Werlinich Asset Management, LLC
400 Columbus Ave.
Suite 170E
Valhalla, NY 10595

July 23, 2008

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

Current Market Analysis

It has been a wild month in the stock market since I wrote to you. After plunging below important support levels to a new year low of 10,962 on July 15, the Dow Jones Industrial Average has surged about 700 points to 11,660 as I write this today. There is a whiff of euphoria in the market as the price of oil has swooned and the financials, led by the bailout Fannie Mae and Freddie Mac, have rallied from near death. Indeed, some of the big money-center banks like Citigroup, Bank of American and JP Morgan Chase are being applauded for losing less money than expected and their shares of risen dramatically over the past week or so.

Interestingly, on July 15, the day the market made it's low for the year, of the 3299 stocks that traded on the New York Stock Exchange, 39.5%, or 1,304 stocks, hit new lows for the year. That is the highest single day percentage in the history of the NYSE. And the 7.2 billion shares traded that day was the second highest ever (thanks to Richard Russell of Dow Theory Letters for those statistics). So has "THE LOW" been made yet? Is the worst now behind us? I honestly have no idea. It is important that the Dow Transports did not make a new low along with the Industrials. It's also important that the Dow remained above the huge support level of about 10,750 that I talked about last month. That being said, I think it's too early to call a bottom. The economy still stinks, housing is still a mess, as is the financial sector. And I don't think we've seen the end of high oil prices by a long shot. So we watch the action and wait for further news.

So let's take a look at the charts to see what the market is telling us. Below is a daily chart of the Industrial Average so far this year. We clearly see the plunge below the March low, taking the Industrials below 11,000 before the recent rally. Considering how dramatically oversold that drop way, it isn't surprising to see a bit of a run-up now. Again, I just want to remind you of the next support level on the downside of about 10,750, which would represent the midpoint of the low set in July 2006 to the high set in October 2007. It is very important that the Industrials remain above that key support level.

The Transportation average remains remarkably strong and could be the one indication that the market is more likely headed higher than lower in the coming months. The Transports are more than 1,100 points higher than the January low and within shouting distance of the May high. Again, according to Dow Theory, the Transports and the Industrials must make new lows (or highs) at the same time to confirm the trend. Therefore,this lack of confirmation suggests that the market may have seen its worst days. We will continue to monitor this action closely. I expect to see the Transports consolidate a bit before making its next decisive move.

Not surprisingly, the S&P 500 broke below its year-long trading range, as shown below. The latest rally though has returned it to the lower range. Interestingly, the approximate midpoint of the S&P 500 from its low in 2002 to its high in 2007 is 1,165. That's a number worth keeping an eye on.

Bond yields are at the high end of the year-long spread between 3.3% and 4.3%. It made sense that bond prices would fall (lifting yields) as equities soared then rise (depressing yields) as equities fell. Bond investors also demand a higher yield in response to the falling value of the dollar. Looking ahead, I expect yields to remain near the high end of this basic trading range for the next few months.

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. The market decline last month ended up being the worst single month since 2002 and the worst June performance since 1930. There was really no safe haven anywhere in equities. The first half of July provided no solace for investors looking for a clues as to when that elusive "bottom" would appear. But then the Fed, and Congress to a smaller extent, stepped in to save the day. And while their intervention may have saved Fannie Mae, Freddie Mac, Lehman Brothers and some other banks from insolvency or bankruptcy, it remains to be seen if those stop-gap measures have a lasting affect.

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

Statistics To Watch

  • According to the Department of Labor, the most recent four-week average for seasonally-adjusted initial jobless claims, for the week ended July 12, was 376,500, a decrease of about 1,750 from the prior month, and an increase of 18,000 from the prior week's revised number. These figures continue to be poor no matter how you look at it. The actual, unadjusted number of initial jobless claims was a much higher 475,954, a large increase from the prior week.
  • Non-farm payroll employment fell by another 62,000 in June. This was the fifth month in a row that payrolls dropped, with about 300,000 jobs being reported as lost since February. As these statistics are revised in the future, you can be sure that the real number of jobs lost could be more than twice than figure. Average hourly wages grew a bit to $18.01 while the average workweek remained steady at 33.7 hours.
  • The number of workers reported in June as unemployed held steady at 8.5 million, keeping the unemployment rate at 5.5%. The seasonally adjusted number of people who could only find part-time work rose to 5.4 million and the number of marginally attached workers rose to 1.6 million. The number of people holding multiple jobs increased to 7.69 million. My Comprehensive Labor Index™ rose to 11.26%, the highest level since the end of 2005. My CLI™ is much closer to the true unemployment number in this country.
  • According to the CBO, the government posted a budget surplus of $51 billion in June, which was $23 billion more than a year ago. This surplus is mostly attributable to one-time events and timing. Normalized, the surplus would have been less than last year. The deficit of $268 billion for the first nine months of the fiscal year billion is running about $148 billion more than a year ago, and is partly attributable to tax rebates included in the the so-called economic stimulus package.
  • According to the Census Bureau, the U.S. trade deficit in May was $59.8 billion, down slightly from a revised lower April figure. I continue to expect this deficit to fall due to the weak dollar.
  • The Census Bureau reported that privately owned housing starts jumped 9.1% in June, after a small decrease in May, but was still down 26.9% from a year ago, to a seasonally adjusted annual rate of 1.066 million units. New building permits were also up a surprising 11.6% from last month and down 23.9% from last year. I'm not sure if the June figures represent a trend or not. We'll have to wait and see.
  • The National Association of Homebuilders/Wells Fargo Confidence Index fell to a record low of 16, below the previous record low of 18 set last month. This index was created in 1985. This incredibly low confidence number belies the one month increase in housing starts and new permits.
  • The Census Bureau reported that on a seasonally adjusted annualized basis, sales of new homes in May fell 2.5% from the prior month and 40.3% from the same period last year, to a projected 512 million units. That is the lowest figure in the four plus years I've been tracking new home sales. The estimate of homes for sale is now 453,000, which represents a whopping 10.9 months of supply at the current rate of sales. The median sales price fell to $231,000 and is below the 12-month moving average price of $236,817.
  • The National Association of Realtors reported that on a seasonally adjusted annualized basis, sales of existing homes in May actually increased 2.0% from the prior month, but were down 15.9% from the same period last year, to a projected 4.99 million units. The estimate of homes for sale, at 4.485 million, represents 10.8 months of supply at the current rate of sales. The median sales price rose to $208,600, which remains below the falling 12-month average of $210,042.
  • According to RealtyTrac, after three straight months of increases, foreclosures decreased by 3% in June to 252,363, but remained 53% higher than a year ago. Nevada, California and Arizona, respectively, continued to report the highest foreclosure rates in the country.
  • The Institute for Supply Management (ISM) index of manufacturing activity was 50.2 in May, breaking a run of five out of six months in which the manufacturing sector failed to grow. The ISM index of non-manufacturing activity decreased to 48.2, suggesting that the service sector continues to struggle.
  • The Conference Board reported that in June it's index of Leading Economic Indicators fell 0.1%, following a revised drop in May. Reductions in the money supply and losses in the stock market helped to pull down the indicator. The six-month rate of decline is -0.9% (or -1.7% annualized). The economy remains weak, but the weakness is moderating.
  • According to the Bureau of Economic Analysis, the "final" estimate of GDP growth in the first quarter was 1.0%, up from the "preliminary estimate" of 0.9%. Remarkably, this was an improvement over the 0.6% GDP growth reported in the fourth quarter. Personally, I find that almost impossible to believe. If GDP were calculated today in the same way as twenty years ago, GDP growth would clearly be negative. I'm convinced we've been in a recession since the fourth quarter of last year and that it continues today.
  • The Federal Reserve reported that in May the amount of outstanding consumer credit increased by 0.3% from the prior month, to $2,571 billion. Amazingly, the American consumer continues to borrow and spend. I maintain that this MUST stop sometime in the coming months, but I've been wrong so far.
  • According to the Census Bureau, retail trade and food service sales rose a meager 0.1% in June and were 3.0% better than a year ago. That retail sales are up at all is pretty amazing, all things considered. I wonder, though, how much of that little increase was due to the tax rebate checks.
  • The Fed held the supply of M-2 steady June. I honestly can't remember the last month in which the Fed did not increase the money supply. The amount of M-2 has increased by only 1.2% in the last three months and 6.1% in the last twelve months. After decreasing the rate of increase the prior two months, the Fed actually decreased the actual supply this month (it was statistically flat). What does that mean for this economy?
  • Consumer confidence continues to decline. The June Conference Board Consumer Confidence Index fell to its fifth lowest figure ever. Looking ahead, consumers' economic outlook is so bleak that the Expectations Index has reached a new all-time low.

Trends To Watch

This month we've seen major reversals in some of the key trends in the market, specifically the fall of the financials and the rise in the price of oil. I have long believed that the financials are an important indicator of the health of the stock market and the economy - the canary in the coal mine if you will. So did that canary, previously thought to be dead or dying, just spring back to life? One month does not a trend make, so we'll just wait and watch. I do know the losses are not done yet. The question is are the worst of the losses behind them? Personally, I'm not fishing in this pond yet.

Like the financial sector, housing has turned up recently. But we've seen this picture many times before, as you can see below. It will take a rise above at least 160 to convince me that the housing sector has turned the corner. I think this is another in a long line of "false bottoms" for housing.

The precipitous decline in the price of oil over the past week has gotten a lot of breathless coverage by the talking heads on CNBC and others. Just as they have been looking for the "bottom" for the banks and the overall market, they've been scanning the heavens for the "top" in oil. The nearly $20 drop in the price of West Texas Crude has helped propel the market to a strong rally. I wouldn't go out an buy a new Hummer quite yet. I think this is simply a natural correction and consolidation. The series of higher highs and higher lows has not yet been violated. I wouldn't be surprised to see the price fall to the low $120's before heading back up again.

Gold continues to consolidate between $850 and $1,000 while it builds a powerful base from which I believe it will ultimately move higher. I feel confident that we'll see $1,000 per ounce again before we see $850. I'll say it again, I don't recommend that you trade gold. It's better to establish a position and simply sit with it. Part of why we own gold is for "portfolio insurance". And part is to protect us against rampant inflation and the debasement of our currency. If I'm wrong about the general upward trend of gold, it will likely mean the stock market is headed much higher, and we would be more than compensated for our "losses" in our gold positions by higher equity prices.

This month, for the first time, I'm going to include a chart showing the daily movement in the price of silver. Guess what? Here is another stealth bull market that is getting little to no mention in the press. The movement in the price of silver looks very much like the action of gold, which isn't too surprising in that they are both considered real currency, although more so for gold than silver.

Dr. Copper continues to be amazingly resilient. Should this index fall below 350 for any length of time, it would suggest that deflationary forces have gained strength around the world and that big problems could be around the corner. Until then, inflation continues to rule the day.

The modest early-June rally in the dollar increasingly looks like a distant memory. The dollar has again rolled over and fallen in the face of weak economic data, mixed corporate earnings and the realization that the Federal Reserve simply cannot raise interest rates. While I believe the Fed must eventually raise rates to curtail inflation, doing so now would send this economy into a deep recession, or possibly a depression. So for now, we'll continue to live with a weak dollar.

I present the following chart of the MSCI EAFE index to remind you that we are not alone in the losses suffered by our stock market. The markets of the rest of the world, in the aggregate, are doing equally poorly. As I said last month, the world markets are becoming more and more correlated, which makes it increasingly difficult for investors to find uncorrelated assets in which to invest.

If you want to feel even better, look at the Shanghai Index, which I use as a proxy for China. Here we have a drop of almost 60%. Over a year and a half of gains have been erased. And look what happened in Pakistan recently, where investors rioted at their stock exchange after incurring massive losses. It isn't easy anywhere these days my friends.

Mid-Year Review of Fearless Forecasts

As I do each year, I use the July newsletter to review the accuracy, or lack thereof, of my annual Fearless Forecasts. I predicated this years predictions by saying that it was a particularly difficult economic environment. With that having been said, let's see how I'm doing so far this year.

  1. Like last year, I expect the Dow Jones Industrial Average to be down for the year. It is already off 9% in only twelve days of trading and will likely fall further, although probably not in a straight line. I believe the worst of it will be done in the first half of the year before a rally ensues in the second half. Let's put the year-end price around 12,500. So far, so good on this one. The Dow had a large decline in March, then rallied, then fell again in June/July, falling as much as 15% before rallying a bit. We'll see if we get that second half rally. Honestly, I'm not so sure.

  2. The Federal Reserve target rate will likely drop 1.00% in the first quarter, and possibly another 0.25% to 0.50% to a low of between 2.75% and 3.00% before the Fed finishes cutting rates. The recession will last two to three quarters and be done by the end of the first half of the year. This has proven to be too optimistic I think. The Fed cut their target rate to 2.00%. And although the government has yet to call this a recession, I believe we're now in either the 3rd or 4th quarter of a recession that shows no sign of letting up just yet.

  3. I think 10-year treasuries will fall to as low as 3.25% before rallying back up to between 4% and 4.25% by the end of the year. Lucky guess here? The yield on the 10-year treasury fell to 3.28% in both January and March before rallying. It has now been trading between 3.8% - 4.3% over the past three months.

  4. I think that the dollar will continue to fall as the Fed cuts rates. It could get to 1.60 vs. the Euro. Then I expect the dollar also to rally in the second half of the year as the economy strengthens. Another lucky guess here? The dollar is now trading at a record 1.58 vs. the Euro. It remains to be seen if it can strengthen over the second half of the year, but I admit I'm not optimistic.

  5. The price of oil could sink as low as $80 per barrel early this year during the worst of the economic news. Then I expect it to strengthen and again trade over $100 per barrel, possibly getting as high as $110 as demand soars and supplies remain tight. Towards the end of January the price of West Texas crude sunk to about $85 per barrel. From there, the price exploded to a high of almost $150 in early July before settling back a bit. I think the days of $100 oil are long behind us.

  6. The price of gold will be the biggest story of 2008 as prices will surge above $1,000 per ounce. Prices will average better than $900 per ounce for the year. There will be the inevitable profit-taking and consolidations, but the general trend will remain upward. The price of gold hit a non-adjusted all time high price of $1,034 per ounce in March before falling back to about $850. The price has recovered to about $975 now, but has averaged about $900 over the past four months.

  7. I still don't think we've reached the bottom of the housing mess, but we're likely getting closer. I believe the worst of it will be over in the first half of the year. Then defaults will start to fall, sales will improve and the inventory of homes for sale will decrease. The housing market certainly continued to deteriorate during the first half of the year. Unfortunately, there doesn't appear to be any good news on the horizon. It doesn't look like things will improve much at all this year; but we'll see.

  8. The two biggest investment stories of 2008 will the the declaration of the recession and the subsequent recovery from it and the financial and political impact of the Sovereign Wealth Funds. The recession has yet to be declared, but I believe that it will. The impact of the Sovereign Wealth Funds has yet to be felt. Indeed, many of them are reeling from huge losses incurred on big bets in the financial sector that have gone sour.

  9. Finally, GDP growth for Q4 2007 through Q3 2008 will likely average no better than 2.0%, with the last half being better than the first half. The trade gap, on balance, should improve over the course of the year thanks to a weaker dollar helping exports and a sick economy hurting imports. The federal deficit will likely grow again as tax revenues shrink. The unemployment rate will likely rise to 5.5% and the democrats will take the White House with the economy being the most important issue. GDP growth was only 0.6% in Q4, 2007 and 1.0% in Q1, 2008. I'm not sure it will be much better in the second half, and those numbers will likely be revised lower in the future. The trade gap is largely unchanged so far this year even with the weaker dollar. The unemployment rate is now 5.5% and headed higher. And while the race for the White House has four more months, clearly the economy will be Issue #1, with the war in Iraq a close second.

What I'm Thinking and Doing

Well, I'm out from under my desk, but I'm ready to duck back at a moment's notice. This is a tough market. All kidding aside, I really believe the best way to look at this market is through a long lens. By that I mean that we have to stretch out our time frame and stop looking at the daily price fluctuations. Unless you are living off the returns of your investments, or if you need your investment money within the next year or so - in which case you shouldn't even be in the market to begin with - then you can afford to relax a bit and look at the bigger picture. While the economy is suffering right now, it is cyclical and will eventually recover, bringing with it those sectors like the financials and housing that are currently suffering the most. You should have a well-thought out investment strategy, a lot of patience, and the fortitude to stick with your plan. If not, find an advisor to help you. You should also minimize your debt, cut back on discretionary spending and save as much as you can. That is the best advice I can give you.

The big questions in the market are: "has a bottom been made" and if not, "when will the bottom arrive"? The reality is that nobody knows that a bottom has been made until well after the fact. I'm certainly not going to pretend I know the answer. My guts tell me that the worst for the overall market may be over, although I think there will be plenty of more pain in the coming months. The fact that the Transports have remained so strong, and that the Industrials did not fall below that important level of 10,750 give me hope that the worse could be over. Regardless, I'm sure that more volatile times are ahead, creating plenty of chances for opportunistic purchases by brave investors with long-term horizons.

As I've said before, I'm concerned that this is going to be a bad summer weather-wise in the country. We've already had major flooding, forest fires and violent rain storms across the country and the first tropical storm has already hit Mexico. Add in uncertainly about the upcoming election and instability around the globe and you have a recipe for some large price swings as trading volumes wane a bit during the (maybe) sleepy summer months. Stick to what works, avoid leverage and remain patient.

I continue to believe that the domestic economy is in a recession that began in Q4 of 2007 and will likely continue into the third quarter of this year, and maybe through the end of the year. I am focusing my attention even more clearly on my core holdings and limiting my exposure to the majority of the market.

After being a net-seller last month, I was a buyer this month. The market pounded some of my core sectors as money rotated out of the old winning areas by investors looking to lock in whatever profits they could find. Sliding oil prices further exacerbated this rotation. To me, this provided compelling buying opportunities. Remember, the best investments are often purchased during the most challenging times.

Personal News and Notes

It's hard to believe that it has been four weeks since I put the kids on the bus to summer camp. And now it's time to drive up for Visiting Day. Shaena and I hit the road tomorrow morning headed for Maine. We can't wait to see how much they've changed in just a month. I want to hear all about new friends, bunk parties, swim meets, basketball games and memories that will last forever. I'm sure many of you will be doing the same thing this weekend. Enjoy this time with your children; the time goes by way too quickly.

The Mets are in a tight pennant race and broke a lot of hearts, including mine, by blowing a big lead in the 9th inning last night against the Phillies. And Shaena and I were there to witness the entire debacle in person; it was not a pretty sight.

More importantly, we're headed to New Jersey Monday night to witness one of the great performers of our, or any, generation: Bruce Springsteen & the E Street Band. Those of you who know me know what a huge Bruce fan I am. I went to three performances on the first leg of this historic tour. One of the great joys and memories of my life was singing Born to Run at the top of my lungs with Shaena, Nola and Lily at Madison Square Garden this past fall. After finishing the European leg of the tour last weekend, The Boss brings the band back home to wrap things up with a summer stadium tour. If you've never seen one of his shows, find a way to go. If you've gone before, go again. You won't be disappointed, and who knows if he'll do a tour like this ever again.

Finally, Shaena and I are getting ready to head out West for some much-needed, and well-deserved, vacation time. We'll be enjoying the Yellowstone and Grand Teton National Forests in Wyoming before heading south to Aspen and some of the surrounding areas in Colorado. I'm really looking forward to exploring some of our great American treasures and getting away from the stock market for a week. I'll share some of the highlights with you next month, at which time I hope to make a special announcement.

That's it for this month. Remember, this newsletter is for you, my readers. If you have any thoughts or suggestions on how to make it even better, please let me know. If you have some ideas for future "Monthly Tips", or even better, if you'd like to be write a Tip, let me know that too. 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. As always, I thank you very much for your continued interest and support and I look forward to writing to you again next month.

Best regards,

Greg Werlinich

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