Werlinich Asset Management, LLC
14 Birch Lane
Rye Brook, NY 10573
LinkedIn, Facebook and Twitter

October 21, 2011

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

Last month I spoke a bit too soon when I opened the letter by saying that it seemed as though the market had stabilized a bit, although I did go on to say that "it's really too early to know if we've seen the worst or if this is just a respite before the turmoil continues." In fact, the turmoil continued as the market got pounded through the end of September and into the first trading day of October. Then, like a switch being turned on, the market swiftly moved higher. So, has the bottom has been made, allowing the market to resume its march toward the summer highs, or is this just a fake to lure investors back into the clutches of the bear? The answer to these questions will depend on decisions made by our political leaders in Europe and the United States, our economy and by corporate earnings. Most immediately, the European leaders have a summit coming up, the results from which they expect to announce by next Wednesday. The market will be on edge until then to learn what their leaders plan to do about Greece and the rest of the PIIGS countries. Q3 earnings seem to be coming in as, or better than, expected. And the economy seems to be holding steady, if not improving ever so slightly. So, on the whole, there is reason for a bit of guarded optimism.

So what do we see when we look at a chart of the Dow Jones Industrial Average? Two months ago I wrote that "hopefully the Industrial average will remain above 10,600 because the next big support doesn't come in until below 10,000." Well, the Dow briefly violated that initial support, falling to about 10,400. But fortunately, that's as low as it went, for a 19% loss from peak to trough. In the three weeks since the low, the Dow as rallied about 11% going into today. In fact, the rally has brought the index right up to resistance at 11,750. Should it successfully pierce that resistance, it could rise all the way back to 12,000. We'll know more in the next few weeks as the European debt crisis plays out.

While the chart of the transportation average has a similar shape to the industrial average, the percentage movements were more dramatic. The loss, peak to trough was almost 30%, while the recent rally is almost 20%. These are truly insane price movements, reflecting panic trading rather than reasoned investing. It will be very important for the transports to move to move above resistance at around 4,800. If this happens, it could indicate a rebound for business in this country. It would be very bullish if this move happened concurrent with the industrial average moving above 11,750.

I'm including a chart of the Dow Jones Utility average to demonstrate something that is being almost completely ignored in the press; that utility stocks are currently in a major bull market! Very quietly, utilities are trading at multi-year high levels not seen since before the failure of Lehman Brothers. Utilities love a low interest rate environment, so I would expect the good times to continue in this sector.

Now that the Federal Reserve as declared war on high interest rates, and investors have shown a willingness to accept zero or near zero yields to escape equities, everything I believed about the inevitability of higher rates can, for now, be thrown out the window. After the Fed announced "The Twist" as a way to drive long term rates down even further, the yield on the 10-year treasury plunged to a ridiculously low 1.7%. Concurrent with the rise in the stock market, investors have sold bonds, helping the yield rise back to about 2.2%. So much for the power of the Fed to affect interest rates over an extended period of time. Last month I wrote that "at the risk of being wrong again, I'd guess that yields will remain between 2%-3% through at least the end of 2012 before slowly rising, as market forces dictate they eventually must. It is only the actions of the Federal Reserve which is keeping rates artificially low. But sooner or later, rates will move higher." I'll stick with that.

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. As you can see by the results below, the broad market averages, led by the carnage in the developed foreign and small-cap markets, were down big in September, marking five straight monthly losses for the market. Making matters worse, this decline wiped out the remaining gains from earlier in the year, leaving all of the averages down for the year, some double-digit. It has been just a brutal market since the end of April. Large-cap value stocks have performed much better than small-caps and growth. The only solace is that the "seasonally bad" time of year is over, and the fourth quarter as already begun with a bang.

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 October 15 was 403,000, a decrease of 6,000 from the prior week's revised figure. The four-week average of 403,000 continued a four week trend of moving lower. About 3.7 million people continue to collect unemployment insurance.
  • Non-farm payroll employment increased by 103,000 in September. This increase partly reflected about 45,000 striking Verizon employees that returned to work. Job gains occurred in construction, health care and the service sector, while the government continued to pare jobs. Almost 100,000 jobs were added in the prior two months thanks to upward revisions to the July and August figures. The total number of workers counted as unemployed remained at 14.0 million helping to keep the unemployment rate at 9.1%. The more comprehensive U-6 rate moved down to 15.7%.
  • 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 rose to 9.3 million and the number of marginally attached workers fell to 2.5 million. The number of people holding multiple jobs rose to 6.95 million. The average hourly wages for blue collar workers inched up to $19.52 while the average work week remained at 33.6 hours. So while this report was an improvement, much more progress needs to be made to improve a dreary employment picture.
  • The Congressional Budget Office (CBO) estimated that on a net present value basis, the Treasury reported a federal budget deficit of $64 billion in September, leaving us with a deficit of $1.3 trillion for the full fiscal year of 2011, which is roughly the same as the record levels from a year ago. Interestingly, tax receipts from individuals rose 21.6% from the prior year, but that was partly offset by greater payments to Medicare and Medicaid and by higher interest payments on the public debt.
  • The Census Bureau reported that the U.S. had a trade deficit in goods and services of $45.6 billion in August, virtually unchanged from the prior month. Our poor economy is likely holding back imports.
  • The Census Bureau reported that privately owned housing starts surged 15.0% in September, after falling 7.0% in August, and was up 10.2% from a year ago, to a seasonally adjusted annual rate of 658,000 units. While this is the higher level of the year, the monthly results have been extremely volatile this year, so a reliable trend is not yet in evidence. New building permits were down 5.0% from the prior month but up 5.7% from last year. I can't explain the surge in housing starts. We'll see if it continues for the next few months.
  • The National Association of Homebuilders/Wells Fargo Confidence Index in September jumped up to 18 from 14 in August, marking the highest level since May 2010. The best market was out West, with the East trailing the rest of the country. Again, I'm not sure what caused the good feelings last month. We'll have to see if this is the start of a trend or simply an anomalous month.
  • The Census Bureau reported that on a seasonally adjusted annualized basis, sales of new homes in August fell 2.3%, which marked the 4th straight decline. But at 295,000 units, sales were actually 6.1% higher than the depressed level of a year ago. The estimate of homes for sale was only 162,000, which represents 6.5 months at the current rate of sales. The median sales price of $209,100, was the lowest level since last October, and well below the 12-month moving average price of $224,733. Last month I wrote that "bad weather will likely negatively impact the August figures". That certainly proved true.
  • The National Association of Realtors reported that on a seasonally adjusted annualized basis, sales of existing homes were fell 3.0% in September to 4.91 million units, but were 11.3% higher than a year ago. The estimate of homes for sale, at 3.5 million represents 8.5 months of supply at the current rate of sales. The median sales price of $165,400 is slightly lower than the 12-month average of $166,417. 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 cash, good credit and can find someone willing to sell.
  • 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 fourth consecutive month in July, increasing slightly while still remaining lower than a year ago. This is now officially an upward trend, although they do conflict a bit with the falling home prices reported by the Census Bureau and the National Association of Realtors. I'm not sure what to make of that.
  • According to RealtyTrac, the number of foreclosures in September decreased 5.82% from the prior month, and remained 38% lower than a year ago. According to James Saccacio, CEO of Realty Trac, while foreclosure activity in September and the third quarter continued to register well below levels from a year ago, there is evidence that this temporary downward trend is about to change direction, with foreclosure activity slowly beginning to ramp back up."
  • The Institute for Supply Management (ISM) index of manufacturing activity was 51.6 in September, a small increase over the prior month. This marked the twenty-sixth consecutive month of expansion in the manufacturing sector, and broke the streak of three consecutive monthly declines. Any number below 50 indicates a contraction. The ISM index of non-manufacturing activity was 53.0, a bit lower than the prior month. This marked growth in the service sector for twenty-one consecutive months. These numbers demonstrate that while business is still growing, it is barely doing so, and remains in danger of contraction.
  • The Conference Board reported that it's index of Leading Economic Indicators increased by 0.2% in September, following larger increases in the prior two months. Says Ataman Ozyildirim, economist at The Conference Board: September data shows moderating growth in both the LEI and the CEI. The weaknesses among the leading indicator components have become slightly more widespread in September. Moreover, the CEI suggests current economic conditions have been slow, with weak gains in all four components over the past six months. The slow pace in the LEI suggests a growing chance that this sluggish economy is going to be here for a while.
  • According to the Bureau of Economic Analysis, the "third" estimate of GDP growth in Q2 was 1.3%, which was equal to the "advance" estimate. This is an improvement on putrid Q1 GDP growth of 0.4%, down 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. Our economy has basically stalled and we're awfully close to achieving the dreaded "double-dip recession".
  • The Federal Reserve reported that in August the amount of outstanding consumer credit remained flat from the prior month, at $2.45 trillion. Consumer credit has expanded slightly since the beginning of the year. Unfortunately, it doesn't seem to be stimulating business.
  • According to the Census Bureau, retail trade and food service sales were up 1.1% in September, the best showing of the year, and was 7.9% higher than a year ago. After the bad weather abated, it seems that people finally went shopping. Auto-related sales really led the way.
  • The Federal Reserve reported that in September the supply of M-2 (a broader view of money) continued to explode higher, up a stunning 14.6% over the prior six months. The supply of M-1 (the most narrow definition of money), on the other hand, rose a whopping 25.7% over the same six months. Where is all this money going, other than to the reserves at your local bank?
  • After plunging in August, The Conference Board's Consumer Confidence Index remained relatively unchanged in September, rising to 45.4 from 45.2. This is the lowest number since April 2009. The index is 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. It could be years before the confidence index again reaches those lofty levels.
  • According to the FDIC, 80 banks had failed through October 14, compared with 139 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

After a precipitous drop for the better part of the past year, or really the past decade, the greenback is now trading like a tech stock, making big short-term moves as news about the fate of Greece and the rest of the ECU filters through to the equity markets around the world. So while the dollar is in terrible shape, it's relatively better than the Euro, which could be fighting for its very existence. So all things considered, it's better to own dollars now.

To put things in greater perspective, I'm updating the monthly chart, which shows the price action of the dollar index for almost 25 years. Now you can clearly see what the easy money policies of the Fed since the Tech Bubble burst, including QE1, QE2 and The Twist most recently, have done to the dollar. This is a stunning debasement of the purchasing power of our currency. Wonder no longer why everything seems to cost so much more than ever before.

The crisis in September, like the crisis in October '08, caused a major selloff in gold as traders sold anything and everything as global markets tanked. And yet, even a sudden 20% reduction in the price of the yellow metal didn't break its long-term upward trend. While the price has fallen below its 50-day moving average, it remains safely above the 200-day average and right on the trendline. I've written before that "each consolidation was followed by a rise to a new high" and I'm confident that this time will be no different; it just might take a little while. For those who have not yet participated in this tremendous bull market, this could be a great buying opportunity. Don't miss your chance as the next stop on this train may be $2,000.

Like I did with the dollar index, I thought I would help put the bull market in gold in perspective with this chart showing the price action of gold over the past decade. I started buying shares in gold stocks, Newmont Mining specifically, in 2001 when the price of gold was $270/oz. I've never sold a share of NEM, or any other gold stock I subsequently acquired, since then. I don't think we're anywhere near the end of this bull market.

Four months ago 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 was absolutely right....for a couple of months. Then silver got crushed again in another wave of panic selling. At around $30 silver looks to be an excellent buy. If this were a stock, or even a sector, this chart might scare you off, and rightfully so. But I believe the underlying fundamentals of the precious metal trade in this economic and political environment justifies going long silver.

Unlike the price of gold and silver, the price of copper greatly concerns me. After remaining in an extended trading range for the first eight months of the year, Dr. Copper is forecasting trouble ahead as the price has fallen below a year-long trading range and well below both moving averages, and is dangerously close to major support around $2.70. The price of copper, which is often viewed as a proxy for the health of the global economy suggests deep concern.

After falling precipitously between May and August, the price of West Texas Crude (WTIC) has traded wildly over the past three months, as marked in green below. So whereas the old trading range was between $90 - $105, the new range is $70 - $90. 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 world economy regains its footing. I don't think the next big move will happen until sometime next year, but oil companies will still earn excellent profits will prices at this level.

I've been bearish on the financial sector since early 2008 and therefore have avoided buying anything in this group since then. While this stance caused me to miss some brief bullish moments, it has helped me avoid tremendous losses when those gains inevitably evaporated. The index is trading below very strong support and seeking some stability. It's hard to imagine any substantial gains in the banking sector until the ECU comes up with a palatable solution for the massive debt crisis engulfing some of their weaker members without either tearing apart the European Union or bankrupting the European banking sector. Good luck with that.

I have been equally bearish on the housing sector since 2007, so I'm not surprised that the price of the housing index fell steadily before inevitably breaking below major support around 86. What I don't understand is why the index has rallied so much recently in spite of the lack of any really good news. Is this simply a "dead cat bounce" or does the market see a better housing market in the near future?

The developed international markets have taken a drubbing just like our domestic market, but it has also enjoyed the recent rally, bringing the index right in line with the 50-day moving average. More importantly, support held right above $46. Like many other charts, just consolidating for a bit, without weakening further, would be very constructive. A rally above $54, which looks to be the next level of resistance, would be bullish.

The index of the emerging markets, which should be somewhat uncorrelated with the developed markets, looks remarkably similar to the chart above. That's not good for investors seeking refuge in the supposedly faster growing emerging markets. Thank goodness the index has rallied furiously in the past three weeks with the rest of the equity markets, but there are a lot of losses still to recover. Results like this confound the historical benefits of global diversification. Let's hope the bottom has been made.

I've been writing for months that the weakness in the Shanghai Index makes me very nervous because of China's importance to the world economy. The index has now dropped well below its moving averages and a two-year old support level, and has brushed against major support just north of 2,300. This is what Dr. Copper sees and is a clear indication of global trouble as China succeeds in slowing their economy.

Two months ago I wrote that there was "so little bullishness [in the NYSE Bullish Percent Index] that it's almost a screaming buy signal." That turned out to be a good call as a rally ensued almost the next day. Last month I said that "the index remains below the "normal" sentiment range, suggesting that the rally could have some legs." That didn't work out so well as the bullishness vanished in the wave of panic selling. Fortunately, the bullishness snapped back almost quickly as it disappeared, so we're again in a more normal range. I'm hesitant to make a call this month, but if my back is to the wall, I'd admit to being cautiously bullish.

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. Two months ago I said that "you can't get much more bearish than this, which again suggests that a rally should follow." We know that's exactly what happened. And similar to the bullish index above, I was wrong last month when I suggested that this index indicates that there is further room for the market to move higher. But now with about 62% of the stock above their 50-day moving average, that is clearly bullish and suggests that the rally can continue for a while.

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. That panic seems to have finally waned, bringing the VIX back to the high end of the normal volatility range. If the fear continues to abate, the rally should continue.

What I'm Thinking and Doing

The global economic malaise and political uncertainty makes for a very difficult and unsettled investment landscape. The big questions are whether the European Currency Union is going to blow up and whether the United States is going to fall back into the dreaded double-dip recession. As to the latter, I don't think we're headed for a full-scale recession. Rather, I believe we're going to slog through a period of below-average growth, but growth nonetheless. GDP growth for most of this year, and into next, will probably be in the 1% and 2% range which is nothing to write home about, but better than a contraction. As to the former, I think Germany will be forced, kicking and screaming, to save the ECU, at least in the short run. But I do believe that Greece, and possibly some of the other PIIGS nations will inevitably default on their debts. And I think that is becoming more and more priced into the market, so when it happens, it won't be a surprise.

Unfortunately, I put some cash to work right before the crash in September, which was bad timing on my part. But I think most, if not all, of those purchases have already returned to profitability. The best time to buy is when there is blood in the streets. Being able to buy, then sit tight, when everyone else is selling, is one of the most difficult things to do, but it separates the best investors from everyone else.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. Remember, markets always go up and down. The key is to remain in the market so you don't miss the gains.

I have made very few trades this year, preferring instead to wait out the tremendous volatility with the securities that I already own and enjoy the steady flow of dividends. For the remainder of the year I plan to pare my weaker positions, add to some of my core sectors (like precious metals) and match up gains with losses where possible to minimize taxes. If you have any questions, please feel free to give me a call and we can discuss your personal financial situation.

Professional News and Notes

There isn't much new to report this month. The best news was that we put the horrible third quarter behind us and moved on to what will hopefully be a much better fourth quarter. I've also made a greater effort towards my professional networking, through which I've met some very talented new professionals with whom I hope to share some business in the coming months.

As I've mentioned earlier, my fan page is up and running and a few more people are "liking" it each month. I would appreciate it very much if some of you would do the same 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 250 followers, up from about 200 just last month. My goal is to surpass 400 by 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

"News and Views", Copyright, Werlinich Asset Management, LLC and All Rights Reserved.