Werlinich Asset Management, LLC
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Rye Brook, NY 10573

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August 17, 2012

Enjoy the Summer Slumber

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 13,250, up about 523 points, or 4%, from when I wrote to you last month. Even more importantly, the DJIA is now only 30 points below the May 1 high. Even more impressive is that if the DJIA can power through that resistance, it will have established the highest level since before the financial crisis of 2008 and will be less than 7% from the all time high price of 14,164 set on 10/9/07. I said last month that "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." That is looking more and more likely.

The normal Summer Slumber on Wall Street means lower volume and sideways, if not lower, action. This year, the volume abated as usual but the remaining buyers decided to sell safe assets (treasuries) and buy riskier securities. Until the DJIA and DJTA concurrently hit new highs I'm not prepared to call this a Bull Market, but it's certainly a very pleasant rally. It's also important to note that the market has managed moved higher while the dollar has remained strong. This is a VERY positive development.

As you can see below, towards the end of July the DJIA blew through resistance (blue line) and has powered higher to approach the next resistance (red line). The key number is 13,279 - that's the May 1 closing high. I would like to see the volume improve, but that could simply be seasonal weakness. No matter how you look at it, this is a very positive chart. Now, if we could just get the transports to move up with it.......

Speaking of the transports, the DJTA simply refuses to move to new highs. This lack of confirmation, according the Dow Theory, is very worrisome. The number to watch is the recent high on April 17 of 5,310 which is about 2.8% higher than the current level. After that, there is major resistance around 5,400 (red line). Currently the index is trading slightly higher than the middle of the range and higher than both moving averages, which is mildly positive. I'm watching this very closely.

The utility average continued to move ever higher until August 1, after which it has displayed weakness. This isn't surprising as investors have begun to move towards riskier assets and as rates have moved a bit higher. If investors are indeed moving away from safe stocks then the utilities could get even weaker. But longer term, I'm still bullish on the sector.

My suggestion last month that treasury rates could fall as low as 1% was apparently a bit premature. No sooner had the words appeared than the bottom was in and bonds started to sell off. Yields have jumped almost 45 basis points in the past month, which is a pretty dramatic move. But as you can see below, although it's painful to bond traders, the yield has simply returned to the normal trading range. Sovereign debt yields in certain countries remains negative as investors are actually willing to pay their governments for the privilege of holding their money. If equities continue to rise, bond prices may continue to move lower, forcing yields higher.

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. July was a bit of a mixed bag, but we'll take it. It's interesting how large-cap stocks are clearly outperforming small-cap stocks. This makes total sense to me as investors will seek more conservative, dividend paying stocks during uncertain times. Notice too how the year-to-date return on the bond index (Barclays Aggregate) is a mere 3.8%. It's going to be difficult to make much money in bonds with rates this low. That's not to say that rates can't go lower still, which they can. I doubt the full year return will be any better than it is now, whereas stocks still have further to run.

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 August 11 was 366,000, an increase of 2,000 from the prior week's revised figure. The four-week average of 363,750, about 12,750 lower than the prior month's tally. Initial claims have held in a fairly steady range for the past few months. 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 July was a marked improvement over the past two months, but still a disappointment when looked at historical norms as 163,000 new jobs were added. The numbers could have been even better if not for a Con Ed strike in New York. There were solid increases across the board, lead by professional and business services and hospitality. Revisions showed little net change in the prior two months. The total number of workers counted as unemployed ticked up to 12.8 million, which meant that the unemployment rate moved up to 8.3%. The more comprehensive U-6 rate,rose for the fourth straight month to 15%.
  • A slightly lower 5.2 million people continued to be unemployed longer than 27 weeks. The seasonally adjusted number of people who could only find part-time work held at 8.2 million and the number of marginally attached workers held at 2.5 million. The number of people holding multiple jobs remained at 6.7 million. The average hourly wages for blue collar workers inched up to $19.77 and the average work week dipped to 33.7 hours. On balance, this was a solid improvement, but still less than needed.
  • The Congressional Budget Office (CBO) estimated that on a net present value basis, the Treasury reported a federal budget deficit of $71 billion for July and $975 billion for the first ten months of fiscal 2012, which was about $125 billion less than the same period a year ago, thanks to higher tax receipts and stable outlays. This is (very) modest progress.
  • The Census Bureau reported that the U.S. trade deficit of goods and services was $42.9 billion in June, down from May, and the lowest figure since December 2010. 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 and a stronger dollar makes those imports even more expensive.
  • The Census Bureau reported that privately owned housing starts fell 1.1% in July from a revised lower level in June. Housing starts are now 21.5% higher than a year ago, to a seasonally adjusted annual rate of 746,000 units. New building permits were up 6.8% from the prior month and remained 29.5% higher than the year before. Even with the small drop, this wasn't a bad months for starts.
  • The National Association of Homebuilders/Wells Fargo Confidence Index gained 2 points in August to 37. That marks the fourth straight monthly increase in builder confidence. And while it's still well below a healthy figure of 50, it's a big increase from the paltry 14 recorded exactly one year ago. Combined with the upward movement we've seen in other key housing indicators this year, the recovery in housing is growing more clear.
  • The Census Bureau reported that on a seasonally adjusted annualized basis, sales of new homes in June fell 8.4%, but at 350,000 units, were still 15.1% higher than a year ago. And the drop comes off a May figure that was revised higher, as was April. The estimate of homes for sale was 144,000, which represents a meager 4.9 months at the current rate of sales. The median sales price of $232,600 was a bit lower than the prior month and about $5,000 higher than the rising 12-month moving average price of $227,650. The new home sale market is tight; and will remain that way until banks relax their lending standards a bit a more new inventory comes to market.
  • The National Association of Realtors reported that on a seasonally adjusted annualized basis, sales of existing homes were 5.4% lower in June to 4.37 million units, but remained 4.5% higher than a year ago. The estimate of 2.39 million homes for sale means there's an estimated 6.6 months supply on the market. The median sales price jumped 5.0% to $189,400, which is well above the 12-month average of $167,758. The reduction in inventory continues to hurt existing home sales, but it is helping to increase the prices for those homes that are being sold.
  • 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 for the second straight month in May. After increases of 1.3% and 2.3% in the last two months, respectively, the bottom in home prices may finally be behind us.
  • The Institute for Supply Management (ISM) index of manufacturing activity was 49.8 in July, making two straight months of contraction 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 49.8 percent, an increase of 0.1 percentage point from June's reading of 49.7 percent, indicating contraction in the manufacturing sector for the second consecutive month, following 34 consecutive months of expansion." The ISM index of non-manufacturing activity was 52.6, up from June, which marked growth in the service sector for 31 consecutive months. These numbers demonstrate that the overall economy is growing slightly, but leaving little room for any downside surprises.
  • The Conference Board reported that it's index of Leading Economic Indicators increased by 0.4% in July after a corresponding decrease of 0.4% in June (which followed a gain of 0.4% in May). Says Ataman Ozyildirim, economist at The Conference Board: "With this month's increase, the U.S. LEI returned to its May level. The majority of its components improved, led by large contributions from housing permits and initial unemployment claims. The LEI's six-month growth rate seems to be stabilizing, pointing to a continuing but slow expansion in economic activity for the rest of the year."
  • According to the Bureau of Economic Analysis, the "advance" estimate of GDP growth for Q2 2012 was 1.5%, down from 2.0% in Q1. If the economy contracts any further this year we're in (more) trouble. As it is, growth has fallen from 3% in Q4 2011, 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 $2.58 trillion, up 0.3% from the prior month, or about 3% annualized. Interest rates near zero leave Americans with no reason to save, creating more incentives to borrow and spend. We'll see in the coming months if the amount of consumer credit contracts a bit as the labor market continues to be weak.
  • According to the Census Bureau, retail trade and food service sales increased 0.8% in July from a particularly bad June, leaving them 4.1% higher than a year ago. Given the weak economy and the lack of job growth, I'm surprised retail sales aren't even worse than this anemic number. The gains were consistent across most retail sectors. We'll see if the gains hold through the fall, although back-to-school shopping in August will help.
  • The Federal Reserve reported that in July the six month rate of growth in the supply of M-2 (a broader view of money) was "only" 5.6% after growing 6.8% in June. The supply of M-1 (the most narrow definition of money), on the other hand, rose a faster 8.5%. With the Fed continuing to "prime the pump" the stock market is bound to continue to rise. How much longer can they keep it up?
  • The Conference Board's Consumer Confidence Index bounced back a bit in July, rising from 62.0 to 65.9, breaking the streak of four straight monthly declines. Says Lynn Franco, Director of The Conference Board Consumer Research Center: "Despite this month's improvement in confidence, the overall Index remains at historically low levels. Consumers' attitude regarding current conditions was little changed in July, but their short-term expectations, which had declined last month, bounced back. However, while consumers expressed greater optimism about short-term business and employment prospects, they have grown more pessimistic about their earnings. Given the current economic environment, in particular the weak labor market, consumer confidence is not likely to gain any significant momentum in the coming months." Ugh.
  • According to the FDIC, 8 banks failed in July, bringing the total number of bank failures so far this year to 39, which is about 25 better than this time last year. 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, notwithstanding a bit of recent weakness. 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 around 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. There are some recent indications that the market may be returning to this relationship. It would be very bullish if the dollar manages to punch through resistance at 84 while the market continues to move higher.

All year I've been pointing out the declining wedge patterns for gold, silver and copper. Nothing has happened recently to the price of gold to alter the chart. Interestingly, the downward trend that had been in place for over 10 months appears to have ended as the price has moved up to the range of $1,600/oz. I still wouldn't expect any major action to happen before the Fall. Indeed, I believe the price of gold will remain between $1,575 and $1,650 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.

In the next month or so the price of silver is going to have to break out of the wedge pattern, one way or another. Support at $26 has been very firm for over a year and a half. Should the economy strengthen at all, or should there be any whiff of inflation, I would expect the price to breakout to the upside. Should the global economic malaise persist, then all bets are off. I'm taking the contrarian position in thinking the price is headed higher.

The wedge hasn't narrowed sufficiently for copper to create much pressure. The good news is that the price remains well above support at $3.00. The bad news is that the spot price is below both moving averages and China looks worse than ever. It's bullish that copper is doing as well as it is considering all the dire news from Europe and China. It wouldn't take much good news to send the price higher.

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 steadily higher, surpassing $95 yesterday. The rally has brought the price well above its 50-day moving average and just below the 200-day. RSI has moved from extremely oversold to mildly overbought. I expect the price to consolidate a bit after such a sudden and powerful rally. The big question is what will be the longer term price for oil. There are so many geo-political and micro- and macro-economic factors involved that it's really hard to say. For now, I like the range of $80 to $100.

The trading range for the financial sector is bounded by the blue lines below. The impressive 10 month rally is drawn in red. Once again, the market gains preceded the actual recovery, which is still in the nascent stages. 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 the ECB 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.

Like the financials, the market clearly discounted all the bad news in housing before there was any evidence of the recovery that is now finally taking shape. I think we can finally say the bottom was made in housing a few months ago. Residential prices and units are rising and inventory is falling and the commercial market seems to be solid. REIT prices, by and large, are trading well. Indeed, all the statistics that I've reported over the past few months indicate that the worst is over. Given all that, it's no surprise that the index is at its highest level since October 2008, when it was 146.

The charts of the overseas markets are much more sobering. The EAFE index remains far too close to support around $46 for comfort. Had it not been for ECB President Mario Draghi declaring his unwavering support for the Euro a few weeks ago, that support would likely have already failed. The index sits midway between support (blue) and interim resistance (red) and above both moving averages, so the picture is certainly better. For now, the contrarian bet I mentioned last month would be a profitable one if taken.

Like the developed world, the picture in the developing markets looks better this month. The price of the EEM is well above support and is creeping up towards the interim resistance just north of 44. The current price is above both moving averages. I'm still baffled by the fact that the IEE and the EEM are trading in lock step. At some point, these wildly divergent markets should trade independent of each other.

This is, by far, the most worrisome chart I'll show this month. The persistent weakness in China could drag the rest of the world down with it. This is as low as the SSEC has fallen since hitting 1,664 in October 2008, at the height of the financial crisis. I worried last month that should the index fall below 2,100 it could take our market with it. I hope that won't be the case.

According to the NYSE Bullish sentiment index, the market is fairly sanguine right now, even though RSI is slightly overbought (red circle) after recovering from a hugely oversold position in the Spring. Last month I said that "based on this picture, I'd say we're likely to trade sideways, or even moderately higher for a bit." That proved to be spot on and I think the trend will remain intact.

This chart shows that less that about 77% of stocks traded on the New York Stock Exchange are currently trading above their 50-day moving average. This is near the high end of the trading area. While this is a little higher than I'd prefer, there is still room to grow so I'd say again that we will either trade sideways for a bit or maybe even a little higher.

According to the "fear index", the market is too complacent given the uncertainty in the global economy and the various financial scandals. This little fear suggests we've got a bump in the road ahead of us, but it doesn't say when. For at least the next few weeks, I think we're likely to be ok.

What I'm Thinking and Doing

It's been relatively quiet since my last letter; not much new on the economic or political landscape other than the announcement Paul Ryan will be Mitt Romney's running mate. So I'll keep things short this month. It's unlikely there will be any significant news until after Labor Day so the last few weeks of summer will likely be uneventful. Much of Europe is on holiday and the majority of Q2 earnings have been reported and by and large they were better than expected. So now we can see if the market can creep ahead to new highs on low volume. In September we have Q3 pre-announcements, more European debt news and the real kickoff to the November election to look forward to. So I'm sure I'll have plenty to talk about next month.

I've used the big rally to trim a number of weaker holdings in order to raise cash for my next big purchase. I eliminated a few smaller positions in the mining and oil sectors without impacting my core holdings. I wouldn't mind raising even more cash should any good buying opportunities present themselves during the next inevitable downturn. I've already identified my next core purchase. Unfortunately, the rally has moved it above my target purchase price. Hopefully I'll be able to pick it up in the next few weeks.

Professional News and Notes

My blog, called "It's Your Money" is up and running. I'm very excited to provide another forum through which I can share my views on the market, the economy, politics and anything else that strikes my fancy. Even better, it gives me a way to have a dialog with my readers. So I would encourage you to share your thoughts with me. Please visit my blog by clicking here. As I'm trying to expand its coverage, I would really appreciate it if you could comment on one or more of the existing blog posts. It would also be helpful if you could suggest topics for future entries. I'm very excited to have this up and running and I look forward to meeting up with some of you in the blogosphere.

As I mentioned last month, I've created a one page promotional "Fact Sheet" on me and the business. I can send it to you now via email and it will be available on my website. If you, or anyone you know, would like to see it, just let me know and I'll get you a copy.

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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