Current Market Analysis

It's now been four months since the stock market hit the March bottom. Since then we had a powerful and widespread rally that had many observers calling an end to the recession and the Bear Market and  proclaiming this to be a new Bull Market. This was followed logically by a significant pullback, during which the naysayers proudly declared "we told you so; this was just a bull rally in a Bear Market." Then yesterday, we had a huge rally. So what do I think? I believe the jury is still out on whether we've escaped the Bear Market. The longer we hold above the March low the better I'll feel. I do believe we are still in a recession, although one that is less bad than it was a few months ago. I'm convinced we are not out of the woods yet, and the dual problems of rising unemployment and federal deficits will likely derail any economic and stock market recovery. So I think the best we can hope for is for the markets to move sideways in a "traders market" for a while until the economy truly begins to improve.

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. The Industrial average made a series of new highs in early June, none of which were confirmed by the Transportation average also reaching a new high, although it was close as the Transports surpassed the high on an intra-day basis, but closed lower. Then everything fell apart. Therefore, according to Dow Theory, the Bear Market retails control. As I write this, the Industrials and Transports are again within shouting distance of those highs of 8,799 for the Industrials and 3,404 for the Transports. So we wait and watch.

Looked at casually, the daily chart of the Industrials looks positive. We have a nice V-shaped recovery and the 50-day moving average crossing above the 200-day average. The recent pullback was normal and not too painful. What is needed is for the average to move above 8,800 then find a way above 9,000.

The movement of the Transportation average is mirroring the action of the Industrial average. For the market to move forward to higher highs, the transports must close higher than 3,404 and break out of the trading range shown below. Interestingly, the moving averages have converged; it would be positive if the 50-day average can move above the 200-day.

After a frightening six-month bond selloff that increased the yield on the 10-year treasury from 2% to 4%, money poured back into bonds during the stock market correction, lowering yields back to around 3.25%. I'll never understand people who talk about the safety of investing in bonds. I fully expected yields to remain below 3% this year (see my Fearless Forecast later in this newsletter), but I do believe that the long-term trend for interest rates is higher, which is bad for bond investors.

Last Month's Results

• According to the Department of Labor, the most recent figure for seasonally-adjusted initial jobless claims for the week ended July 11 was 522,000. The four-week average has declined to 584,500. The seasonally adjusted number of continuing claims for unemployment is 6.27 million. That's a lot of people collecting unemployment insurance. And the average time on unemployment is at an all-time high of 22 months.
• Non-farm payroll employment worsened in June, falling by 467,000 versus a revised 322,000 in May. Average hourly wages were unchanged at $18.54, while the average workweek fell to 33.0 hours, so real wages actually fell at bit.
• The number of workers reported in June as unemployed rose to 14.7 million, bringing the unemployment rate to 9.5%, its highest level since 1983. The seasonally adjusted number of people who could only find part-time work fell to 9.0 million and the number of marginally attached workers held at 2.2 million. The number of people holding multiple jobs fell to 7.07 million. My Comprehensive Labor Index™, which is much more representative of the real unemployment situation, rose to 19.67%. I've been saying for months that I expected to see my CLI™ at around 20% later this year. This could happen before the kids go back to school.
• The Congressional Budget Office (CBO) estimates that on a net present value basis, the Treasury will report a federal budget deficit of $1.1 trillion for the first nine months of fiscal year 2009 as the June deficit of $97 billion was $130 billion worse than last year. TARP payments, as well as support for Fannie Mae and Freddie Mac were partly responsible for the increased deficit. We are now well into uncharted and very dangerous territory now my friends.
• The Census Bureau reported that the U.S. trade deficit in May was $26.0 billion, down from $28.8 billion (revised lower) in April. I think it's a slightly positive sign the the trade deficit is growing again as it demonstrates a general strengthening of the economy. About 61% of this deficit is with China. And we think we can tell China what to do with their currency? Or with anything?
• The Census Bureau reported that privately owned housing starts jumped 17.2% in May following an 12.9% drop in April, and was still down 45.2% from a year ago, to a seasonally adjusted annual rate of 532,000 units. New building permits were up 4.0% from last month but were still down 47% 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 dipped "unexpectedly" in June from 16 back to 15. To me, this was no shocker. Only the "experts" were surprised.
• The Census Bureau reported that on a seasonally adjusted annualized basis, sales of new homes in May were roughly the same as the prior month but were still down 32.8% from the same period last year, to 342,000 units. The estimate of homes for sale is down to 292,000, which represents 10.2 months at the current rate of sales. The median sales price increased to $221,600, which was slightly above the 12-month moving average price of $219,533. Home prices increased two months in a row, possibly indicating that the number of foreclosure sales is decreasing.
• The National Association of Realtors reported that on a seasonally adjusted annualized basis, sales of existing homes in May rose 2.4% for the second straight month, and were down 3.6% from the same period last year, to a projected 4.77 million units. The estimate of homes for sale, at 3.8 million, represents 9.6 months of supply at the current rate of sales. The median sales price rose to $173,000, but remained below the steadily falling 12-month average of $183,717.
• 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 150.34 in April, the lowest level since June 2003. The only good news is that the rate of decline appears to be slowing.
• According to RealtyTrac, foreclosures increased by 4.6% in June to 336,173, and remained 11% higher than the last quarter and 20% higher in the quarter than a year ago. Nevada, Arizona and Florida, reported the highest foreclosure rates in the country while California, Florida and Arizona had the highest actual number of foreclosures.
• The Institute for Supply Management (ISM) index of manufacturing activity increased to 44.8 in June, continuing the general uptrend in place so far this year. This was the eighteenth 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 47.0.
• The Federal Reserve reported that industrial production decreased 0.4% in June after having fallen 1.2% in May. For the second quarter as a whole, output fell at an annual rate of 11.6%, a more moderate contraction than in the first quarter, when output fell 19.1%. Manufacturing output moved down 0.6% in June, with declines at both durable and nondurable goods producers. Outside of manufacturing, the output of mines fell 0.5% in June, and the output of utilities increased 0.8%. The rate of capacity utilization for total industry declined in June to 68.0%, a level 12.9 percentage points below its average for 1972-2008. Prior to the current recession, the low over the history of this series, which begins in 1967, was 70.9% in December 1982.
• The Conference Board reported that it's index of Leading Economic Indicators rose a strong 1.2% in May, the second increase in a row. Most of the components of the index gained sharply.
• According to the Bureau of Economic Analysis, the "final" estimate of GDP growth in the fist quarter was -5.5%, better than the "preliminary" estimate of -5.7% and the "advance" estimate of -6.1%. This follows a horrible -6.3% in Q4 '08. The hope is that worst of the recession is now behind us. We'll see.
• The Federal Reserve reported that in May the amount of outstanding consumer credit fell by 0.1% from the prior month, to $2,520 billion. That means that consumer credit has declined in eight of the last ten months. That's good for consumers, bad for the economy.
• According to the BEA, even though disposable personal income continues to fall, the personal savings rate, which for years had been negative, was 6.9% in May, up from 5.6% in April. This is the highest savings rate since 1993.
• According to the Census Bureau, retail trade and food service sales increased 0.6% in June. This improvement in retail sales dovetails with other coincident indicators that the economy is improving, albeit slowly.
• The Federal Reserve reported in that in May the increase in the supply of M-2 was only 3.9% in the prior three months, while the supply of M-1 rose by 9.6% in the same period. In the prior six months, the rates of increase were 9.6% and 9.7%, respectively. The rate of monetary expansion may be slowing a bit. We'll see if this trend continues.
• After surging to 54.9 in May, the Conference Board Consumer Confidence Index surprisingly fell in June to 49.36. A rapidly falling stock market will do that.

This is an interesting time for the financial sector. The index moved sideways for about three months now. So has the rally petered out, or is it simply taking a breather? I believe the fate of the financials is tied to the unemployment rate. If unemployment moves too much higher, housing foreclosures, credit card defaults and loan losses all rise, forcing already sick banks to raise even more capital. Watch this situation very closely.

Not surprisingly, the housing index has again turned down over the past couple of months as investors recognize that the sector remains in terrible shape. I believe it will be 2010 before there is any meaningful recovery in this sector.

The price of West Texas Crude fell with the rest of the market last month. As I write this, the current futures contract calls for a price of $61.12 per barrel, down from $72.48 one month ago. The sharp selloff doesn't really bother me too much. Regardless of any short-term movements, I'm convinced that the price of oil is headed inevitably higher. And the rising triangle pattern is bullish also.

After a fourth attack on $1,000 last month, the price of gold once again fell victim to profit taking and tumbled back towards $900. I'm confident that gold will take another run at $1,000 before the year 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's still a positive. On a purely technical basis, the fact that the 50-day moving average has crossed above the 200-day average, that the metal is making higher highs and higher lows, is very bullish. I would expect prices to continue to rise.

The action on the Baltic Dry Index, while still highly volatile, is also in a general upward trend. This too is bullish.

The price action of the dollar index looks very bad. The index has fallen below both the 50- and 200-day moving averages and the 200-day average has moved will above the 50-day. As the budget deficit grows to unprecedented levels and the economy remains weak, I expect the dollar to fall further. 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 the trend follows the head and shoulders pattern that I outlined, the index could drop back to the low 70's.

Foreign markets, as represented by the MSCI EAFE index, continue in their basic uptrend also and the moving averages have crossed to the positive side, 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. The good news is some some of the frothy exuberance has sold off, bringing the index down to a more reasonable level of 50, with RSI in a very oversold position, suggesting upside ahead. This is good.

The volatility index, also known as the "investor fear gauge", continues to move lower as the panic has subsided. At these levels, one would expect the market to be a bit less volatile. 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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