Werlinich Asset Management, LLC
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Rye Brook, NY 10573
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August 22, 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

A lot can change in a month. When I wrote to you in July, it looked as though the June Swoon was simply another correction in a normal market cycle. Unfortunately, it turned out to be a prelude to a significant market decline brought on by fears of a global economic slowdown precipitated by the debt woes of the U.S. and members of the European Currency Union. I was certainly surprised by the strength and rapidity of the decline. The Dow Jones Industrial Average (DJIA) fell five out of six weeks. Indeed, between July 21 and August 10, the Dow dropped 15.8% in 14 frantic trading days. Then it snapped back to gain 7.1% in only four trading days, before falling again to settle close to the August 10 low. It's enough to give any investor heartburn.

As a result of this market turbulence, there has been the usual finger pointing among politicians, looking to cast blame rather than have an intelligent discussion about how to fix the underlying problems, which is the unsustainable debt levels and languid economy. In response to the latest market crisis, the Federal Reserve announced that they would keep rates low at least through 2012. That did little to salve the nerves of market participants. We now must all look at the economy and the market as dispassionately as possible and ignore the noise while trying to divine what's going to happen going forward.

So, what do the charts tell us now? They show an awful lot of ugliness. Every single chart shows a massive breakdown of every technical pattern from panic selling. The question is, is the panic over? Can we consolidate at these levels for a bit then rally, or is this just the beginning of a larger sell off within a bear market? I'm afraid only time will tell for sure. Hopefully the Industrial average will remain above 10,600 because the next big support doesn't come in until below 10,000. Finally, remember this date: August 8. On that day, there were 77 declining stocks for every 1 that advanced. That was the worst relationship of advances to declines in 80 years. That suggests that it could mark a bottom. We'll see.

The transportation average, which outperformed the industrial average on the way up, fell even further on the way down as investors fretted that the weakened economy would have an especially deleterious effect on the trucks and railroads. The next support level looks to be at about 4,000. A rally above 4,700 would be bullish.

All I can say about Treasuries is wow, was I wrong. I really thought rates were headed inevitably higher, based on the simple fact that yields were at historically low levels and had nowhere else to go but up. Then one disaster or crisis after another hit this year, which left investors seeking the shelter from equities. This surge of buying helped yields plunge below 2%, which is the lowest level recorded in its 60 year history. So where do yields go now? At the risk of being wrong again, I'd guess that yields will remain between 2%-3% for at least the next year before slowly rising, as they eventually must.

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 again in July, for the third month in a row. Yet as bad as things were, the market was still solidly in the black for the year. Unfortunately, those gains were all wiped out by the panic earlier this month. Last month I wrote that I expected "at least one more bump in the road before the end of the year". Let's hope this was it, so that my forecast that "we're likely to finish the year with double-digit gains for the broad equity markets" will come to pass.

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 August 12 was 408,000, a decrease of 14,000 from the prior week's revised figure. The four-week average was stable at 424,750, roughly the same as the prior month, but still too high. The weekly numbers remain choppy, and there is no discernable trend.
  • Non-farm payroll employment increased by 117,000 in July, with 154,000 private sector jobs added and 37,000 government jobs lost. The tepid increase in June was revised upward from 18,000 to 46,000 and May was revised up from 25,000 to 53,000. That is a positive change. The average hourly wages for blue collar workers rose to $19.52 while the average work week remained at 33.6 hours.
  • The total number of workers counted as unemployed fell by about 200,000 back to 13.9 million. Therefore the unemployment rate fell to 9.1%. The more comprehensive U-6 rate inched lower to 16.3% from 16.7% in June. 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 fell to 8.4 million and the number of marginally attached workers rose to 2.8 million. The number of people holding multiple jobs fell to 8.72 million. This was much better than last month, but that's not saying much. This trend will have to continue for the next few months to start to be anything meaningful.
  • The Congressional Budget Office (CBO) estimated that on a net present value basis, the Treasury reported a federal budget deficit of $132 billion in July, leaving us with a deficit of $1.05 billion for the first ten months of fiscal 2011, which is $66 billion less than the record levels from a year ago. The good news is that tax receipts continue to be higher than the same point last year.
  • The Census Bureau reported that the U.S. had a trade deficit in goods and services of $53.1 billion in June, up from $50.8 billion in the prior month. The trade deficit has jumped $10 billion in only two months; that is not good.
  • The Census Bureau reported that privately owned housing starts fell 1.5% in July, after rising 10.8% in June, and were up 9.8% from a year ago, to a seasonally adjusted annual rate of 604,000 units. The monthly results have been extremely volatile this year, so a reliable trend is not yet in evidence. New building permits were down 3.2% from the prior month but up 3.8% from last year. The prolonged weakness in new construction will eventually set the stage for the recovery as the inventory of new homes for sale diminishes to match a smaller number of buyers.
  • The National Association of Homebuilders/Wells Fargo Confidence Index in July remained at 15, the lowest level since September 2010. Again, this demonstrates a simple lack of interest in new housing at this point. Builders are being squeezed by falling existing home prices and rising material costs.
  • The Census Bureau reported that on a seasonally adjusted annualized basis, sales of new homes in June fell 1.0%, after decreasing 0.6% in May, but was actually 1.6% higher than the depressed level of a year ago, at 312,000 units. The estimate of homes for sale was only 164,000, which represents 6.3 months at the current rate of sales. The median sales price was a slightly higher $235,200, which is above the 12-month moving average price of $224,492. It's no surprise that the early summer numbers are better than the harsh winter and wet spring months.
  • The National Association of Realtors reported that on a seasonally adjusted annualized basis, sales of existing homes were fell 3.5% in July to 4.67 million units, but were 21% higher than a year ago. The estimate of homes for sale, at 3.6 million represents 9.4 months of supply at the current rate of sales. The median sales price of $174,000 is slightly lower than the 12-month average of $167,683. With mortgage rates at historically low levels, and prices at very attractive levels, this is a great time to buy a home, if you have the cash and good credit.
  • 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, showed improvement for the second consecutive month in May, increasing 1.1%, but remained 3.6% lower than a year ago. Hopefully this is the beginning of a trend that will demonstrate that the bottom has been made in house prices.
  • According to RealtyTrac, the number of foreclosures in July decreased 4.5% from the prior month, and were down 35% from a year ago, to the lowest level in over three and a half years.
  • July foreclosure activity dropped 35 percent from a year ago, marking the 10th straight month of year-over-year decreases in foreclosure activity and the lowest monthly total since November 2007, said James J. Saccacio, chief executive officer of RealtyTrac. This string of decreases was initially triggered by the robo-signing controversy back in October 2010, which forced lenders to substantially slow the pace of foreclosing, but the downward trend in foreclosure activity has now taken on a life of its own. It appears that the foreclosure processing delays, combined with the smorgasbord of national and state-level foreclosure prevention efforts including loan modifications, lender-borrower mediations and mortgage payment assistance for the unemployed may be allowing more distressed homeowners to stave off foreclosure.
  • The Institute for Supply Management (ISM) index of manufacturing activity was 50.9 in July, a huge decrease from June. This marked the twenty-fourth consecutive month of expansion in the manufacturing sector, but marked the second straight month of declines. Any number below 50 indicates a contraction. The ISM index of non-manufacturing activity was 52.7, also lower than the prior month. This marked growth in the service sector for nineteen consecutive months. These numbers demonstrate that while business is still growing, it is barely doing so, and in real danger of contraction.
  • The Conference Board reported that it's index of Leading Economic Indicators increased by 0.5% in July, following a smaller increase of 0.3% in June. Says Ataman Ozyildirim, economist at The Conference Board: The U.S. LEI continued to increase in July. However, with the exception of the money supply and interest rate components, other leading indicators show greater weakness consistent with increasing concerns about the health of the economic expansion. Despite rising volatility, the leading indicators still suggest economic activity should be slowly expanding through the end of the year.
  • According to the Bureau of Economic Analysis, the "advance" estimate of GDP growth in Q2 was an anemic 1.3%. And the BEA lower the estimate of GDP growth in the first quarter to a putrid 0.4% from a previously announced 1.9%. This compares with 2.3% (down from 3.1%) in Q4, 2.5% (down from 2.6%) in Q3, 3.8% (up from 1.7%) in Q2 and an artificially inflated 3.9% (up from 3.7%) in Q1 of 2010. Given the trend of downward revisions over the past few quarters, it's reasonable to expect the the final estimate for Q2 is likely to be lower than the advance estimate. Our economy has basically stalled and we're awfully close to achieving the dreaded "double-dip recession".
  • The Federal Reserve reported that in July the amount of outstanding consumer credit ticked up fractionally from the prior month, to $2.45 trillion. Consumer credit has now expanded, albeit slightly, almost every month this year. What is that money being used for?
  • According to the Census Bureau, retail trade and food service sales were up 0.5% in July from the prior month, and was 8.5% higher than a year ago. Electronics and appliance and gas station sales showed the best month-over-month sales gains.
  • The Federal Reserve reported that in July the supply of M-2 (a broader view of money) exploded higher, up 2.2% from the prior month and 10.7% during the prior six months. The supply of M-1 (the most narrow definition of money), on the other hand, rose a whopping 16.8% over the same six months. Where is all this money going, and what good is it doing, other than increasing the price of gold?
  • The Conference Board's Consumer Confidence Index continued to perk up a bit in July, rising to 59.5 from 57.6 in June, but still down considerably from 72.0 in February, which was a three-year high. The index remains well below a healthy reading as the economy stagnates while home prices and incomes decline. A reading above 90 indicates the economy is solid, and 100 or above indicates strong growth.
  • According to the FDIC, 64 banks had failed through August 15, compared with 110 at roughly the same point last year. A record 160 banks were either closed or merged into healthier banks in 2010, versus 140 in 2009. By comparison, 26 failed in 2008 and only 3 in 2007.

Trends To Watch

While the financial media parses every little move in the dollar, minute by minute, when you step back and look at the big picture, you can clearly see that the dollar is in terrible shape. And any positive movement for the greenback is usually just because other currencies, like the Euro, are in even worse shape. Because of the debt crisis the normal inverse relationship between a declining dollar and a rising stock market seems, at least for now, to be broken. So for now, we should all hope the greenback will stabilize.

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. Last month I wrote that "each consolidation was followed by a rise to a new high, and I believe this time will be no different." I was right, as gold has powered to ever higher highs. Again, don't be deterred by any of the so-called experts who proclaim the end of the gold trade; they're just wrong. Buy on weakness.

Over the last two months I told you that the big correction in the price of silver was a good buying opportunity and that you shouldn't be scared out of this trade as silver would again move higher. I hope you listened. The price of silver finished consolidating between $32 and $38 per ounce and has moved back into the low $40s. The next phase for silver is to move north of $50.

The price of copper has remained in an extended trading range for the entire year. The weak economy has caused the price to plunge recently. Dr. Copper forecasts more trouble ahead as the price has fallen below both moving averages, which interestingly, have converged. This is a dangerous inflection point. We'll know more in the next month or so.

Like many commodities, the price of West Texas Crude (WTIC) has fallen considerably over the past few months, owing to a weak global economy, and poor prospects ahead. Longtime readers know I've been an oil bull for about a decade, and I'm not changing my opinion now. I expect crude prices to remain above the floor around $70/barrel. I would be perfectly happy to see the price consolidate between $80-$90 for a while as the economy regains its footing. It wouldn't take much good news to send the price higher.

I have been bearish on the financial sector since 2008 and therefore have avoided buying anything in this group. While this stance caused me to miss some brief bullish moments, it has helped me avoid tremendous losses. And as you can see, those losses are piling up now as the index has plunged below a very strong floor, and way below the moving averages. While I wouldn't be surprised to see a short rally in the face of this plunge, I remain bearish and warn you again to buy the banks at your own peril.

I have been equally bearish on the housing sector since 2007, so I'm not surprised to see the price of the housing index fall slowly but steadily before inevitably breaking below its trading floor. As I've made clear month after month, 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, and as a result, I remain entirely uninvested in this sector, and recommend you do the same.

The developed international markets have taken a drubbing just like the our domestic market. The index is now far below both moving averages, which have bearishly crossed. It will be important for the index to remain above the support level around 46.5. Like every other chart, just consolidating for a bit, without weakening further, will be very constructive.

Like every other sector, the index of the emerging markets plunged recently, and banged right off the floor before rallying a bit. Like the IEE, this index is now significantly below the moving averages which have also crossed. And like the IEE, the best scenario in the short term is to simply consolidate while catching its breath. 

As it has for months, because of China's importance to the world economy, this chart makes me nervous. The good news is that the index did not pierce the trading floor during the recent panic. And the index is trading very close to both moving averages. Just a little good news out of China could send this index moving higher.

Each of the next three charts shows the panic in all its horrible glory. First, the NYSE Bullish Percent Index, which represents the percentage of stocks listed on the NYSE that signal a buy. Contrarians suggest that extreme levels of exuberance is a bearish indicator, and vice-versa. Right now, there is so little bullishness that it's almost a screaming "buy" signal.

Next is a chart which shows the percentage of stocks traded on the New York Stock Exchange that are trading above their 50-day moving average. You can't get much more bearish than this, which again suggests that a rally should follow.

Finally we have the "Fear Index". This year we had spikes in the VIX due to the tsunami in Japan and the initial Greek debt crisis. Those jumps in volatility were dwarfed by the recently global debt crisis. Hopefully as the initial panic wanes, the volatility will subside back to more normalize levels, which would suggest a rally in the market. And to put things in perspective, the VIX was over 80 during the banking crisis of 2008.

What I'm Thinking and Doing

Last month I inveighed against our inept and impotent "leaders" in Washington. Calling them leaders is really absurd. Most of them are gutless idiots, interested only in their narrow self interest and getting reelected, rather than in doing what's best for this nation. The debacle that was the negotiation to raise the debt ceiling was a pathetic joke. The deal that was agreed to at the last minute wasn't worth the paper it was printed on, and the whole world knows it. That's why the stock market sold off so violently in the wake of their collective cowardice. We are craving REAL leadership right now. And with the elections only a year away, there will certainly be lots of talk between now and then. Let's hope that out of that talk comes some substantive change; but I'm not holding my breath.

Unfortunately, the global economic and political uncertainty makes for a very difficult and unsettled investment landscape. The big question is whether or not we are going to fall back into recession. Even trying to discern that is difficult because it's hard to trust the numbers announced by Washington. That being said, I don't think we're headed for a recession. Rather, I believe we're going to slog through a period of below-average growth, but growth nonetheless. And in a period of low inflation, low interest rates and low growth, dividends will be even more important than ever. Historically, dividends have made up at least 50% of the annual returns for equities. During the 1980s and 1990s, investors forgot about dividends. Now, more than ever, it's time to remember their importance. More than 90% of all WAM investments pay a dividend yield in excess of 1%.

Unfortunately, I put some cash to work right before the crash; that was bad timing on my part. But I'm very confident that every one of those acquisitions will be profitable in the not-too-distant future. It's virtually impossible to call a market top or bottom. The best you can do is buy great companies at reasonable prices and hold them for as long as your original thesis for buying them remains in force. It's crucial that investors have a longer term perspective. Unless you need the money in the next year or two, there is really no reason to be out of this market, and given where interest rates are, there are few alternatives to equities right now. 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

After a great deal of consideration, I have decided to eliminate this section of the newsletter. Going forward, this newsletter will be strictly about the economy and the stock market. I'm hoping that the majority of the people who have read this section with interest will to stay abreast of news about me and the kids through Faceboook.

Speaking of Facebook, as I've mentioned earlier, my fan page is up and running. I would appreciate it very much if some of you would "like" it so as to increase its visibility. Just go to Facebook, type in "Werlinich Asset Management" in your search bar, visit my fan page, then click the "like" button. Currently all of my tweets are stored there. I plan to continue to add more 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've recently passed 200 followers, up from about 50 or so at the beginning 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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