NEWS AND VIEWS

Werlinich Asset Management, LLC
400 Columbus Ave.
Valhalla, NY 10595
914-741-6839
800-746-6926
Email: greg@waminvest.com
URL: www.waminvest.com

 
September 16, 2005 Comments   |   Refer A Friend   |   Sign Me Up   

I certainly don't need to remind anyone about the tragedy in New Orleans. And I don't want to trivialize the pain and suffering of the people down there by talking about Katrina's impact on the market or on corporate earnings. But the reality is that as a nation and as a people, we must continue to move forward. The best we can do is offer whatever support we can, whether it be monetary, physical or spiritual, to those people in need. If you haven't already done so, please consider donating either your time, your expertise or your money to a charitable organization of your choosing. Thank you.

Market Analysis...Choppy
Last Month's Results - Weak
What I'm Doing Now...Enjoying Profits
Statistics...Tough To Gauge
Trends To Watch...Gold Is Back
Monthly Tip...IRA Rule Changes
Personal News and Notes

Market Analysis...Struggling

Almost three-quarters of the year are gone and what do most investors have to show for it? Little to nothing at best, or irritating losses at worst. As of the close of the market yesterday, the Dow was down 2.21% for the year, while the NASDAQ was down a slightly better 1.20% and the S&P 500 was up a modest 1.24%. On the other hand, WAM's clients are reaping tremendous profits. If you'd like to find out why, give me a call. While the Dow continues to trade broadly between 11,000 - 10,000, over the past five months, the range has narrowed recently to 10,750 - 10,250. It will be interesting to see if that range holds for the balance of the year, especially as the financial aftermath of Katrina, and it's affect on the economy and stock market, is better understood.

All the pundits, writers and talking heads are trying to discern what effect, if any, Katrina will have on the market for the rest of the year. I think they are missing the bigger picture and the reality that Katrina really won't have much of an impact on the overall market at all. The disaster does give companies a convenient excuse for missing their earnings estimates for the next quarter or two, and it has already exacerbated certain trends, like high oil and gas prices. Yet with maybe a minor hiccup or two, I expect the domestic and global economies to remain virtually unchanged, which means it will have a negligible affect on the stock market.

The Dow closed yesterday at at 10,558, or down about 72 points since my July newsletter. But we need the chart below to see that there was a 370 point swing during the intervening period. Interestingly, the Dow is currently trading right at its 50- and 200-day moving averages. I won't try to forecast the short-term move for the Dow, but I'm still sticking with my prediction that the Dow will be down for the year.


Notwithstanding the sell off so far this month, oil prices have continued their meteoric rise, briefly extending to $70 after Katrina. As I write this, oil is trading for slightly more than $65 per barrel, which is just above its 50-day moving average, but still well above the steadily rising 200-day moving average. In July, I wrote that "I think we could see $70 within the next 12 months." Check. I expect that oil prices will remain above $60 per barrel, and could exceed $75 before the year is over. The good news is that the economy is proving to be far more resilient than I had expected. We'll see if it can withstand these prices and the short-term effects of Katrina before our domestic economic growth begins to ebb.


Not surprisingly, after Katrina, there was a flight to safety and quality as buyers rushed to Treasuries. This dropped yields back down below 4.00%, albeit only briefly. Yields are now back to 4.20%, which is right on the 50- and 200-day moving averages. The spread between the 10-year Treasury and the TIPS has risen marginally to 2.47%, which continues to suggest that inflation fears have abated.

I've written a lot about the Fed and their program of rate hikes. I expected that the July increase would be the final one. I believe that if Katrina had not happened, the Fed would have raised rates again, proving my forecast to be wrong. Now, I'm not so sure. I think the lingering effects of the recovery effort, the dampening effects of high oil prices, the temporary spike in unemployment and the slowing retail numbers suggest that the Fed should pause and take a wait and see approach. They can always resume the increases at subsequent meetings. I think the risk of recession right now far outweighs any possible risk of inflation. So I hope Mr. Greenspan and Co. will do the right thing for the country right now and leave rates unchanged after their meeting next week.


Last Month's Results...Weak

As always, I provide the following chart to show the raw results for the month, the quarter-to-date and the year-to-date. After a strong showing in July, the broad equity averages resumed their downward trend in August. As has been the case for most of the year, value continues to trump growth. The worst performing major index continues to be the Dow Jones Industrial Average. And while that is only a 30 stock average, it does include many of the major corporations in the world, and is therefore a negative indicator for the health of the overall market.

Name of Index

Aug

QTD

YTD

Description

S&P 500

-1.12

2.44

0.69

Large-cap stocks

Dow Jones Industrial Average

-1.50

2.01

-2.80

Large-cap stocks

NASDAQ Composite

-1.50

4.63

-1.07

Large-cap tech stocks

Russell 1000 Growth

-1.29

3.54

1.75

Large-cap growth stocks

Russell 1000 Value

-0.43

2.45

4.25

Large-cap value stocks

Russell 2000 Growth

-1.41

5.48

1.70

Small-cap growth stocks

Russell 2000 Value

-2.30

3.26

4.19

Small-cap value stocks

MSCI EAFE

2.56

6.35

4.81

Europe, Australia, Far East

Lehman Aggregate

1.28

0.36

2.88

US government bonds

Lehman High Yield

0.19

1.94

3.07

High-yield corporate bonds


What I'm Doing Now...Enjoying Profits

It has been a great year, to this point, for WAM's clients. We have benefited by investing heavily in the dominant trends in the market for the past three to four years: energy and natural resources. Long before it cost us $50 to fill the gas tanks in our cars I had identified those two sectors as being the most important investment ideas in the market. Nothing has happened in the world to shake that opinion.

I have added a couple of new positions in the past few months that I believe dovetail nicely with my view of the world.

Gold has had a strong resurgent over the past few months, again cresting $450 an ounce. This justifies my long-held belief that having a small position in gold as "portfolio insurance" makes a lot of sense.

Finally, one of my speculative micro-cap stocks has exploded recently, turning a losing position into gains of 200% or 300% in a matter of only three months. As I've said many times, patience is one of the keys to successful investing.

Statistics To Watch...Tough To Gauge

  • After a very strong showing in July, during which 242,000 new jobs were created, a seasonally weak 169,000 jobs were created in August. Average hourly wages rose nicely from $16.07 to $16.16 in the past two months. The average workweek dropped slightly to 33.7 hours.
  • The number of unemployed workers fell from 7.5 million to 7.4 million while the number of part-time workers held steady at 4.5 million and the number of "marginally attached" workers remained at 1.6 million. This caused my "underemployment rate" to drop to 9.5%. The official unemployment rate reported by the government dropped to 4.9%. I think my number is a better indication of the true employment situation in this country.
  • 7.22 million people held more than one job in August, a reduction of about 450,000 since June.
  • The four-week average for initial jobless claims held steady at 319,000. This number will certainly rise in the wake of Katrina. In fact, last week initial jobless claims shot up by 71,000. 
  • The University of Michigan Consumer Confidence Index dropped to 89.1 from 96.0, thanks in no small part I'm sure to the increase in oil prices.
  • According to CBO estimates, the federal deficit for the first eleven months of fiscal 2005 is $353 billion, an increase of over $100 billion in the past two months. It is very unlikely that the White House forecast of a full year budget deficit of $350 billion or less will come to pass.
  • According to the Census Bureau, the U.S. trade deficit grew to $59.5 billion in June before falling back a bit to $57.9 billion in July.
  • The Labor Department reported that the CPI, which measures changes in the prices paid by urban consumers for a representative basket of goods and services, rose 0.5% in both July and August, while the "core" CPI, which excludes food and energy, rose a modest 0.1% in both months. Not surprisingly, energy prices represented most of the increase.
  • The Federal Reserve reported that, after falling in May for the first time this year, total outstanding consumer credit increased by 1.2% in June, then stayed virtually flat in July.
  • The American Association of Individual Investors' (AAII) bullish sentiment ebbs and flows with the fortunes of the market. It remained steady from two months ago at 42.30%.
  • According to the Census Bureau, retail and food service sales were down 2.1% in August from July. Part of that decline was certainly because of higher gas prices and vacation schedules.
  • The Census Bureau reported that on a seasonally adjusted annualized basis, sales of new homes in July grew 6.5% (after a more tepid 2.0% growth in June) to a projected 1.410 million units.
  • The National Association of Realtors reported that on a seasonally adjusted annualized basis, sales of existing homes fell 2.6% in July, after rising 2.9% in June, to a projected 7.16 million units.
  • The Institute for Supply Management (ISM) index of manufacturing activity measured 53.6 in August, down from 56.6 in July. So while the economy appears to still be growing, it isn't doing so by much as anything above 50.0 is considered to be an indication of growth.
  • The NYSE reported that on August 3rd, a seat on the Exchange sold for a new record price of $3 million.

So what does all this mean to you? It appears that the economy continues to muddle through (to borrow a phrase from John Mauldin). It has shown remarkable resiliency in the face of shocks like Katrina, the continuing war in Iraq, the conflict in Afghanistan and every other thing that the world can throw at it. It would be ironic if the Fed were to push the economy into recession by an overly aggressive posture towards an inflation which, outside of food and energy, doesn't appear to be materializing. So we sit and wait to hear what the Oracle will say next week.

Trends To Watch

The trading range of 11,000 to 10,000 for the Dow continues to hold, with the current price just above the midpoint of that range.

The price of gold never did fall below $420 and has now broken out of its recent trading range to close today at almost $460 per ounce, which represents the highest price in almost 17 years. The buying opportunity I spoke about two months ago has passed.

The dollar has weakened a bit recently, falling to 1.225 versus the Euro, down from 1.2086 two months ago. This makes sense in light of the strength in gold.

As we all know, the price of oil prices continues its long-term growth. The November contract for light sweet crude closed today at $65.25 per barrel. Don't look for prices to soften too much any time soon.

The real estate frenzy continues. News that pension funds are buying real estate concerns me. Everyone wants to party like it's 1999 (with apologies to Prince).

Foreign purchases of US corporate securities hit a record of $71.2 billion in June. What would we do without foreign investors buying all of our debt?

Delta and Northwest airlines joined US Air and United in bankruptcy. That's going to put further pressure on pricing in the airline industry. Hello Jet Blue.

Monthly Tip - IRA Rule Changes

This month, I'm going to review some key rules, or changes to the rules, for IRA 's that you should all be aware of.

New contribution limits in 2005: For tax year 2005, you may contribute up to $4,000 to your traditional or Roth IRA. For those of you aged 50 and above, the limit is $4,500.

IRA rollovers: There are two times when you might roll assets into a new IRA: when you retire or leave a job with a defined-contribution plan (like a 401(k)), or when you simply move an IRA from one financial institution to another. In either case, you have 60 days to get the money from one tax-deferred account to another. Failing that, you will be subject to income tax on the full amount and an IRS penalty of 10%.

Name a beneficiary: When it comes to your IRA, your will is irrelevant. You should name a beneficiary when you open an IRA. It's a good idea to review those forms regularly. If you fail to name a beneficiary, your heirs lose the ability to stretch out the distributions over their lifetimes.

Inherited IRA's: If you inherit an IRA from anyone other than your husband or wife, you can't roll it into your own IRA. You also can't withdraw the assets from an inherited account and then deposit them into a new IRA. And you can't consolidate IRA's you inherit from different people into one account. You can, though, stretch out the withdrawals across your lifetime in order to postpone the tax bite (see the next paragraph). But you must take a distribution every year.

Beware of leaving an IRA to a Trust: Using a trust to inherit an IRA could pose some big risks. First, it could wind up paying higher taxes than your heirs would because trust tax rates are often higher than most individuals' rates. Second, the IRS could decide that the trust doesn't qualify as a "look-through" or "see-through" trust, meaning your heirs wouldn't qualify for the stretched out distributions.

Waiving the five-year rule: Under IRS regulations, any named IRA beneficiary has the ability to stretch IRA distributions over his or her entire life expectancy. The "named beneficiary" is usually an individual, not an estate, charity or trust. This means that inherited IRA's need not be used up within five years.

Roth Conversions: If you want to pass along your IRA to your children and you want them to have it as a Roth, you have to do the conversion; you can't leave it up to them to do it after you die.

72(t) payments: It's possible to take regular payments from your IRA and avoid paying the 10% penalty for early withdrawals before turning 59 1/2. To do so, you must take a series of substantially equal periodic payments, on a particular schedule. And you must continue taking these payments for at least five years, or until you turn 59 1/2, whichever period is longer.

Estate-Tax break: When you inherit an IRA on which federal estate tax has been paid, you're entitled to a little-known tax break call the Income in Respect of a Decedent, or IRD, deduction. 

New life expectancy tables: The three current life expectancy tables being used are the Uniform Life Table, the Single Life Table and the Joint Life Table. These tables can be found in IRS Publication 590.

I hope this information has been helpful. While I believe the information contained above is accurate, I suggest that before making any final decisions, you should consult your financial or tax advisor. As always, I can be reached at 914-741-6839 or at greg@waminvest.com.

Personal News and Notes

The biggest personal news I have to report this month is that all three of my children returned to school last week. I know that brings a knowing smile to the faces of parents everywhere. It's good to get back into a normal routine.

I should have some news next month to report on the long overdue launch of The Black Book on Personal Finance, which is scheduled to hit bookstores in October.

As always, I thank you for your interest and consideration, and invite you to contact me if you have any questions or if I can be of service to you in any way.

Best regards,


Greg Werlinich
President

Copyrightę 2005, Werlinich Asset Management, LLC and www.waminvest.com. All Rights Reserved.