S. had a trade deficit in goods and services of $48.2 billion in March, up from $45.4 billion in the prior month. Both imports and exports increased in the month.
  • The Census Bureau reported that privately owned housing starts fell 10.6% in April, after rising 12.5% in March, but remained down 23.9% from a year ago, to a seasonally adjusted annual rate of 523,000 units. The monthly results have been extremely volatile this year, surely impacted by the severe late winter and spring weather across much of the country. New building permits were down 4% from the prior month and 12.8% from last year. While the sluggish housing market continues, the weakness in new construction will ultimately set the stage for the recovery as the inventory of hew homes for sale diminishes to match a smaller number of buyers.
  • The National Association of Homebuilders/Wells Fargo Confidence Index in May remained at 16, where it has been for six of the last seven months. Again, this demonstrates a simple lack of interest in new housing at this point.
  • The Census Bureau reported that on a seasonally adjusted annualized basis, sales of new homes in April rose 7.3%, after increasing 8.3% in March, but remained 23.1% lower than a year ago, at 323,000 units. The estimate of homes for sale was only 175,000, which represents 6.5 months at the current rate of sales. The median sales price was a slightly higher $217,900, which is far below the 12-month moving average price of $222,442. It's no surprise that the spring numbers are better after the very harsh weather across much of the country in January and February. It will be interesting to see if the May numbers fall due to all the rain.
  • The National Association of Realtors reported that on a seasonally adjusted annualized basis, sales of existing homes were virtually unchanged at 5.1 million units, but remained 12.9% lower than a year ago. The estimate of homes for sale, at 3.9 million represents 9.2 months of supply at the current rate of sales. The median sales price inched higher to $163,700, which is lower than the 12-month average of $169,633. The market for existing homes continues to lag, and is still dominated by repossessions and foreclosures, which forces prices lower.
  • The S&P/Case-Shiller Home Price Index (10-city index), which uses a three-month moving average to track the value of home prices across the US, fell again in March, and was far weaker than a year ago, giving further evidence of the trend of falling home prices across the county. While this is a trailing indicator, it does paint a bleak picture. In fact, this index suggests that home prices have declined to 2002 levels, erasing almost a decade of gains.
  • According to RealtyTrac, the number of foreclosures in April decreased 8.6% from the prior month, but were down 34% from a year ago. Foreclosure activity is now at a 40-month low, although this appears to be more due to legal and regulatory issues than any fundamental recovery in housing. This suggests that foreclosure activity will increase once the court system clears the legal hurdles currently stalling many of the in-process foreclosures.
  • The Institute for Supply Management (ISM) index of manufacturing activity was 53.5 in May. This marked the twenty-second consecutive month of expansion in the manufacturing sector, but was also the second monthly decline since March. The ISM index of non-manufacturing activity was 54.6. This marked growth in the service sector for seventeen consecutive months. This provides evidence that while business is still growing, that rate of growth has slowed considerably in the past two months.
  • The Federal Reserve reported that capacity utilization in the industrial sector in April was 76.9%, which leaves it 3.5% below the average level of the period from 1972 through 2010. After improving for much of last year, capacity utilization seems to be stagnating so far this year.
  • The Conference Board reported that it's index of Leading Economic Indicators decreased by 0.3% in April, following an increases of 1.0% in February and 0.4% in March. Says Ataman Ozyildirim, economist at The Conference Board: "The U.S. LEI has been rising since March 2009, with only a brief one-month interruption in June 2010, and now, in April 2011. The U.S. CEI, a monthly measure of current economic conditions, continued to increase, supported by improving employment figures. Overall, the composite indexes still point to strengthening business conditions in the near term, although the path may be uneven."
  • According to the Bureau of Economic Analysis, the "second" estimate of GDP growth in the first quarter of 2011 was equal to the "advance" estimate of a tepid 1.8%. This compares with 3.1% in Q4, 2.6% in Q3, 1.7% in Q2 and an artificially inflated 3.7% in Q1 of 2010. A large growth in imports and a large decrease in government spending hurt GDP growth, as did a reduction in consumer spending.
  • The Federal Reserve reported that in March the amount of outstanding consumer credit ticked up slightly from the prior month, to $2.425 trillion. If consumer credit were to begin to expand again after falling for much of the past four years, it would be a boon to the economy.
  • According to the Census Bureau, retail trade and food service sales were 0.5% higher in April, and were 7.6% higher than a year ago. This growth is misleading as almost all of the increase comes from higher gas station sales. Furniture, electronics and appliance sales were down considerably.
  • The Federal Reserve reported that in April the supply of M-2 increased slightly from the prior month and was up 4.5% during the prior six months. The supply of M-1, on the other hand, rose a whopping 13.1% over the same six months. At this point, it appears that the Fed's efforts to "prime the pump" to get the economy moving again is failing as business growth is slowing. What does this mean for the future of Quantitative Easing programs?
  • The Conference Board's Consumer Confidence Index fell in May to 60.8 from 66.0, down considerably from 72.0 in February, which was a three-year high. The index remains well below a healthy reading as inflation worries grow while real incomes decline. An overall reading above 90 indicates the economy is solid, and 100 or above indicates strong growth.
  • According to the BEA, the personal savings rate in April remained at 4.9%. As I've expected, the savings rate is trending lower from a high of 6.2% last June, thanks to a rising stock market and historically low interest rates on savings.
  • According to the FDIC, 45 banks have failed through June 3, compared with 77 failures at roughly the same point last year. There were a record 160 banks failed for the full year in 2010, surpassing the prior mark of 140 banks that were either closed or merged into healthier banks in 2009. By comparison, 26 failed in 2008 and only 3 failed in 2007.

Trends To Watch

The dollar index rallied almost 4.5% during most of May, helping to send equity markets lower. This rally though was not because of any good domestic news, but rather because the news out of Europe was so bad. So this upward move was nothing more than a "relatively better" buying spree. Sure enough, the dollar quickly turned down and headed back to its historically low levels. For years I've been warning that the dollar is headed inevitably lower and that's exactly what's come to pass. I've also been investing according to that thesis, and have made substantial profits in hard assets. When and if the Fed really does end their programs of quantitative easing, and we begin to tackle our own debt crisis, the dollar could strengthen.


Rather than bore you with the same bullish sentiments I've been writing about for the past eight years, just look at the chart below. That's really all you need to know about the bull market in the price of gold. Each consolidation was followed by a rise to a new high, and I believe this time will be no different.

Last month I wrote that "we'll likely see $50 before summer vacation. But as you can see below, RSI is wildly overbought, suggesting a correction is imminent." Well, I was likely wrong with the former sentiment but dead on with the latter. After a parabolic rise in the price of silver in April and May, the bull trade broke with a vengeance, driving the price of silver down almost 30% in just a few days. And just as quickly, all the pundits announced the end of the silver trade. Wrong!! It was simply a correction to an overheated trade, brought on by limiting the margin requirements of traders. The price of silver, which never violated the rising blue trendline, has already begun to move higher again. This is a very good buying opportunity.  

The price of copper is sitting dangerously close to the bottom of its eight month old trading range. You'll notice the the prior trading range lasted eight months before moving higher. Consolidations are a normal and vital part of any market move. Like all commodities, copper benefits from a generally weak dollar and strong international demand (read: China), but suffers during times of economic malaise. Remember, Dr. Copper is often thought of as a proxy for economic growth. So this chart is now telling us that the prospects for future growth have dimmed a bit. Should demand from the Far East slow even more, we'll see the price of copper quickly head south.

The price of West Texas Crude (WTIC) remains in a clearly defined upward channel. In the last newsletter, I predicted a correction, although I didn't think it would be quite so brutal. Technically, it's a little worrisome that the current price is below the 50-day moving average, after plunging during the recent dollar surge. But I remain solidly bullish on the future of oil as a major investment theme, and it remains a core holding.

I don't take a lot of satisfaction in seeing the financial sector roll over and fall back into its trading range (well, maybe a little bit). I just saw no reason for the bank stocks to be doing well while the housing sector remained weak and while our economy remained constrained. The index of the financial sector is now below both the 50- and 200-day moving averages. And the averages are starting to converge. If the 200-day average moves above the 50-day average, it will be VERY bearish for the financial sector. Personally, I don't want to own any stocks in this sector.

Not surprisingly (at least not to me), the rally in housing failed, and the price of this index fell back below resistance at 115 and is heading south. As was made clear by the figures listed above, there are simply too many problems in the housing market to believe that this sector can be a good investment. I believe there are more losses to come. I remain entirely uninvested in this sector.

I had a hard time deciding how to portray the chart of the European stock market. Rather than draw an upward trendline from last summer to now, showing the general upward bias of the market, I've gone with a reverse head and shoulders pattern, which I'm not even sure is correct. But it does show a broad pattern, which if correct, and if the right shoulder has fully formed, could predict higher prices in the developed world. Granted, that's a big "could" as Greece, Portugal and Spain, among others, struggle with their debt burdens. But if a deal is worked out, those markets could move much higher. Stay tuned.

The emerging markets suffered less from the recent problems than the developed markets and are again near their highs. The chart shows a consolidation followed by a breakout to its highest level since the Lehman failure, before correcting back into the trading range. The countries in the emerging markets earn most of the GDP growth in the world right now, so investors ignore these markets at their own peril.

The health of the Chinese economy, and by proxy, it's stock market, is very important to the world's economy as they buy much of the world's output of raw materials and produce most of the goods sold to the world. Therefore, the chart makes me a little nervous. After rising from the lower blue band (floor) to the upper blue band (resistance), the Shanghai Composite has fallen right back to test the floor. That's not good. If the Chinese economy slows too much, they will take the price of hard assets, and much of the world economy, down with it.

The NYSE Bullish Percent Index represents the percentage of stocks listed on the NYSE that signal a buy. Contrarians would argue that extreme levels of exuberance is a bearish indicator, and vice-versa. Clearly there is a growing lack of exuberance right now, which will set up the next rally.

With thanks to Richard Russell of the Dow Theory Letters, I'm adding a new chart this month. Below is a chart showing the percentage of stocks traded on the New York Stock Exchange that are trading above their 50-day moving average. The fact that only about 33% of stocks are currently trading above the 50-day average demonstrates the current bearishness.

As you can see below, the fear after the disaster in Japan subsided so quickly it's almost as if it never happened. This is a perfect example of how people panic at just the wrong time, and make snap decisions that they quickly come to regret. The best investors and advisors remain calm, wait for the facts, and make decisions based on information, not emotion. Now, the VIX has again bounced off the floor at 15, and appears to be moving higher after five consecutive down weeks. This is to be expected when stocks are correcting. I won't worry unless the VIX moves north of 25.

What I'm Thinking and Doing

Right now I'm thinking a lot about the consequences of having too much debt, and the effects on Greece, Portugal, Spain and the United States. I'm thinking about what will happen to our economy and our stock market when (if) QE2 ends later this month (at least that's what the Fed has promised). I'm thinking about what happens to our country as we bump against the debt ceiling, and Congress plays political handball with a loaded cannon. I'm pondering what happens if they don't arrive at a solution that's acceptable to both parties before our government defaults on its obligations. I'm wondering about what's really happening in China, because we can never really know. And I'm wondering when we'll really see the bottom of the housing crisis, and when we will see a prolonged recovery in employment. Because if I can discern the answers to any of these questions, I can make my clients a lot of money.

Now that I've completely depressed you, let me give you the good news. I believe the recent slowdown in the economy is temporary, thanks in part to natural disasters and unusually harsh weather patterns. The second half of the year should be stronger than the first. Corporate profits, taken in total, continue to be very strong. Companies are sitting on hundreds of billions of dollars in cash, just waiting to be deployed. Interest rates remain at historically low levels, which is good for business as well as investors and homeowners. And notwithstanding the announced end to QE2, we still have very a accommodative Federal Reserve doing whatever it can to prop up the economy.

I continue to selectively put new cash to work in my core sectors during times of weakness. Unless you need the money in the next year or two, there is really no reason to be out of this market. Remember, markets always go up and down; it's the normal cycle. The key is to remain in the market so you don't miss the gains. If you have any questions, please feel free to give me a call and we can discuss your personal financial situation.

Personal News and Notes

There are only 18 more days until the last day of school. Final exams begin next week. Summer is just around the corner. Can I get an "amen"???

Lily's bat-mitzvah was wonderful. The weather was perfect all weekend. Lily did an absolutely amazing job leading the service and chanting the prayers. I was incredibly proud of her. And I only choked back tears once when it was my turn to address her at the end of the service. Everyone had a fun time at the party where the food and drinks were amazing. All in all, things could not have gone any better. I have some pictures up on Facebook if we're "friends" there and you want to take a look.

Last weekend the kids and I attended my 25th college reunion at Princeton University. It was a great weekend seeing old friends and roommates and reminiscing about the good old days of the mid-80's. The weather was better than expected and the P-rade went off without a hitch. Our reunion attire was (literally) a sight for sore eyes, but it was a great event nonetheless. I hope we'll all be back again in five years. And again, I'll be posting a bunch of photos on Facebook.

This week, Nola will be going to the senior prom!! With a mix of pride and fear I'm looking forward to seeing her in her prom gown. Parents out there, you know what I mean. Then before you know it, all three kids will be off on their summer adventures. Indeed, by the time I write to you next, they'll all be gone. It's good to be my kids.

Finally, my fan page on Facebook is up and running. So for those of you with Facebook accounts, please type in "Werlinich Asset Management" in your search bar, visit my fan page, then please "like" it. I plan to continue to add content over time. And don't forget that you can connect with me on LinkedIn or follow me on Twitter. I tweet the latest market and economic news every day. Following me is a very easy way for you to receive stock market updates in between my newsletters. I'm closing in on 200 followers, up from about 50 or so at the end of the year. I'd like to double that before year-end, so help a guy out by following me, and ask your colleagues, friends and family members to do the same.

As always, I thank you, my readers, and remind you that this newsletter is for you. I have been writing to you now for over seven years. I hope some of you have learned something about our economy and our stock market, and that you will continue to follow along with me into the future. If you have any thoughts or suggestions on how to make it better, please let me know. And if you'd like to speak with me about your investment needs, I'd be pleased to be of service. Simply give me a call or drop me an email.

Best regards,

Greg Werlinich

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