Werlinich Asset Management, LLC
400 Columbus Ave.
Valhalla, NY 10595

November 17, 2005 Comments   |   Refer A Friend   |   Sign Me Up   

The Black Book on Personal Finance, which I co-authored with a chapter entitled "Sector Rotation Investing", is now available for sale. You can buy it on by clicking here or on Barnes and by clicking here. The book is also available at selected bookstores around the country. Please consider buying a copy. I'm sure you will learn something. Thank you.

Market Analysis...Confusing
Last Month's Results - Bad
What I'm Doing Now...Watching and Waiting
Statistics...Mixed Messages
Trends To Watch
Monthly Tip...Beware the AMT
Personal News and Notes

Market Analysis...Confusing

No matter how you slice it, October was not a good month. All of the broad market averages were down, which is clearly shown in the Last Month's Results section. But as usual, I prefer to look ahead than look backwards. The good news is that there has been a very strong rally so far this month, and that rally has brought the Dow Jones to the brink of breakeven for the year. Maybe this is the beginning of the big "Year-End Rally" that so many guru's have been expecting. I hope they're right, but I'm not convinced yet. I'd want to see the Dow break above 10,700 and test the high set earlier in the year. That would be a breakout from the declining funnel shown by the black lines.

After peaking above 10,700 during the day. the Dow closed today at 10,675, which was about 400 points higher than the same point last month. So rather than approaching the lows for the year, now we're winking at the highs. One thing this demonstrates is the relatively narrow trading range that the Dow has been stuck in all year (see the range between the pink lines). Right now the Dow is trading well above its 50- and 200-day moving averages and appears overbought on both RSI and MACD (see the top and bottom sections of the chart). So let's watch and see what happens next.

It appears to me that one of the strongest reasons for the recent market rally is the concurrent drop in the price of oil. Over the past two months, the price of oil has dropped from just over $70 to about $58 today. While part of this drop can be attributed to a world-wide reduction in demand, I believe this is temporary. The unseasonably warm weather in the US is certainly another factor, and one that isn't likely to last much longer. To reiterate an investment thesis that I've held for more than three years now, I believe we are in a bull market in energy and natural resources. We're just in a period of consolidation right now. Times like this shake out the weak investors and embolden the strong ones.

For almost two and a half months yields on the 10-year Treasuries had surged to almost their highest levels of the year. This can partly be attributed to a stronger dollar and to continued rate tightening by the Fed. It seems certain that the Fed will raise rates again at their next meeting, which would make the short-rate 4.25%. If long rates don't continue to rise, we could be very close to an inverted yield curve, which almost always presages a recession. The spread between the 10-year Treasury and the TIPS remains around 2.50%, which demonstrates a certain amount of inflation concerns.

Last Month's Results...Bad

As always, I provide the following chart to show the raw results for the month, the quarter-to-date and the year-to-date. October was not a kind month for investors. All of the broad indices were down. Last month's losses have left the Dow, S&P and NASDAQ in negative territory for the year. There has been a lot written and discussed in the media over the last few weeks about a big year-end rally. Personally, I didn't think it would happen and I've been proven wrong so far. But there are six weeks left in the year and a lot can happen between now and then.

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

Lehman Aggregate




US government bonds

Lehman High Yield




High-yield corporate bonds

What I'm Doing Now...Watching and Waiting

WAM's portfolios took a hit in October as energy stocks dropped about 10% or more. We used that weakness to add to some existing positions and start two new ones. Even with that bad month, all of our portfolios are solidly profitable for the year and well positioned for the future. So now we're going to step back and try to listen to the market. While we wait, we're ever mindful of Rule #1, which is "Don't Lose Money." So I will continue to shed underperforming assets and look for weaknesses in our sector positions. I don't mind holding a little cash right now. Cash may not be exciting, but you can sleep well at night knowing you have some.

Statistics To Watch...Mixed Messages

  • There was a nominal increase of 56,000 non-farm jobs in October. As with September, I don't assign any special importance to this number, nor will I place any additional weight on the number of jobs added or lost for the rest of the year as the post-hurricanes employment picture gets sorted out. Average hourly wages rose to $16.27 from $16.19. The average workweek inched up to 33.8 hours.
  • The number of unemployed workers in October returned to 7.4 million from the hurricane- augmented 7.7 million in September. The number of part-time workers fell from 4.6 to 4.3 million. The number of marginally attached workers (those individuals who had looked for work sometime in the past year, but not in the past four weeks, and are therefore not counted as unemployed) remained at 1.4 million. My Comprehensive Labor Index™ fell to 9.16%, its lowest level of the year while the official unemployment rate reported by the government dropped to 5.0%.
  • The number of people holding more than one job in October rose to 7.81 million. This is the highest level of the year.
  • The most recent four-week average for initial jobless claims fell to 333,000, its lowest level in two months.
  • The University of Michigan Consumer Confidence Index dropped in October to 74.2. The persistent drop in consumer confidence is starting to manifest in weaker retail sales numbers. If this continues, it could be a grim holiday season.
  • According to CBO estimates, the federal deficit for October, the first month of the new fiscal year, was $50 billion, which was $7 billion better than last year.
  • According to the Census Bureau, the U.S. trade deficit grew to a record $66.1 billion in September from a revised $59.3 billion in August.
  • 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 a modest 0.2% in October. The "core" CPI, which excludes food and energy, also rose 0.2%. Certainly the drop in the price of oil had a lot to do with the smaller CPI figure.
  • The Federal Reserve reported that total outstanding consumer credit was flat in September, and remained at $2.16 billion. It makes sense that people are spending less as their confidence in the economy ebbs.
  • The American Association of Individual Investors' (AAII) bullish sentiment, which ebbs and flows with the fortunes of the market, rebounded strongly in the past two weeks (concurrent with the strong market rally) to 58.6%, after bottoming out at 32.1% only two weeks ago.
  • According to the Census Bureau, retail trade and food service sales edged down 0.1% in October from September. That decline was entirely the result of weak auto sales.
  • The Census Bureau reported that on a seasonally adjusted annualized basis, sales of new homes in September rose 2.1% to a projected 1.222 million units, after plunging 11.6% in August. The estimate of 493,000 new homes for sale represents about 4.9 months at the current rate of sales, and an increase of 0.2 months from last month. This is the largest supply of new homes available for sale in the past year. Rising interest rates are clearly effecting home sales.
  • The National Association of Realtors reported that on a seasonally adjusted annualized basis, sales of existing homes were flat in September, remaining at a projected 7.28 million units. The estimate of 2.849 million existing homes for sale represents about 4.7 months at the current rate of sales, which is roughly the same inventory as last month and the largest available supply in years.
  • The Institute for Supply Management (ISM) index of manufacturing activity measured 59.1 in October, down marginally from 59.4 in September. This marks the 29th month in which economic activity in the manufacturing sector is reported to have grown. Anything above 50.0 is considered to be an indication of growth.
  • According to the Bureau of Economic Analysis, the "advance" estimate of real gross domestic product, the output of goods and services produced by labor and property located in the United States, increased at an annual rate of 3.8 percent in the third quarter of 2005. The revised estimate will be released on November 30. In the second quarter, real GDP increased 3.3 percent.
  • The NYSE reported that on November 16th, a seat on the Exchange sold for $3.25 million a new record price.

While I continue to be amazed by the resiliency of our domestic economy and the recent strength of the stock market, I'm concerned that troubles are building. My biggest worry is rising interest rates and the effect on the housing market. I'm also worried the consumer may be tapped out, which would hurt the retail sector. Pay close attention to Thanksgiving sales numbers. While everyone is talking about inflation, the greatest fear that nobody is talking about is recession. If the housing bubble does pop, and if consumers stop spending money at the mall, I wouldn't be surprised to see our economy grind to a halt.

Trends To Watch

The broad, year-long trading range of 11,000 to 10,000 for the Dow continues to hold, as does the tighter, and more recent, range of 10,700 - 10,200. All we can do is watch and wait to see if this range will be broken.

The price of gold exploded up by $10.20 yesterday to close at $478.30, its highest closing price in 18 years. And in trading today, a December contract is currently quoted at $486.20. For three years I've been advocating that everyone should have a position in gold. My prediction that $500 gold is not so far away no longer seems so far-fetched. Similarly, platinum prices are at a 25 year high and copper and silver are also at new highs.

Concurrent with the rise in the price of precious metals is the general rise in the price of all commodities. The following chart, which covers almost three years, shows that very clearly, and it burnishes my belief that we continue to be in a bull market for natural resources. Obviously, this index has shown some weakness in recent weeks, which is mostly attributable to the drop in the price of oil, which I think is just a temporary price consolidation.

The value of the dollar as risen in lockstep with the increase in interest rates. The dollar is now at 1.726 versus the Euro. This makes the rise in gold even more impressive, because a strong dollar usually means weak gold.

It appears that oil is indeed consolidating, and may have bottomed out at around $57. It wouldn't surprise me to see the price around $55. But I'm convinced we're in the early stages of a long bull market in energy prices.

I think the real estate market is on very dangerous ground. If interest rates continue to rise, home builders continue to warn of weakness, and the sales of new and existing homes continue to soften, it could deal a mortal wound to our domestic economy.

As expected, the Fed increased their short-term lending rate to 4%. It is almost assured that they will increase the rate to 4.25% at the next meeting. Pay very close attention to the yield curve. If it flattens, or inverts (where short-term rates are higher than long-term rates), a recession is very likely to follow.

Monthly Tip - Beware the AMT

This month I've asked Edward Heben, CPA, CVA, AEP, of Puglisi, Heben, Gioffre & Moore, LLC to educate us on one of the significant traps in the existing tax code: the Alternative Minimum Tax. For those of you are are, or may be, affected by the AMT, I hope this article will help with your annual tax planning.

Taxpayers beware the infamous Alternative Minimum Tax (the AMT). The AMT is a concurrent, or parallel, Federal Tax computation that runs along side of what is now referred to as the Regular or Traditional Federal Tax calculation. The AMT was originally conceived to impose a minimum tax on only the very wealthiest taxpayers. However, because the AMT was never indexed for inflation, it is increasingly becoming a burden to the middle class.

You probably thought that the Jobs and Growth Tax Relief Reconciliation Act of 2003 was going to slash your tax bill. Unfortunately, it hasn’t turned out that way. In fact for some people, your tax burden may have actually increased thanks to the pernicious effects of the AMT.

Rather than stick your head in the sand and hope the AMT goes away, I suggest that you begin planning now so as to avoid any possible unpleasantness at tax time. So let’s look at some of the current and upcoming issues that many taxpayers will face.

The 2003 Tax Act lowered income tax rates, which ensnared more taxpayers than ever in the AMT. AMT tax rates are 26% for AMT taxable income of up to $175,000 and 28% for AMT taxable income above that amount. For married couples filing separately, the cut-off is half of the $175,000, or $87,500. Notice that I used the term "AMT taxable income" or AMTI. That’s because that amount can differ radically from taxable income calculated under the regular tax method.

Once you determine your AMTI, you can reduce that amount by your AMT exemption, which for tax year 2005 is $58,000 for married-joint filers and $40,250 for singles. Under the AMT regulations, some taxpayers’ biggest deductions will be disallowed and replaced with an AMT exemption. The long list of lost deductions includes, but is not necessarily limited to, state and local income taxes, real estate taxes, certain home equity interest, all work-related miscellaneous itemized deductions, and personal family exemptions. For 2005, that exemption is $3,200 per dependent.

Unfortunately, the exemption is subject to certain income limits and will be phased out when AMTI exceeds $150,000 for married filing joint, $112,500 for singles, and $75,000 for married filing separately.

If or when your AMTI reaches $382,000, married-joint filers lose their $58,000 exemption completely. This is because $382,000 exceeds the $150,000 phase-out range by $232,000, and 25% of $232,000 is $58,000, thus reducing the exemption amount to zero. Singles lose their exemption at $273,500 and married-separates at $191,000.

The bad news is that even if taxpayers lose their entire AMT exemption, the regulations still cause you to lose all the other deductions not allowed under AMT. So if their incomes are too high, they will lose both their tax deductions and the AMT exemptions, and will therefore end up paying an even larger tax bill.

Remember how you cheered when the new tax law cut the rates on long-term capital gains and certain dividends to 15%? You probably even started loading up on dividend-paying stocks. But beware: capital gains and dividend income increase your AMTI, and if it proves high enough, you may lose your AMT exemptions and end up paying a higher tax bill.

If you live in a high-tax state, the extra state tax you pay on the capital gain is not deductible under AMT. The loss of a deduction is the same as a tax increase. Think of it this way, if you are in the AMT phase-out range, every dollar of capital gain increases your AMTI by $1.25. Although the AMT tax rate is lower than the regular tax rate, it's still expensive because it is based on a higher income base.

Let's look at how a $40,000 long-term capital gain really costs a taxpayer more under the AMT. A $40,000 capital gain will reduce your AMT exemption by $10,000 (25% of the $40,000). By losing $10,000 of this exemption, and assuming that you are in the 28% AMT rate bracket, you would owe an additional $2,800 in AMT. Add that $2,800 to the $6,000 capital gains tax ($40,000 x 15% = $6,000), and the real tax burden on the $40,000 is $8,800, effectively raising your capital gains tax rate from 15% to 22% ($8,800/$40,000 = 22%). That rate will be even higher in a state, like New York, that taxes capital gains. At 22%, the AMT actually causes a 46.67% increase in the "lower" 15% capital gains rate.

While the AMT system is tough to beat, there are a few planning strategies that can lessen the pain to some extent. So, if it looks like you may get hit with the AMT, you can go into a reverse planning mode. If you find yourself forced into AMT you will most likely be in one of the lower tax rate brackets. At lower tax rates, you may want to bring income into the current year and defer expenses until next year. The usual regular tax strategy is of course exactly the opposite. Deductions are worth less at lower tax rates and are completely worthless if they are lost under the AMT system.

One tactic would be to postpone your fourth quarter estimated state income tax payment to the ensuing year. Another is to step-up IRA withdrawals depending on which side of the planning scenario you’re on. Be sure to consult your tax advisor regarding these issues.

With the proper planning, you may be able to arrange and/or shift your income and deductions each year in order to lessen the blow of the AMT when it occurs. Self-employed individuals and investors have the greatest flexibility in shifting income and expenses.

There is an AMT credit, which can reduce the impact of AMT to some extent. But the credit is very limited and won’t apply to many taxpayers. Your tax preparer should be able to tell you if you qualify.

When it comes to the AMT, the best thing you can do is to plan ahead. The AMT is one of the greatest stealth tax increases ever enacted. The tax revenue it generates keeps increasing, so don’t expect Congress and/or the IRS to end this cash cow any time soon.

If you would like more information on the AMT, or would like to speak with Ed about any tax matter, he can be reached at 914-925-1120, or via email at

Personal News and Notes

As I mentioned at the beginning of the newsletter, The Black Book on Personal Finance is now available for sale on, Barnes and and a number of retailers around the country. I urge you to go out an buy a copy. Let's see if we can make it a bestseller.

In an unprecedented move, Congress has recently made temporary tax law changes to encourage more charitable giving. The Katrina Emergency Tax Relief Act of 2005 (KETRA) includes a number of important provisions pertaining to charitable giving. Among these provisions are incentives for taxpayers who give gifts of cash between August 28 and December 31, 2005. As you may already know, deductions for cash gifts to charities are generally limited each year to 50% of a taxpayer’s adjusted gross income (AGI). Any gift amounts beyond this limit may be carried over as a deduction, up to five additional years. Effective August 28, Congress has suspended the 50% limit on cash gifts to qualified charities. In other words, this year alone individuals may deduct charitable cash gifts in amounts up to 100% of their AGI. If you have already given more than 50% of your AGI prior to August 28th, you should speak with your professional tax advisor about the different deductibility limitations for gifts made before and after that date. Also waived is the 3% mandatory reduction on charitable deductions for taxpayers whose AGI exceeds a certain level.

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

Copyright© 2005, Werlinich Asset Management, LLC and All Rights Reserved.