Werlinich Asset Management, LLC
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Rye Brook, NY 10573

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September 17, 2012

The Bernanke Rally

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 13,593, up about 343 points, or 2.6%, from when I wrote to you last month. More remarkably, the DJIA is now only 571 points below the all time high for the Dow of 14,164 set October 9, 2007. It is looking more and more likely that the year-end rally I've been calling for is going to come to pass, as Ben Bernanke and the Fed is doing everything they can do to ensure that's exactly what happens.

Wall Street returned to work after Labor Day to a furious rally stoked by the anticipated Fed intervention. The old adage "Don't Fight the Fed" was never more true than today. The Fed has promised to buy $40 billion worth of collateralized mortgage bonds, and keep interest rates artificially low, for years to come, or until job growth is finally stimulated. Personally, I think this is a complete waste of time, energy and money, but I don't make the policy.

I'm still hoping that the transportation average will confirm the new highs set by the industrial average. Until that happens, I'll remain cautious about the rally. Also, the rally has accelerated as the dollar has weakened. This suggests that should the dollar strengthen again, we'll give back our gains. But these worries are for a later date; for now, we enjoy the gains.

As you can see below, the DJIA recently blew through resistance (red line) and has powered higher to a new post financial crisis high (green line). From here, the next resistance level would be the psychological barrier of 14,000, then the old high of 14,164. I wouldn't mind a small pullback to provide a breather before the market tries to surmount the next levels. 

The transportation average simply refuses to move to new highs. This lack of confirmation, according the Dow Theory, is very worrisome. The good news is that there have been some gains recently, moving the index above the middle of the range and higher than both moving averages. So we'll keep waiting and watching.

The rally in the utility average has finally broken down a bit. This isn't really a huge surprise given that  investors have rotated out of "safe" stocks into riskier assets. Also, interest rates have moved a bit higher and utilities are very sensitive to interest rate increases. While this dynamic could last a little while longer, I would use the weakness to buy a stake for investors seeking conservative, high-yielding income opportunities.

This chart can't make Ben Bernanke very happy. It shows the yield on the 10-year Treasury rising to about 1.85%, up from a low of about 1.4% only a month and a half ago. You'll notice that this is the second time the yield as archived this level. Last time it abruptly dropped back down. We'll see if the Fed's machinations help drive it back down again. Sill, even with the increase, rates are still historically low, and likely to remain that way for the next few years. I wouldn't expect the yield to deviate much from the range outlined below.

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. August defied the summer doldrums and produced a solidly winning month. Large-cap stocks continue to outperforming small-cap stocks, although the gap closed a bit. Technology and growth stocks, as usual, led the rally. Notice too how the year-to-date return on the bond index (Barclays Aggregate) is a mere 3.9% vs. the double-digit returns in all the domestic equity indices. I'll reiterate that it's going to be difficult to make much money in bonds this year with rates this low. That's not to say that rates can't go lower still, which they can. But I doubt the full year return will be much 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 September 8 was 382,000, an increase of 15,000 from the prior week's revised figure. The four-week average of 375,000 is about 11,250 higher than the prior month's tally. Initial claims have been rising ominously for the fast few weeks. About 3.30 million people continue to collect unemployment insurance, similar to the prior month. There just isn't any improvement.
  • Non-farm payroll employment in August was very disappointing, but just about every metric as only 96,000 low-paying jobs were added. The additions were mostly in the food and drink services and health care sectors. Revisions to prior months lopped off 41,000 jobs, which doesn't bode well for future revisions to the August figures. The total number of workers counted as unemployed dropped to 12.5 million as people apparently fled the labor force, but which meant that the unemployment rate fell to 8.1%. The more comprehensive U-6 rate dipped to 14.7%.
  • A slightly lower 5.0 million people continued to be unemployed longer than 27 weeks. The seasonally adjusted number of people who could only find part-time work dipped to 8.0 million and the number of marginally attached workers inched up to 2.6 million. The number of people holding multiple jobs remained at 6.6 million. The average hourly wages for blue collar workers actually dropped to $19.75 while the average work week remained at 33.7 hours. On balance, this was a uniformly poor report.
  • The Congressional Budget Office (CBO) estimated that on a net present value basis, the Treasury reported a federal budget deficit of $1921 billion for August and $1.167 trillion for the first eleven months of fiscal 2012, which was about $70 billion less than the same period a year ago. The seemingly large monthly deficit was mostly due to the timing of the Labor Day holiday which moved some payments into August. Therefore, the September deficit should be lower.
  • The Census Bureau reported that the U.S. trade deficit of goods and services was $42.0 billion in July, roughly the same as June, which was the lowest figure since December 2010. I suspect the trade deficit will stabilize as reduced oil imports are offset by a weakening dollar.
  • 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 July rose 3.6%, and at 372,000 units, were 25.3% higher than a year ago. The estimate of homes for sale was 142,000, which represents a paltry 4.6 months at the current rate of sales. The median sales price of $224,200 was a bit lower than the prior month and about $4,500 lower than the 12-month moving average price of $226,883. The new home sale market is very tight; and will remain that way until banks relax their lending standards a bit, prices rise and more new inventory comes to market.
  • The National Association of Realtors reported that on a seasonally adjusted annualized basis, sales of existing homes were 2.3% higher in July to 4.47 million units, and remained 10.4% higher than a year ago. The estimate of 2.4 million homes for sale means there's only an estimated 6.4 months supply on the market. The median sales price fell a smidge to $187,300, which is well above the 12-month average of $169,050. As with new homes, the banks need to relax their lending standards just a bit to really get the housing market percolating again.
  • 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 third straight month in June, posting a solid 2.1% increase. After increases of 1.3% and 2.3% in the prior two months, respectively, I think it's safe to say the bottom has been made in home prices.
  • The Institute for Supply Management (ISM) index of manufacturing activity was 49.6 in August, marking three straight months of contraction in the manufacturing sector. There is simply too much uncertainty facing big business between the election, potential tax increases, deflation in Europe and unrest in the Middle East, just to name a few problems. Therefore, companies are reluctant to hire, favoring hunkering down instead. On the other hand, the ISM index of non-manufacturing activity was 53.7, up from July, which marked growth in the service sector for 32 consecutive months. All the growth right now is in the service industries, which is holding down wage growth.
  • 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 "second" estimate of GDP growth for Q2 2012 was 1.7%, up from 1.5% in the "advance" estimate, but still down from 2.0% in Q1. Growth has fallen from 3% in Q4 2011, which was much better than the 1.8% in Q3, 1.3% in Q2, and 0.4% in Q1. Yet this is hardly the recovery that President Obama was hoping for heading into November election. This is just one of the many reasons that the Fed announced another round of quantitative easing (QE3).
  • The Federal Reserve reported that in July the amount of outstanding consumer credit was $2.70 trillion, down a bit from the prior month, or about 1.2% annualized. This breaks a spell of rising consumer credit levels. Is this a blip or the start of a new trend? I asked last month if we'd see the amount of consumer credit contract a bit as the labor market continues weaken. Maybe this is beginning. 
  • 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 August the six month rate of growth in the supply of M-2 (a broader view of money) was 5.7%, about the same as July. The supply of M-1 (the most narrow definition of money), on the other hand, rose a faster 10.3%. With the Fed continuing to "prime the pump" the stock market is bound to continue to rise. The problem is that it appears much of this "new money" is sitting on the balance sheets of the banks rather than being lent out to needy consumers.
  • The Conference Board's Consumer Confidence Index plunged in August, falling to 60.6 from 65.4, continuing the declines from March through June. Says Lynn Franco, Director of The Conference Board Consumer Research Center: "The Consumer Confidence Index is now at its lowest level since late last year (Nov. 2011, 55.2). A more pessimistic outlook was the primary reason for this month's decline in confidence. Consumers were more apprehensive about business and employment prospects, but more optimistic about their financial prospects despite rising inflation expectations." Not good.
  • According to the FDIC, only 1 bank failed in August, bringing the total number of bank failures so far this year to 40, which is 28 better than this time last year. If a bank can't make money in this low rate environment, they should go out of business. 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. That should be the norm.

Trends To Watch

What a difference a month makes. After rising in fits and starts for a year, the dollar began to roll over in early August. The weakness picked up steam in September, heading into the announcement by the Fed that they were going to again crank up the printing presses. The greenback has lost about 6% of its value over the past six weeks. So much for the recent confluence whereby the dollar and the market were rising together. The next support for the dollar is around 78. Below that it's 74.

For the past few months I've really been focusing on the declining wedge patterns for gold, silver and copper and I've been suggesting that a big move was coming. Well, those moves have come, big time, and before I expected it! The price of gold has surged about $175/oz in the past month and has blown right out of the wedge, approaching major resistance around $1,800. RSI is very overbought, so I wouldn't be surprised to see a bit of profit-taking, but looking ahead, this is extremely bullish.

Last month I wrote that "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. I'm taking the contrarian position in thinking the price is headed higher." As you can clearly see, that's exactly what happened as the price has soared almost to the next resistance level around $36 or so. Like gold, the RSI is very overbought so the silver trade is ripe for short-term profit-taking. Still, I think the bigger picture has the price moving higher.

And lastly we see copper moving higher before the wedge even had time to fully develop. It too is a bit overbought as it all happened so fast. This is the one I'd be most concerned about because of its inherent economic sensitivity and its connection to China, which looks worse than ever (see below).

The price of West Texas crude has surged steadily higher over the past two and a half months, teasing the $100/barrel mark recently. After such rapid gains, I expect the price to consolidate a bit before attempting to penetrate resistance at around $105. Given today's economic climate, it's political and social unrest in the Middle East, and the constant threat of conflict, that's inflating the price. Absent those forces, the prices would undoubtedly be lower. I still believe the "normal" trading range will be between $80 and $100. But if fighting breaks out, all bets are off.

During the recent really the financial index has again moved up to test resistance around $16.25. Last month I said "If QE3 is announced, then it's off to the races" and that's exactly what happened. The Fed is doing everything in its power to prop up the banks so it's hard to bet against further increases. Maybe I'm just being stubborn at this point, but I still can't bring myself to buy a bank stock.

There's nothing really to say about this chart except "wow". The housing sector has doubled over the past twelve months in a virtually nonstop rally. I finally capitulated and bought a mutual fund that will profit from future gains. If indeed the bottom has been made, then there should be greater profits ahead.

Finally, some good news from the developed international markets. The EAFE index has surged off support and is trading just below resistance about $56. We can thank the continued vocal support of ECB President Mario Draghi. So, like our own Fed, maybe we "Don't Fight the ECB".

Like last month, the picture in the developing markets again shows some improvement. The price of the EEM is well above support and is approaching resistance just north of 44. The current price is above both moving averages. I'm remain baffled by the fact that the IEE and the EEM are trading in lock step. At some point, these wildly divergent markets should trade independently of each other. There is little or no growth in the IEE markets and solid growth in the EEM markets. Sooner or later the markets will reflect this.

The carnage in the Shanghai index concerns me greatly. Honestly, I'm not sure why this isn't affecting world markets. Can the index fall lower still? Are things REALLY this bad in China? If so, the world has a pretty big problem on its hands.

According to the NYSE Bullish sentiment index, the market is overly bullish right now, as demonstrated by the wildly overbought RSI. This isn't surprising given the huge rally recently. It may be time for a short breather. But I don't expect a large pullback; maybe simply a bit of sideways trading to cut the froth. 

The fact that about 85% of stocks traded on the New York Stock Exchange are currently trading above their 50-day moving average is another example of a market that's gotten a bit ahead of itself. This is another signal for a pause in the rally.

According to the "fear index", the market is simply too complacent right now. Like the two indicators above, this suggests a downturn, or at least some sideways action, ahead, but it doesn't say when. The smallest bit of bad news could spark the selling.

What I'm Thinking and Doing

With your indulgence, this month I'm going to re-post a few items I've written in my blog recently because I think they're still timely. I hope you agree.

On August 22 I asked, "Is your money under your mattress, or buried in the back yard, after losing money, or losing faith, in the stock market? Have you simply “gone to cash”? First was the bursting of the ”tech bubble”, and the resulting stock market debacle, that spanned much of 2000 – 2002. From peak to trough that cost investors an average of about 40% of their portfolios. Then after waiting over five years to recover, the financial melt down of 2008 cost investors as much as 55% of their hard-earned investments over six horrific months from October 2008 to March 2009. Amazingly, the market has recovered almost all of those losses as the Dow Jones Industrial Average sits a scant 7% below the all time high. And yet how many of you have participated in those gains? How many threw their hands up in despair and quit the market for good? Or did the “flash crash” drive you out? Maybe something else like the recent LIBOR scandal?

If you’re out, what are you doing to save and invest for your future needs? Current research suggests that many individual investors, average Americans like yourself, gave up in fear (or disgust) and are sitting on the sidelines with their money in the bank, earning next to nothing. If you’re one of those people, you’re potentially endangering your entire financial future. Fear and avoidance is not a plan. It’s time to speak with a trusted advisor and implement a plan that can put you back on track to achieve your financial objectives."

After selling into the rally, and eliminating a few small and under performing positions, I finally pulled the trigger on next big purchase.  I added the dominant player in the food service industry. This blue chip company is by far the leader in the industry, is taking market share from its smaller competitors and pays a market-beating dividend. And, as a bonus, is strictly a domestic play, so we endure no European risk. I'm already looking for our next big purchase while continuing to look for opportunities to pare weaker positions. 

Professional News and Notes

My blog, called "It's Your Money" is up and running with more than a dozen posts and a number of reader comments. 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 please check it out and share your thoughts by clicking here.  As I'm trying to expand its coverage, I would really appreciate it if you could forward the link to some of your friends and colleagues and comment on one or more of the existing blog posts. It would also be helpful if you could suggest topics for future entries. If you "follow" the blog, you'll be notified by email any time I post some new copy.

As I mentioned before, I've created a one page promotional "Fact Sheet" on me and the business. If you'd like, I can send it to you now via email. It will be available on my website before the end of the month. 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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