November 27, 2007

Current Market Analysis
Last Month's Results
Statistics to Watch
Trends To Watch
Monthly Tip
What I'm Thinking and Doing
Personal News and Notes

To say it has been a bad month or so would be an understatement. It might be more appropriate to describe the stock market action as "carnage". The market, as represented by the Dow Jones Industrial Average, has plunged 932 points, or 6.8%, since I wrote to you last month. The Industrials have also fallen 1,455 points, or 10.25%, from the high of 14,198 set on October 11. The Talking Heads will call this a "correction". I'm sure CNBC is in a lather about it right now. But as I tell my clients, I try to avoid most of their breathless commentary, and so should you. By way of comparison, the S&P 500 is down 169 points from the high of 1,576, which is a 10.72% drop. We'll take a graphical look at the market below.

Clearly, the effects of the mortgage and lending crises, and growing worries about a consumer credit crisis, continue to ripple through the economy and Wall Street. According to the November 12 issue of Fortune magazine, there is about $915 billion in US credit card debt, an amount that is strikingly similar to the amount of mortgage debt outstanding. That's a lot of money that will have to be repaid in a very difficult financial environment.

Last month, the Federal Reserve cut the Fed Funds rate another 25 basis points, as expected. Their attendant press release suggested that further cuts would not be forthcoming. That clearly spooked the stock market as it saw the likely need for further cuts. All of the bad news released over the past few weeks have virtually guaranteed that Chairman Bernanke will have to eat those words and cut rates again when the Fed meets in two weeks as the financial picture, and the stock market, continues to deteriorate.

I've been saying over the past few months that the stock market was telling us that things weren't as bad as some of the pundits would have us believe. Well, I may not have read those tea leaves as well as I would have liked. The market is highly news driven right now, and most of the news is bad. So let's take a look at some charts to get a better view of things.

The daily chart of the Dow Jones Industrial Average clearly shows the wild price swings over the past five months. Most ominously, it shows that the Industrials recently fell below the closing low of August 16. This means that both the Industrials and the Transports (see below) have violated technical lows and have therefore traced a bearish signal according to Dow Theory (thanks as usual to the guru of Dow Theory, Richard Russell). That is not a good thing. It also suggests that when I wrote last month that I believed that "the Industrials will surpass 14,000 again before the end of the year" I may have been a little too optimistic. If things continue to deteriorate, the next support level would be 11,939 low from March.

The Transportation average looks even worse than the Industrials. After consolidating above a support level of 4,700 during August, September and October the Trannies have plunged in November below the closing low of 4,672 set on August 16. I was right to worry when the 50-day moving average moved below the 200-day average. That was a warning sign. This is a very worrisome picture.

So what does the bond market look like? To put things in greater perspective, I've shown you the graph on the 10-year Treasury for as long as the TNX has traded, which is about 17 years. In that time, only the period from late 2002 through early 2004 has brought investors a lower yield than what we have today. The bond market is clearly telling us that it is worried, and that it's forecasting lower rates ahead. Bonds yields have dropped more than a percentage and a half in the past five months as investors have flocked to the "safety" of treasuries. It's possible that yields could fall even further as the economy weakens, stocks suffer further, and the Fed is forced to drop rates again next month.

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. The market managed to eke out some modest gains in October, with growth stocks again leading the way. At the end of the month, even with all the bad news, the market looked as though it would end the year solidly in the black. Unfortunately, that appearance may have been premature as the market has plunged in November. We'll have to see what the market does in the last five weeks of the year.

Name of Index	Oct	QTD	YTD	Description
S&P 500	1.48	1.48	9.24	Large-cap stocks
Dow Jones Industrial Average	0.25	0.25	11.77	Large-cap stocks
NASDAQ Composite	5.83	5.83	18.38	Large-cap tech stocks
Russell 1000 Growth	3.40	3.40	16.51	Large-cap growth stocks
Russell 1000 Value	0.01	0.01	5.98	Large-cap value stocks
Russell 2000 Growth	4.50	4.50	14.27	Small-cap growth stocks
Russell 2000 Value	1.09	1.09	-1.64	Small-cap value stocks
MSCI EAFE	3.94	3.94	18.05	Europe, Australia, Far East
Lehman Aggregate	0.90	0.90	4.75	US government bonds
Lehman High Yield	2.62	0.33	3.21	High-yield corporate bonds

Statistics To Watch

According to the Department of Labor, the most recent four-week average for initial jobless claims, for the week ended November 17, was 329,750, down slightly from four weeks ago. At the same time, non-farm payroll employment rose by 166,000 jobs in October, following a revised lower gain of only 96,000 in September. Not enough jobs are being created for true economic growth, and most of those are in the government, health care and service sectors. Average hourly wages grew an anemic $0.01 to $17.58. The average workweek remained steady at 33.8 hours.
The number of unemployed workers remained unchanged at 7.2 million. The seasonally adjusted number of people, who for economic or business reasons, could only find part-time work, fell dramatically to 4.0 million and the number of marginally attached workers inched up to 1.4 million. The number of people holding multiple jobs rose to 7.85 million. My Comprehensive Labor Index™ fell to 8.65%, while the unemployment rate reported by the government remained at 4.7%.
One final employment statistic that I find a little unnerving is the growth in number of people out of the labor force. There were 77.9 million people reported out of the labor force in Q1, 78.7 million in Q2, 79.0 million in Q3 and 79.5 million in October. What is happening to those people? They aren't counted as unemployed; they're just gone. This trend has been virtually unabated for the past decade.
According to the CBO, the government posted a budget deficit of $59 billion in October, which was $10 billion more than a year ago. The fiscal 2007 deficit of $163 billion reported last month was the lowest annual figure in five years.
According to the Census Bureau, the U.S. trade deficit in September was $56.5 billion, slightly better than the revised $56.8 billion in August. Our trade deficit with China rose to $23.8 billion.
The Census Bureau reported that privately owned housing starts grew 3% in October, but was still down a better 16.4% from a year ago, to a seasonally adjusted annual rate of 1.22 million units. New building permits were down 6.6% from last month and down 24.5% from last year, which suggests that the outlook for future housing starts remains bleak and continues to worsen.
The Census Bureau reported that on a seasonally adjusted annualized basis, sales of new homes in September rose 4.8% from the prior month, after falling 7.9% in August, but were still down 23.3% from the same period last year, to a projected 770 million units. To give you an idea of the magnitude of this problem, 1,109 million homes were sold just this past December. The estimate of homes for sale is now 523,000, which represents 8.3 months of supply at the current rate of sales. The median sales price of $238,000 is below the 12-month average of $245,300.
The National Association of Realtors reported that on a seasonally adjusted annualized basis, sales of existing homes in July fell 8% from the prior month, and were 19.1% lower than the same period last year, to a projected 5.04 million units. This marked the seventh straight month in which fewer homes were sold than the prior month. The estimate of homes for sale, at 4.49 million, represents a staggering 10.5 months of supply at the current rate of sales. The median sales price fell slightly to $211,700, which remains below the 12-month average of $219,667.
According to RealtyTrac, foreclosures actually fell 8.4% in September, after rising 36% in August. Foreclosure filings are up 99% from a year ago, to 223,548 filings. Nevada, Florida and California had the highest foreclosure rates, while California, Florida and Ohio continued to have the highest absolute number of foreclosures.
The Institute for Supply Management (ISM) index of manufacturing activity was 50.9 in October, down from 52.0 in September, marking the fourth straight month in which the index has decreased. While the experts claim that the economy is still expanding, I see this as another example of a slowing economy.
The Conference Board reported that it's index of Leading Economic Indicators decreased 0.5% in October, leaving this index down since March, again suggesting limited economic growth in the near future.
The Bureau of Economic Analysis announced that the "advance estimate" of GDP growth for the third quarter of 2007 was 3.9%, slightly better than the 3.8% reported in the second quarter. The increase in real GDP in the third quarter reflected positive contributions from personal consumption expenditures (PCE), exports, federal government spending, equipment and software, nonresidential structures, private inventory investment, and state and local government spending that were partly offset by a negative contribution from residential fixed investment. While I'm surprised by the strength of this number, I expect it to be revised downward in the coming months.
The Federal Reserve reported that the amount of outstanding consumer credit increased by 0.15% from the prior month (or 1.75% annualized) in September, to $2,482 billion. This growth has been very steady all year, and is up about 17% in just under three years.
According to the Census Bureau, retail trade and food service sales rose 0.2% in October from the prior month and were up 5.2% from a year ago; not horrible but nothing to write home about.
The Fed increased M-2 by 0.3% in October. The supply of M-2 has increased by 6.7% in the last three months and 6.7% in the last twelve months. According to John Williams on his website "Shadow Government Statistics" (www.shadowstats.com), the increase in M-3, which the Fed no longer publishes, is approaching 16%! If true, and I believe it's probably very close to the truth, then the "true inflation" numbers are much higher than reported, and the crumbling value of the dollar is likely to continue heading lower.

Trends To Watch

It would be impossible to begin a discussion of trends in the stock market without talking about the financial sector. It is the mortgage/credit crisis that appears to be one of the principal reasons for the economic malaise in this country, and the attendant damage to the stock market. Below is a graph of the Financial Spyders Index, which represents 93 financial stocks, the top ten of which represent 47% of the index. You can see that this index, which accounts for almost 18% of the S&P 500, has fallen about 26% over the past six months. While this sector is somewhat oversold, and could be due for a bounce, I believe there is further to fall before we reach a bottom.

The price of West Texas Crude continues to rise and has broken well above the trading range shown below. The price is now bumping up against the $100 per barrel barrier. It is just a matter of time before that level is breached, and there is nothing the pundits and talking heads who give all the reasons why it shouldn't be this high can do about it. That being said, there is no reason why we couldn't have a bit of a retracement or consolidation before the next move higher begins.

Like oil, the price of gold continues to rise regardless of what the critics say. Last month I said that "if the Fed cuts next week, we could see $800 sooner rather than later", which is exactly what happened. Let me know predict that when the Fed cuts the rate again in three weeks, the price of gold will likely be closer to $900 than $800. On an historical note, if the price of gold is over $800 on Friday, it will mark the first time in history that the price of gold exceeded $800 at month-end. Expect even more history to be made before this run is over.

So what is Dr. Copper telling us about the economy? He's telling me that the economy is looking sick. A 23% drop in less than two months is nothing to sneeze at (pardon the pun). I find this very worrisome, although I'm not convinced that the copper is headed significantly lower just yet due to demand from China and the rest of the rapidly developing world.

Like the financials and housing, the action on the dollar is just horrible. In fact, the dollar index is now at its lowest point since the index was created in 1983. I've been saying for years that the future of the dollar looks bleak (thank you Federal Reserve) and I expect it to get even worse as the economy continues to falter. If the Fed cuts rates in December as expected, the dollar index will likely go even lower. Ultimately, this is going to put a big "For Sale" sign on American assets. The latest example is the $7.5 billion investment by Abu Dhabi today in a struggling Citigroup. I'm certain that this is just the tip of the iceberg.

The housing sector continues to suffer with no end in sight. I've been talking about this for so long that there really isn't anything new to say, so let's move along.

How's China doing while the our stock market is suffering? The chart of the Shanghai Index shows us that they're feeling our pain a bit. While we're down 10% from the peak, China is down 20%. I said last month that this "looks like a bubble to me ... and as we all know, bubbles have an unfortunate history of deflating at the worst possible times. So buyer beware." I hope you took that advice.

I'm going to go out on a limb here. I think that before 2008 is over, the Fed Funds rate will be no higher than 3.5%, as opposed to its current 4.5% level. It might even be as low as 3%. The Fed will fight a recession tooth and nail, inflation and the dollar be damned. Last month I said that "either the Fed Funds would fall or the longer maturities would rise. If I had to bet, I'd say the former is more likely." So far, so good with that thought. I still think we're in the midst of an economic slowdown, or even a mild recession, that will continue through at least the first half of next year. But it isn't the end of the world and things will inevitably get better.

Monthly Tip - Protecting Accounts and Assets for your Children

This month I'm reprinting an article written by Michael Markhoff, Esq. and Stanley Bulua, Esq. on how to protect custodial assets for your children. I hope you'll find this to be helpful and informative.

Protecting custodial accounts

A number of clients have accumulated funds in custodian accounts for their children with the intention of using the funds for college. However, in many instances, the parents were able to pay the tuition from current income, leaving a substantial balance in the custodian account.

The funds in the custodian account become property of the child when he or she attains age 21. At this point, the parents have two concerns: first, that the account will be at risk in case the child marries and the marriage ends in divorce, and second, that the child may spend the money frivolously.

Our approach in either case is to have the child transfer his or her custodian account to an irrevocable trust created by the child, with the parents as trustees. The trust’s income and principal will only be paid to the child in the discretion of the parents. Upon the child’s death, the assets are distributed to the child’s children. The important point is that the account cannot be distributed to the child’s spouse.

If the parents decide at some point that the trust is no longer necessary, they can, in their role as trustee, consent to collapse the trust and distribute the assets to the child.

A guardianship proceeding is time-consuming and costly, leaving the minor children in a state of limbo until a final decision is rendered by the governing court. Moreover, without a will, the children will have very limited access to the estate assets while they are minors. More troublesome is that all of the assets will be distributed to the surviving children upon their eighteenth birthdays. Most parents believe that an eighteen-year-old is too young to be completely responsible for his/her own finances. A will can govern how and when the estate assets will be distributed to the surviving children through a trust provision.

The trust's income will be taxed to the child. The trust does not have to file separate income tax returns and does not have to apply for a taxpayer identification number.

Upon the child’s death, the trust will count as an asset of his of her estate for estate tax purposes. No marital deduction will be available in the child’s estate because the trust property cannot pass to the child’s spouse. The trust agreement provides that the trust is to bear its own share of the child’s estate taxes.

The virtue of such a trust is that the child has given up control of the assets to his or her parents. In exchange, the trust helps earmark the assets as “separate property” for equitable distribution purposes and insulates the assets from any divorce proceeding. Since it is frequently awkward for parents to recommend a prenuptial agreement, this is a more palatable alternative. Of course, such a trust will not protect earned income or other assets not in trust from spousal claims. Also, the child now cannot use the custodian account to purchase sports cars or take lavish vacations.

The trust has estate tax consequences at the child’s death and should be drawn with these in mind. We have prepared this type of trust for numerous clients, and both clients and children have been pleased with the result.

Protecting your assets from your children's creditors after you die

Instead of relying on your children to plan for their own protection against potential creditors’ claims, there are techniques which you can employ to prevent creditors from reaching the inheritance you leave to your children.

Rather than leaving your inheritance outright to the child, you should consider leaving the inheritance in the form of “generation-skipping trusts” for your children. These trusts provide income to the children and distributions of principal with the consent of another trustee. When the child dies, the trust will be distributed to grandchildren.

The advantage of the trust is that since the child does not have control of the assets (the trustee has the control), creditors cannot attach the trust principal. As a side benefit, this technique enables you to “dictate from the grave” that your estate will not pass to your son-in-law or daughter-in-law upon your child’s death if that is the desired result.

Michael Markhoff, Esq. and Stanley E. Bulua, Esq. are partners at the White Plains, New York law firm of Danziger & Markhoff LLP. The firm is a business and tax-oriented law firm that has been representing clients for over 45 years. Mr. Markhoff and Mr. Bulua can be reached at 914-948-1556 or by email at mmarkhoff@dmlawyers.com and sbulua@dmlawyers.com. For more information, please visit their website at www.dmlawyers.com.

What I'm Thinking and Doing

Each month I seem to reinforce the notion and importance of patience when it comes to investing. Well, during times when the stock market drops about 10% in six weeks the need for patience becomes paramount. It is just when you panic and begin to sell your holdings indiscriminately that things will oftentimes begin to get better. This doesn't mean that we must stand pat and hold all of our stocks when the market is crumbling. Market conditions sometimes dictate that certain stocks should be sold. But that doesn't mean that you should sell everything, even though almost everything has gone down over he past few weeks. Stick to your discipline and your core holdings until the market clearly tells you otherwise.

So what have I done over the past month? Honestly, not too much. I've sold some of my financial holdings, but otherwise have done very little. I'm basically sitting on the sidelines trying to figure out which way the market is heading. The only buying I've done is to add to core holdings at better prices for new clients. It's likely that I'll allow cash to build up a bit for the next few weeks as we head towards year-end.

Remember, when the risk/reward proposition is no longer in your favor, it's time to sell. If you are managing your own investments, it's also time to start looking at your portfolio and harvest losses to offset any gains taken earlier this year. Don't wait for the Christmas rush.

Personal News and Notes

It's hard to believe that Thanksgiving is behind us already and that Christmas and Hannukah are less than a month away. It never ceases to amaze me how fast time goes by, and it seems to go faster as I get older. Sometimes I look at my children and I can't believe how old they've become in the blink of an eye. And it seems as though they are getting taller each week too. My oldest daughter Nola turns 12 next month and she proudly announces that she has already crested five feet tall. Lily and Ezra don't seem to be too far behind. Amazing.

My incredible concert run ended in Albany with my friend Robert a few weeks ago as we witnesses one of the final US Springsteen shows before he headed off to Europe. It had been about 22 years since Robert and I had last seen Bruce and the boys and it was a very special night. I'll never forget my run of three shows in the span of about five weeks.

That's it for this month. I expect to produce a slightly shorter newsletter in the middle of December (before everyone disappears for the holidays). If you have some ideas for future "Monthly Tips" or even better, if you'd like to be write a Tip, please let me know. I welcome all of your comments and suggestions. As always, I thank you very much for your continued interest and support and I look forward to writing to you again next month.

Best regards,

Greg Werlinich
President