Werlinich Asset Management, LLC
14 Birch Lane
Rye Brook, NY 10573
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July 17, 2012

The Market Is Like A Sheep

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

Current Market Analysis

As the market opened for trading today, the Dow Jones Industrial Average stood at 12,727, down 165 points from when I wrote to you last month. For all the daily volatility recently, the reality is that since early June the DJIA has traded in a relatively tight range between 12,500 and 12,950 as you can see below. It has also bumped up against, but failed to pierce, an important resistance level around 12,850-12,900. I view the market holding steady at these levels as a major positive given all of the negatives and uncertainly swirling around. Should we get through the summer, and head into the election with the Dow remaining in the 12,000s, we could set things up for an end of the year rally.

It's hard to look at the current market and call it either a Bull or a Bear. Maybe I'll call it a Sheep, as the overall market seems to be simply following the dollar up and down, rather than moving according to any fundamentals. Correlation remains too high, with most asset classes moving up and down together rather than their relative merits. This continues a trend that began last year. That being said, until the market gives a clear signal one way or another, I intend to hold steady with my general investment strategy, making small changes here and there as general market conditions dictate.

As you can see below, the DJIA twice failed to remain above the blue resistance line. Still, the index remains above both moving averages and well above support. RSI and MACD are both flat, so the market appears to be sanguine about the current levels. The next move will likely be precipitated by news from Europe or Q2 earnings surprises as the Fed appears willing to step aside for now.

As I've said before, the action in the transportation average might be even more important than the industrial average as it is such an important barometer for the health of the global economy. As you can see below, the transports have moved within a clear trading range for the past nine months. The index failed each time it attempted to piece resistance at 5,400. Currently the index is trading in the middle of the range and around both moving averages, which suggests neither bullishness nor bearishness. The summer doldrums continue.

I'm amazed, but not surprised, that utilities continue to be one of the best performing sectors in the market. They continue to thrive in our abnormally low interest rate environment. The sector also benefits from investor appetite for higher yield. The current price is trading well above both moving averages and continues to make new highs. I've often suggested that people establish, or add to, positions in this sector; I hope you listened as utilities should continue to outperform the overall market.

It appears we have established a "New Normal" for interest rates with Treasury yields at a previously unfathomably level of 1.4% - 1.5%. Indeed, I now believe that, at least in the short term, interest rates could actually fall further, to as low as 1% or even lower. Sovereign debt yields in certain countries has actually gone negative as investors are actually willing to pay their governments for the privilege of holding their money. In this environment, it isn't beyond reason to see our yields go lower. I would keep maturities less than five years because when (not if) rates eventually rise, bond investors will be hammered. But for now, the bond rally isn't over.

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, including the reinvestment of dividends. June was a wonderful respite from the widespread losses in May. I said last month that if the June rally were to continue for the rest of the month, "I'd expect the EAFE to be the best performing index as investors breathe a sign of relief that Greece, at least temporarily, voted to keep the current leadership in power." That is exactly what happened, bringing the EAFE into the black for the year. Investors have a trigger finger on the sell button, wary of any further bad news. But for now, and heading towards the seasonally slow time in August, we may be ready for some relative calm.

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

* Return numbers include the reinvestment of dividends

Statistics To Watch

  • According to the Department of Labor, the figure for seasonally-adjusted initial jobless claims for the week ended July 7 was 350,000, a decrease of 25,000 from the prior week's revised figure. The four-week average of 376,500, about 5,500 lower than the prior month's tally. Initial claims have now dropped for three weeks in a row. Not yet sure what that means, if anything. About 3.30 million people continue to collect unemployment insurance, an increase from the prior month.
  • Non-farm payroll employment in June, like the prior two months, was worse than expected, posting a very disappointing increase of only 80,000 jobs as the economy continued to slow. Service and temporary jobs posted the largest gains. Revisions showed little change from the prior two months. The total number of workers counted as unemployed held firm at 12.7 million, which meant that the unemployment rate held at 8.2%. The more comprehensive U-6 rate, moved from 14.5% to 14.9%, the third increase in a row.
  • 5.4 million people continued to be unemployed longer than 27 weeks. The seasonally adjusted number of people who could only find part-time work rose to 8.2 million and the number of marginally attached workers rose to 2.5 million. The number of people holding multiple jobs fell to 6.7 million. The average hourly wages for blue collar workers inched up to $19.74 and the average work week rose to 33.8 hours. On balance, this was another gloomy picture. The only silver linings were the increases in hourly pay and average workweek; but I'm really scraping for crumbs here.
  • The Congressional Budget Office (CBO) estimated that on a net present value basis, the Treasury reported a federal budget deficit of $60 billion for June and $905 billion for the first nine months of fiscal 2012, which was about $66 billion less than the same period a year ago, thanks primarily to higher tax receipts. If not for some accounting adjustments related to the TARP program, the deficit would be about $130 less this year than last.
  • The Census Bureau reported that the U.S. trade deficit of goods and services was $48.7 billion in May, down a bit from an upwardly revised April figure. I have been suggesting that the deficit will shrink a bit over time as we grow less dependent on foreign oil. In addition, our economic slowdown suggests that imports will drop a bit.
  • The Census Bureau reported that privately owned housing starts fell 4.8% in May from a revised higher level in April. Housing starts are now 28.5% higher than a year ago, to a seasonally adjusted annual rate of 708,000 units. We'll see if the May numbers are revised higher in subsequent months. New building permits were up 7.9% from the prior month and 25% higher than the year before. We'll need a few more positive months before we can declare a trend.
  • The National Association of Homebuilders/Wells Fargo Confidence Index gained 6 points in July to 35. That's a big increase and marks three months in a row of gains in builder confidence, although it's still well below a healthy figure of 50. “Combined with the upward movement we’ve seen in other key housing indicators over the past six months, this report adds to the growing acknowledgement that housing – though still in a fragile stage of recovery – is returning to its more traditional role of leading the economy out of recession,” said NAHB Chief Economist David Crowe.
  • The Census Bureau reported that on a seasonally adjusted annualized basis, sales of new homes in May rose 7.6%, and at 369,000 units, were 19.8% higher than a year ago. The estimate of homes for sale was 145,000, which represents a meager 4.7 months at the current rate of sales. The median sales price of $234,500 was roughly the same as last month and about $6,500 higher than the rising 12-month moving average price of $228,000. The new home sale market is actually starting to get tight; we need the banks to slightly relax their lending standards to really get things moving.
  • The National Association of Realtors reported that on a seasonally adjusted annualized basis, sales of existing homes were 1.5% lower in May to 4.55 million units, but remained 9.6% higher than a year ago. The estimate of 2.49 million homes for sale means there's an estimated 6.6 months supply on the market. The median sales price jumped to $182,600, which is well above the 12-month average of $166,800. It appears that the minor drop in sales is more due to supply constraints rather than a lack of demand. We'll see if things improve next month.
  • After slipping for seven straight months, the S&P/Case-Shiller Home Price 10-city index, which uses a three-month moving average to track the value of home prices across the US, rose in April. Last month I wrote that "It's possible that we are approaching the bottom in existing home prices." If we're lucky, I was right.
  • The Institute for Supply Management (ISM) index of manufacturing activity was 49.7 in June, breaking a streak of 34 consecutive months of expansion in the manufacturing sector. This is a very negative development, but not completely surprising. According to Bradley J. Holcomb, CPSM, CPSD, chair of the Institute for Supply Management™ Manufacturing Business Survey Committee, "The PMI registered 49.7 percent, a decrease of 3.8 percentage points from May's reading of 53.5 percent, indicating contraction in the manufacturing sector for the first time since July 2009, when the PMI registered 49.2 percent." The ISM index of non-manufacturing activity was 52.1, down from May, which marked growth in the service sector for 30 consecutive months. These numbers demonstrate that the overall economy is growing slightly, but shrinking to dangerous levels.
  • The Conference Board reported that it's index of Leading Economic Indicators increased by 0.3% in May after a small decrease in April. Says Ataman Ozyildirim, economist at The Conference Board: "Weakness in the average workweek in manufacturing, stock prices and consumer expectations kept the LEI from rising further. Its six-month growth rate remains in expansionary territory and well above its growth at the end of 2011, pointing to a relatively low risk of a downturn in the second half of 2012." This contradicts that data presented in the PMI. Which one is right? We'll see in the next few months.
  • According to the Bureau of Economic Analysis, the "final" estimate of GDP growth for Q1 2012 was 1.9%, the same as the second estimate. I guess the good news was that GDP growth didn't shrink even further. It's crucial that the economy doesn't contract too much further in Q3 or we're headed for (more) trouble. As it is, growth has fallen from 3% in Q4 2011. The GDP growth rate was 1.8% in Q3, 1.3% in Q2, and 0.4% in Q1.
  • The Federal Reserve reported that in February the amount of outstanding consumer credit was $2.57 trillion, up 0.7% from the prior month, or over 8% annualized. Interest rates near zero leave Americans with no reason to save, creating more incentives to borrow and spend. I'm surprised that the weak jobs market isn't putting a bigger dent in consumer borrowing.
  • Not surprisingly, according to the Census Bureau, retail trade and food service sales were down 0.5% in June, marking the second straight monthly decline, but still 3.8% higher than a year ago. Given the weak economy and the lack of job growth, retail sales simply have to be bad. There were simply no good areas to report. I said last month that "If consumers retrench in any meaningful way, it will have a very deleterious effect on the economy." If that's true, it will start to appear in the Q2 GDP numbers.
  • The Federal Reserve reported that in June the six month rate of growth in the supply of M-2 (a broader view of money) was 6.8% after 6.3% in May. The supply of M-1 (the most narrow definition of money), on the other hand, rose a faster 8.1%. It's no surprise that after the market tanked, the Fed opened the monetary spigots a bit, which helped stocks rise. They can't keep doing that forever.
  • It is no surprise that the Conference Board's Consumer Confidence Index fell again in June, marking four straight months of declines, to 2.0 from 64.9 in May. The bad news has been almost unremitting. Says Lynn Franco, Director of The Conference Board Consumer Research Center: "Consumers were somewhat more positive about current conditions, but slightly more pessimistic about the short-term outlook. Income expectations, which had improved last month, declined in June. If this trend continues, spending may be restrained in the short-term." That won't help retail sales, or housing, one bit.
  • According to the FDIC, 7 more banks failed in June, bringing the total number of bank failures in the first half of 2012 to 31, which is a big improvement over 2011. It's clear that there will be far fewer bank failures this year than the 90 banks that failed in 2011, which was a big improvement over the record 160 banks that were either closed or merged into healthier banks in 2010, and 140 in 2009. By comparison, only 26 failed in 2008 and a negligible 3 in 2007.

Trends To Watch

The dollar continues to rise in the face of weakness in the Euro. But to put this in greater historical perspective, the dollar index was 121 in 2001 and 89 as recently as early 2010, so the current level of 83 remains below its "normal" historical average level in the mid-90's. The 1990's demonstrated that we can have a strong dollar and a bullish stock market, which has not been the case over the past few years. A return to this former relationship would be very good for investors.

The next three charts show a similar declining wedge pattern; as the wedge tightens it creates pressure which hopefully will result in strong upward movement. Gold has been mired in a downward trend for over 10 months. Given that the wedge remains relatively wide, I wouldn't expect any major action to happen before the Fall. Indeed, I believe the price of gold will remain between $1,650 and $1,550 for a few more months before heading higher towards the end of the year. In the near term, it would be constructive if the price could move higher than both moving averages, and if the 50-day could move higher than the 200-day.

The falling wedge pattern for silver has formed over the past fourteen months and as you can see, it has narrowed dramatically. This suggests that within a month or two, if support at $26 holds, there could be an explosive move to the upside as the pressure builds to an unsustainable level. Taking a position right now is very contrarian, and not for the faint of heart, yet it could pay off handsomely if/when the price again heads higher.

The chart for copper isn't as dramatic right now, and the wedge hasn't tightened sufficiently to create much pressure. The good news is that the price is well above support at $3.00 and is trading above the 50-day moving average. The recent announcement of Chinese GDP growth at 7.6% helped. Better news out of Europe would be needed for any long lasting growth here.

The plunge in the price of West Texas Crude that began in May continued in June before finally finding a bottom around $77/barrel, just north of support around $76. Since then, the price has moved higher, almost reaching $90 again. The rally has brought the current price back to its 50-day moving average. RSI has finished working off a very oversold position. In the short run, a lot will depend on the dollar and global economic stability. I don't expect any significant near term gains unless our relations with Iran take a turn for the worse. Longer term, the picture is less clear than it used to be. I'll talk more about this in the coming months.

The recovery in the financial sector that began in June has continued so far in July. Whether there is enough strength to make another attempt to pierce resistance around $16.25 remains to be seen. I think a lot depends on Europe and the Fed. Left to it's own devices, I don't think the domestic economy is strong enough to warrant another big move from the financial stocks. So for now, I remain wary of this sector. If QE3 is announced, then it's off to the races.

The market has clearly discounted all the bad news in housing and is banking on a lasting recovery. While all the statistics that I've reported over the past few months suggest that the worst may indeed be over, it all assumes that the economy doesn't get any worse, and that's a big assumption. Still, after trading sideways for five months, the index broke above resistance this month to achieve a new high around 140. That means this index has nearly doubled in the past 10 months. I clearly missed this move.

As we leave the US and head to Europe, things don't look nearly as good. The EAFE index is barely holding above crucial support around $46. It's hard to make a case for investing in the developed markets in Europe, Asia and the Far East right now unless you are a serious contrarian. Personally, I've drastically cut the developed markets exposures for my clients.

I said last month that it makes no sense for the chart of the emerging markets to be identical to the chart of the developed markets, and I still believe that. The countries that make up the emerging markets are growing much faster than the stagnant developed world, yet they are treated with equal disdain. China's GDP is "only" 7.6% vs 1.9% in the US vs. negative growth throughout parts of Europe. This disconnect creates an investment opportunity for the brave. Eventually, rational investors will dedicate a greater percentage of their international exposure to those markets that are growing at the expense of those that are stagnating (or shrinking). At that point, the relative performance of these two sectors should begin to diverge.

The optimism in April and May has ebbed, leaving pessimism and fear in June and July. The Shanghai Index is trading perilously close to major support. This could either be a great trading opportunity with RSI at very oversold levels, or could presage huge problems should the index fall further. If the index breaks below 2,100 it will likely take our stock market down with it.

According to the NYSE Bullish sentiment index, the market is basically sanguine right now, even though RSI is touching overbought levels after recovering from a hugely oversold position (see the red circle). Based on this picture, I'd say we're likely to trade sideways, or even moderately higher for a bit.

This chart shows that less that about 66% of stocks traded on the New York Stock Exchange are currently trading above their 50-day moving average. This is about the middle of the trading area. As with the sentiment index, I'd say that this chart suggests we will either trade sideways for a bit or maybe a little higher.

According to the "fear index", the market is surprisingly complacent given the uncertainty in the global economy and the various financial scandals. Yet pictures don't lie (at least not in this case - no Photoshop). As a contrary indicator, this suggests to me sideways trading ahead.

What I'm Thinking and Doing

As I write this, Ben Bernanke, Chairman of the Federal Reserve, is testifying before Congress regarding the LIBOR scandal and available Fed policy tools that could be used to help prop up our flagging economy. As is usually the case when he speaks publicly, the market moves south. (Interestingly, the market moved higher later in the testimony and ultimately finished the day higher.) What traders want to hear are concrete plans for a new stimulus plan, or a QE3. The absence of such an announcement is viewed as a negative. To me, that's a positive. There's little, if any, true long term value ascribed to further monetary expansion policies. In fact, it will only further debase our currency end set the stage for even more punitive problems, like rampant inflation, down the road. As a nation, we need to accept our medicine and deal with our problems rather than try to put our thumbs in the dike that is our growing budgetary problem. But there is little collective will in this country, either among the population or our elected leaders, to accept hard times in the short run in order to put our country on a better footing for future generations. As a father of three teenagers, I worry about what life will be like for them and for my future grandchildren. It infuriates me to see how gutless our leaders truly are, and how they invariably pander to the monied special interests at the expense of the people who asked them to look out for their best interests. And I fear that this election will only bring us more of the same, now that the Supreme Court voted to allow unlimited donations to PACs. So the super wealthy like Sheldon Adelson can almost literally buy himself a president. It makes me want to puke.

That's enough political ranting for today. I'm sure I'll have more to say in the fall as the election grows nearer. In the meantime, what's an investor to do with all of this? You should try to shut out the "noise" and focus on the fundamentals of why you're investing in the first place, and what you're trying to accomplish. Look at the big picture and try to stay the course. We have few other options, so we have to simply do the best we can with what's available. 

A recent dip in the market brought the stock I wanted down to my target price so late in June I pulled the trigger on a purchase of about $520,000 of this leading chemical products company. It's a wonderful addition to our portfolio of great companies. It's been around for more than 100 years, is solidly profitable, pays a hefty dividend and has tremendous competitive advantages that can't easily be replicated. I've already got my eye on my next purchase so I'll look to raise some cash over the next few weeks so I can pick up this stock if the price is right.

Professional News and Notes

I've finished the one page promotional "Fact Sheet" on me and the business. I can send it to you now via email and it will be available shortly on my website. Of you, or anyone you know, would like to see a condensed bio on me, just let me know and I'll get you a copy.

The other big news is that in order to facilitate a dialog between me and my readers, I've decided to start a blog. I anticipate it being up and running sometime this month. I hope to be able to briefly discuss relevant news items, answers questions and share some opinions about current events. I'm very excited to get this started and look forward to meeting up with some of you in the blogosphere.

As always, I thank you, my readers, and remind you that this newsletter is for you. I have been writing News and Views for over eight and a half years now. If you'd like to read any prior edition, simply go to my website and click on the link to my newsletter archives. I hope you have learned something about our economy and our stock market, and that you will continue to follow along with me in 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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