Current Market Analysis

So much for consolidation. After two months of trading between 13,250 and 13,750 the Dow Jones Industrial Average has again blasted to new highs. As I write this, the index closed for the day at 13,950 (after hitting 13,989 earlier today), which is seductively close to 14,000. You can be sure that the media will be breathlessly pontificating on this. Just watch CNBC's tireless coverage as an example.

When I wrote to you last month, the Industrials were trading at 13,352, a full 600 points below today's lofty heights. A pause that refreshes indeed! I have said for the past few months that that most of the technical indicators appear favorable for the market to rise even higher. Until proven otherwise, I'm sticking with that opinion. As the Industrials, Transports, S&P 500 and other major indices all make new highs, it would appear that the market will continue to move higher.

Look at the chart below to see the powerful upward move out of the consolidation. RSI looks somewhat overbought, but in a powerful rally, that becomes less important as the market can stay overbought for a while. One thing to be aware of is how far the index is currently trading above its 200-day moving average. Sooner or later that gap will have to narrow, either by the market falling, or trading sideways long enough for the rising average to catch up.

As you can see, the Transportation index remains in a solid uptrend as it has been making higher highs and higher lows. This is very bullish. As with the Industrials, just watch the gap between the current price and its moving averages. Sooner or later the spread will have to diminish.

Last month I wrote that I was worried about the recent downward trend for utilities (especially since WAM owns some utility stocks and funds). Part of the concern was due to the effects of rising interest rates, which usually portend bad times for rate-sensitive utilities. Rates have now leveled off, and the utility average has again turned up. The current price is right on the 50-day moving average and remains above the 200-day. I believe the bullish trend remains in force.

The daily chart of the S&P 500 looks very much like the chart of the Industrials. The overall trend is solidly bullish.

I've shown this chart a few times in the past. This is the monthly chart of the S&P 500, going back to the beginning of this decade. Here you can clearly see the fall during the crash, then the subsequent rise over the past five years until the index finally recovered its losses. It's taken a LONG time to return to the high set in early 2000. What worries me is that the RSI has been overbought for about a year. That cannot last forever, but like the Dow, a sustained sideways move could work that off.

I'm presenting a slightly different picture of the bond market this month. Below is a weekly chart of the past 3 1/2 years (rather than a daily chart of the past year and a half). By smoothing out some of the short-term volatility, a weekly chart sometimes gives a clearer picture of what's really going on. A key item that I take from this chart is that when the moving averages converged in late 2005, and the 50-day moving average passed above the 200-day, yields tended to be higher. Bond prices (and their yields) appear to be consolidating right now. The stock market has rallied strongly while yields have softened a bit. If yields begin to head towards 5.50%, that would be bearish for equities and housing. On the other hard, if yields again fall below 5%, that would be very bullish for equities.

Last Month's Results

• The most recent four-week average for initial jobless claims, for the week ended July 7, was 317,750, down from 324,000 three weeks ago.
• According to the Department of Labor, non-farm payroll employment rose by a decent 132,000 in June, maintaining the strong results from May. The biggest gains came from health care, hospitality and government jobs. Manufacturing employment continues to decline. Average hourly wages rose to $17.38 from $17.30 as wages continue to rise slowly but steadily. The average workweek remained steady at 33.9 hours. The number of people holding multiple jobs fell slightly to 7.54 million.
• The number of unemployed workers inched up to 6.9 million. The seasonally adjusted number of people, who for economic or business reasons, could only find part-time work, fell to 4.3 million and the number of marginally attached workers rose to 1.5 million. My Comprehensive Labor Index™ stayed at 8.70%, and the unemployment rate reported by the government held at 4.5%.
• The Conference Board reported that it's index of Leading Economic Indicators increased 0.3% in May, reversing the decline in April. The Leading Index has grown by 0.3% over the past six months, suggesting moderate economic growth in the near future.
• The University of Michigan Consumer Confidence Index fell to 85.3 in June from 88.3 in May. Rising gasoline prices and falling home values are straining household budgets.
• According to the CBO, the government posted a budget surplus of $25 billion in June. That resulted in a deficit of $123 billion for the first nine months of the fiscal year, which was $83 billion less than a year ago. The receipt of estimated taxes usually creates a surplus in June.
• According to the Census Bureau, the U.S. trade deficit in May was $60.0 billion, up from a revised $58.7 billion in April. The three month moving average is $60.4 billion. Our trade deficit with China was $20 billion for the month.
• The Labor Department reported that on a seasonally adjusted basis, the CPI for urban consumers rose 0.7% in May while the "core" CPI, which excludes food and energy, rose only 0.1%. I wouldn't even bother reporting these phony numbers if the government and the media didn't make such a big deal about them. But I find them to be just about meaningless.
• The Federal Reserve reported that the amount of outstanding consumer credit increased by 0.5% from the prior month (or 6% annualized) in May, to $2,440 billion. So the American consumer continues to do his and her part to buttress the economy by borrowing to spend.
• According to the Census Bureau, retail trade and food service sales fell 0.9% in June from the prior month but remained up 3.8% from a year ago. Sales of automobiles, home furnishings and consumer electronics were among the biggest laggards in the month.
• The Census Bureau reported that privately owned housing starts fell 2.1% in May from a revised lower April figure, and was down 24.2% from a year ago, to a seasonally adjusted annual rate of 1.47 million units. New building permits were up about 3% from last month and down 22% from last year, so the outlook for future housing starts remains poor.
• The Census Bureau reported that on a seasonally adjusted annualized basis, sales of new homes in May fell 1.6% from revised lower April levels, and down 15.8% from the same period last year, to a projected 915 million units. New home sales have been down five of the last six months, with the one up month seemingly due to builders slashing prices to move inventory. The estimate of homes for sale is now 536,000, which represents 7.1 months of supply at the current rate of sales. The median sale price is only $236,100, below the 12-month average of $243,433.
• The National Association of Realtors reported that on a seasonally adjusted annualized basis, sales of existing homes in May slid 0.3%, and were 10.3% lower than the same period last year, to a projected 5.99 million units. This marked the third straight month in which fewer homes were sold than the prior month. The estimate of homes for sale, at 4.43 million, represents a whopping 8.9 months of supply at the current rate of sales. The median price of homes sold increased to $223,700, the fourth straight monthly increase.
• According to RealtyTrac, foreclosure filings fell 7% in June but were still up a whopping 87% from a year ago. Nevada, Colorado and California had the highest foreclosure rates, while California, Florida and Ohio had the highest absolute number of foreclosures.
• The Institute for Supply Management (ISM) index of manufacturing activity was 56.0 in May, up from 55.0 in May. This marks the fifth month in a row in which the index has increased demonstrating strength in the manufacturing sector of the economy.
• The Bureau of Economic Analysis announced that the "final estimate" of the growth in GDP for the first quarter of 2007 was an anemic 0.7%. This was up marginally from the "preliminary estimate" of 0.6%, and down from the "advance estimate" of 1.3%. This follows the Q4 2006 growth rate of 2.5% and the full year growth rate of 3.3%. Even though these figures are worthless, they do show a clear trend of slowing economic growth. I'm guessing that at some point in the future we will be told that the U.S. is now in the midst of a mild recession.
• Also according to the BEA, personal savings was estimated to be a negative $139.8 billion in May, or 1.4% of personal disposable income. This marked the second consecutive month in which the negative savings increased.
• The Fed increased M-2 by 0.2% in June after a 0.3% increase in May. The supply of M-2 has increased by a smaller 5.1% in the last three months and 6.1% in the last twelve months. The constantly increased supply of "money" is the dollar keeps falling and why everything costs more.

Last month I remarked that I found it very interesting that as the price of crude oil again approached $70 per barrel, there was little of the public outcry that accompanied the last such move. Now, the price of oil has zoomed past $70 and is approaching $75, yet with the market hitting new highs every week, nobody seems to notice or care. The inverted "head and shoulders" pattern that has been forming for the past year continues to hold. It remains clear to me that the price of West Texas Crude is going higher and on average, will remain high for the foreseeable future. Next stop: $80 per barrel.

So how is the yellow metal doing? The chart below shows gold recovering from an oversold position in June while remaining in a solid uptrend. Notice that since bottoming last October, the price of gold has made ever higher lows on each correction and ever higher highs on each push upward. If this trend were to continue, we could see gold again crest $700 per ounce within the next month or so. On a technical basis, gold looks very appealing right now.

There are three clear phases displayed in the chart of the Dow Jones Commodity Index (which represents 19 physical commodities). First there was the declining triangle pattern that lasted most of 2006. The subsequent breakout lasted about two months. The current consolidation phase has endured for almost five months. I suspect that the next phase will be a new upside breakout, taking the index above 180. Time will tell.

Unlike oil, precious metals and commodities, the chart of the dollar is not just bearish, it's downright depressing. Below I've presented a chart showing the dollar index for the past 20 years. I've been saying for the past year or so that the future of the dollar looks bleak (thank you Federal Reserve). The dollar now hangs on the precipice of its historical low. What does this mean to you and me? It means the continued erosion of the purchasing power of the green stuff in our wallets. It means that it keeps getting more expensive to travel overseas. It also means that our trade deficit will continue to shrink as it gets cheaper to send our goods overseas and more expensive to bring their goods into our country. This is hardly the picture of an economic superpower.

Similar to the dollar, the housing picture continues to deteriorate. The housing index is firmly below the April low and headed towards the historical low set last July. I've been writing all year about the bleak outlook for housing. I believe that the worst in the housing market is ahead of us as the subprime lending mess deepens and as the majority of the adjustable rate mortgages reset this fall. This is going to get much worse before it gets better, and it will likely be years before it gets appreciably better.

The world market, as represented by the MSCI EAFE index (Europe, Asia and Far East), continues to look very good. Much of the rest of the world is enjoying a similar, or better, bull market than the U.S. Hold onto your international holdings.

Finally, let's look at the yield curve. As I noted last month, the curve is no longer inverted. The long end of the curve now yields more than the short end. And what does this mean? Historically, it has meant a stronger economic outlook, a little more risk of inflation and a stronger dollar. The spread between the 10-year Treasury and the 10-year TIPS is holding steady at around 2.4%, which suggests very little fear of inflation in the bond market. As long as rates stay below 5.5%, there should be minimal impact on the stock market. 

This past month I bought two new stocks: an iconic consumer brand and a large agricultural company that were both selling at relatively depressed prices with average dividend yields. While neither operates within my core sectors, they are businesses that I expect to be able to own for years to come and I'm pleased to have been able to pick them up at such good prices.

Personal News and Notes

So far it has been a very enjoyable summer in the Werlinich household. The weather has been good, the golf, while not plentiful, hasn't been too bad. Visiting day for my girls, who are a sleep away camp, was this past weekend and it was a joy to see them. My son is having a great summer at day camp. Shaena and I have found a wonderful little beach in Greenwich that we tried yesterday and enjoyed enough to plan a few return visits. After the beach, we had a couple of lobsters at a local joint then home for a quiet night. What a great way to end the weekend.

Greg Werlinich
President