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

November 26, 2008

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

Current Market Analysis

You would think (hope?) that after a horrific stock market in October, that things would improve a bit in November. Well, unfortunately, that simply has not come to pass. The major market averages are down another 10% or so with only two trading days left in the month. As I begin writing this letter about a half an hour before the market is due to open, early indications are that it will be a poor opening, which will drive the averages down even further. And what is the over-riding reason for all of this negative action? "It's the economy, stupid!" The economy is in a tailspin with no relief in sight. Almost every indicator suggests a deepening and lengthening recession. Oh yeah, the government is finally copping to the fact that we are indeed in a recession because they simply could no longer hide behind their bogus statistics. I'm sorry if this newsletter is going to be a downer, but I try to be honest with my readers, and there is not a lot of good news right now. It's time to hunker down, eliminate debts, save as much as possible and try to ride out the storm. So, let's look at some charts and see what's going on in the stock market right now.

In prior newsletters, I asked whether "the low" had been made? I admit that I didn't know the answer to that question, but suggested that there were two important numbers to keep your eye on: 10,962 and 10,750. The former was the low set by the Dow Jones Industrial Average on July 15. The latter was roughly the midpoint of the low set in July 2006 and the high set in October 2007. I speculated that "should the Dow break below both of these support levels, the resulting crash could get very ugly". Well, the crash has been ugly and fast, dragging the Dow down almost 2,500 points in less than two months. So again we're left to ask, "has the low been made?" Again I don't know, but the next two numbers to keep your eyes on are Dow 7,470 and 7,286. The former is the half-way point between the low in 1982 and the high of 2007 and the latter is the low set in October 2002. If these support levels are broken, we could be headed to unprecedented low levels. The recent closing lows were made on November 20, with the Industrials at 7,552.29, the Transports at 2,988.99 and the S&P at 752.44. Interestingly, 101 of the 500 stocks in the S&P 500 were below $10 per share, which has never happened before, and 186 of them were below $4 billion in market capitalization. These are indeed scary times.

There is one small silver lining I can report, thanks again to Richard Russell of the Dow Theory Letters. On October 10, when the Industrial average closed at 8,451, 2,901 of the 3,130 stocks traded on the New York Stock Exchange hit a new low price. That means that an amazing 92.6% of all stocks traded on the NYSE that day fell to a new 52-week low. Even though the market has fallen further since that day, the number of new lows has not again reached that level. So maybe there is a little hope yet.

I'm now going to show you the daily, weekly and monthly charts of the Dow Jones Industrial Average in order to give you three different perspectives. The daily chart clearly shows that the decline has broken through every prior support level and has fallen very close to the 50% level of 7,470 that I mentioned above. It is very important that the Industrials remain above that level. After that, 7,286 is the final line of defense.

On the weekly chart we can clearly see how the panic selling that started in September has brought us perilously close to our next major support level. It would be very beneficial for the Industrials to remain over 8,000 and form a solid base.

Finally, we'll look at the monthly chart shows how the Industrials have broken below a long-term trend-line, as represented by the blue line. That's bad. The market is also down about 40% right now, which as also bad. The good news is that the Dow has rallied a bit to close higher for three days in a row, the first time this has happened since August. This suggests that we may have a little rally off an over-sold position. This could provide a small measure of relief.

The Transportation average basically mirrors the negative action of the Industrials. Indeed, on November 20, both averages sunk to new lows, confirming the bear market trend. There would need to be a reversal above 4,000 to offer a glimmer of hope of a sustained rally.

The monthly chart of the S&P offers some perspective. We have an almost mirror image of two huge bull rallies and bear declines over the past decade or so, with a key support level around 775. That's a key number because there is really no clear support below it. And again, we could be set up for a small rally.

Has the year-long trading range of the 10-year Treasury been broken? After holding all year between 3.3% and 4.3%, the yield slumped yesterday to a low of 3.1%. The bond market is telling us that inflation, at least for now, is dead, and deflation is the current worry. That same concern is registered in commodity prices, as we'll see later in this newsletter. This is not good.

Last month I introduced the chart of the 1-month T-bill. Since the credit crisis began in earnest in September, investors have been willing to buy T-bills even though they paid virtually no return. Two days ago, the yield on the T-bill was 0.01%. This is clearly a crisis of confidence that won't be abated until yields have risen to at least 1.5%.

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. Only a horrendous month like October could make a terrible month like September look good by comparison. Last month was historically bad, and there was almost no place to hide. And as awful as it was here in the U.S., it was worse for most of the rest of the world. And unfortunately, market returns have continued to be poor in November. 

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

Statistics To Watch

  • According to the Department of Labor, the most recent four-week average for seasonally-adjusted initial jobless claims, for the week ended November 22, was 518,000, much higher than the 336,000 reported a year ago.
  • Non-farm payroll employment fell by 240,000 in October. The August job losses were revised from 73,000 to 127,000 and September was revised from 127,000 to a staggering 284,000. You can expect that the October figures will likely be revised to more than 300,000 job losses. This brings the number of jobs lost, as currently reported, to more than 1 million so far this year. Average hourly wages grew a bit to $18.21, and the average workweek held steady at 33.6 hours.
  • The number of workers reported in October as unemployed rose to 10.1 million, bringing the unemployment rate to 6.5%. It is estimated that the unemployment rate will rise above 8% next year. We started the year with 7.7 million people out of work and an unemployment rate of 5.0%. The seasonally adjusted number of people who could only find part-time work rose to 6.7 million and the number of marginally attached workers remained at 1.6 million. The number of people holding multiple jobs increased to 7.82 million. My Comprehensive Labor Index™ rose to 13.44%, the highest level since the end of 2005. My CLI™ is much closer to the true unemployment number in this country.
  • According to the CBO, the government posted a deficit of $455 billion for 2008 fiscal year ended in September. Relative to the size of the economy, the 2008 deficit was equal to 3.2 percent of gross domestic product, compared with a deficit of 1.2 percent in 2007 and an average deficit of 2.6 percent over the 2002-2006 period. It is anticipated that the deficit will be at least $1 trillion in 2009, but could easily be as large as $2 trillion. As proof, the government will now report two deficit numbers: adjusted and cash. The adjusted October deficit was estimated to be $134 billion while the cash-basis deficit was estimated to be $232 billion, thanks the TARP payments.
  • According to the Census Bureau, the U.S. trade deficit in September was $56.5 billion, down slightly from $59.1 billion in August. The stronger dollar hurts exports, but the weaker economy hurts imports more, thereby reducing the trade deficit a bit.
  • The Census Bureau reported that privately owned housing starts dropped 4.5% in October, following an 3.0% decline in September, and was down 38.0% from a year ago, to a seasonally adjusted annual rate of 791,000 units. New building permits were also down 12.0% from last month and 40.1% from last year. While these are terrible numbers, the declines are needed in order to help clear out excess housing inventory.
  • In September, the National Association of Homebuilders/Wells Fargo Confidence Index fell to a record low of 9, down from the old low of 14 the month before. This index was created in 1985. Look for the homebuilders to start lobbying Congress for a bailout.
  • The Census Bureau reported that on a seasonally adjusted annualized basis, sales of new homes in October fell 5.3% from the prior month and 40.1% from the same period last year, to a projected 433,000 units. That is by far the lowest figure in the almost five years I've been tracking new home sales. The estimate of homes for sale is now 381,000, which represents a whopping 11.1 months of supply at the current rate of sales. The median sales price fell to $218,000 and is below the steadily falling 12-month moving average price of $232,367.
  • The National Association of Realtors reported that on a seasonally adjusted annualized basis, sales of existing homes in October fell 3.1% from the prior month, and were down 1.6% from the same period last year, to a projected 4.98 million units. The estimate of homes for sale, at 4.234 million, represents 10.2 months of supply at the current rate of sales. The median sales price fell precipitously to $183,300, which remains below the steadily falling 12-month average of $186,733. It is obvious that prices are falling, and must continue to fall, to move the inventory of existing homes for sale. It's safe to assume that many of these are foreclosed properties.
  • The S&P/Case-Shiller Home Price Index, which uses a three-month moving average to track the value of home prices across the US, fell to 173.25 in September, it's lowest point since April 2004.
  • According to RealtyTrac, foreclosures increased by 5.1% in October to 279,561, and were 25% higher than a year ago. The good news is that these numbers remained below the high levels set in August. Nevada, Arizona and Florida, respectively, reported the highest foreclosure rates in the country. Many states, like California, recently signed legislation intending to limit new foreclosures.
  • The Institute for Supply Management (ISM) index of manufacturing activity plunged to 38.9 in October, following a weak 43.5 in September. This is the worst level since 1982. Any number below 40 suggests a serious recession. The ISM index of non-manufacturing activity was 44.2, down from 50.2. There is just no way to sugar-coat these terrible numbers.
  • The Conference Board reported that in October it's index of Leading Economic Indicators declined 0.8%, marking a decline in six of the last seven months. It would have been even worse if not for the large increase in the money supply. The six-month rate of decline is -2.4% as the economy gets weaker, and the outlook is no better.
  • According to the Bureau of Economic Analysis, the "preliminary" estimate of GDP growth in the third quarter was -0.5%, down from the estimate of 2.8% GDP growth in the second quarter and 0.9% in the first quarter. The second quarter "growth" was surely an illusion. If GDP was calculated today in the same way as twenty years ago, GDP growth would clearly be negative. I'm convinced we've been in a recession since the fourth quarter of last year.
  • The Federal Reserve reported that in September the amount of outstanding consumer credit increased by 0.3% from the prior month, to $2,588 billion. In August, there was actually a decline of 0.2%. That had been the first time I had ever seen the amount of outstanding consumer credit go down from one month to the next. A general reduction in consumer credit is very bad for the retail sector, and the economy as a whole.
  • According to the Census Bureau, retail trade and food service sales fell 2.8% in October, following a 1.2% decline in September, and was 4.1% worse than a year ago. These horrible retail numbers are no surprise and are getting worse each month. It doesn't bode well for the holiday season.
  • The Fed is again ramping up the supply of money. The amount of M-2 has increased by 10.4% in the last three months. But the headline here is that they've increased the supply of M-1 (which is basically the sum of currency, traveler's checks and demand accounts at banks - the narrowest definition of money) by a staggering 19.9%. The Fed is desperately trying to re-liquefy this economy and avoid the horrors of deflation.
  • The Conference Board Consumer Confidence Index plunged in October to an all-time low of 38.8. It managed to rise a bit in November to 44.9 as the October panic wanes a bit. Still, there is little confidence in this economy.

Trends To Watch

We have lots of trends to look at this month. As usual, let's start with the financials. Another month, another rescue as Citigroup received a federal helping hand on Monday. That bailout provided some bounce to the XLF this week, taking the index off the bottom. I still expect more failures, mergers and bailouts as the economy continues to worsen. One can trade this sector, but I wouldn't look to be a long-term investor just yet.

Housing, like the financials, remain a mess. I have been consistently bearish on housing, and I believe that things will continue to get worse before they get better. The housing sector remains the epicenter of the entire financial/economic crisis and has a long way to go before heading up in any meaningful way.

The precipitous decline in the price of oil certainly took me by surprise. I never thought that we would see $50 per barrel again. Last month, with oil at around $70, I said that "anything can happen in the short-term. Long-term, meaning over the next few years, I'm convinced oil will again move higher." Well, what happened was the price dropped through two more support levels to about $48 before moving back over $50. There is speculation that the price could fall back into the $30's. I suppose anything is possible right now, but I am very confident that the price of oil will be higher one year from now.

Gold seems to once again be moving up, as I have been expecting. I think that the price of gold could again, with some fits and starts of course, head north of $900 per ounce on its way to test that $1,000 level. Remember, I don't recommend that you trade gold. It's better to establish a position and simply sit with it. Part of why we own gold is for "portfolio insurance". And part is to protect us against rampant inflation and the debasement of our currency. If I'm wrong about the general upward trend of gold, it will likely mean the stock market is headed much higher, and we would be more than compensated for our "losses" in our gold positions by higher equity prices. So if you own gold, just sit tight. If you don't, consider buying during times of weakness.

The movement in the price of silver is similar to the action in gold, and I expect the price of silver to rise along with gold over the next few years.

The price of copper, which is often thought of as a proxy for the economy, continues to spiral down. It has now fallen over 60% in the past four months and, in the short-term, could drop further still. Longer-term, as the world attempts to fix, or build its infrastructure, the price of copper will inevitably recover.

This might be the most frightening chart of all, and the greatest example of the world-wide recession. The Baltic Dry Index measures the demand for shipping capacity versus the supply of dry bulk carriers and indirectly measures global supply and demand for the commodities shipped aboard dry bulk carriers, such as cement, coal, iron ore and grain. Because dry bulk primarily consists of materials that function as raw material inputs to the production of intermediate or finished goods, the index is also seen as a good indicator of future economic growth and production. As such, it appears that the prospects for future economic growth look dim indeed as the index has fallen more than 90%. I would though expect at least a short-term bump because this index is massively oversold. Longer-term, I would expect a tremendous recovery here as the price of hard assets inevitably go back up. This is not the end of global commerce.

The dollar index has surged over 21% in the past seven months as the world continues to view the dollar as the safest port in the global economic storm. In addition, our falling trade deficit puts fewer dollars in foreign hands, thereby increasing the relative value of those fewer dollars. I suppose it could move even higher before the inevitable day of reckoning. And when that day comes, and the debts created during this economic crisis come due, the dollar will fall, and fall hard. So now's the time to take that overseas vacation that was too expensive last year.

The next chart puts he action of the dollar into better perspective. The recent rally has only served to bring the dollar index close to the middle of a 20-year trading range. Notice that both the relative strength and the MACD show the index moving close to overbought levels, which would suggest some price weakness coming up.

Foreign markets, as represented by the MSCI EAFE index, continue to be even worse than our markets and are down more than 50% for the year. There really has been no place to hide during this crisis.

Finally, I want to show you one new chart: the volatility index, or VIX. According to Investopedia, "the VIX is constructed using the implied volatilities of a wide range of S&P 500 index options. The VIX is a widely used measure of market risk and is often referred to as the "investor fear gauge". VIX values greater than 30 are generally associated with a large amount of volatility as a result of investor fear or uncertainty, while values below 20 generally correspond to less stressful, even complacent, times in the markets." VIX levels have been over 50 since October, with spikes into the 80's. Until the VIX returns to more normal levels we can expect the market to remain highly volatile. 

What I'm Thinking and Doing

These continue to be the most difficult market conditions that I've experienced in my 15+ years in this business. Many market observers have suggested that this is the worst financial/economic crisis in this country in more than 60 years. What started as a housing bubble has morphed into a worldwide financial crisis that has in turn precipitated a global recession that has threatened the very fabric of our banking system. Banks won't lend to each other, much less other businesses or consumers. Home sales and prices are plummeting. Consumer spending has contracted for the first time since 1991. Unemployment is rising at a frightening rate as the country will have lost close to 2 million jobs in 2008 when the final numbers are tallied. The stock market has spiraled lower. The government has had to step in and nationalize part of our financial system. The domestic auto industry is on death's doorstep. The housing sector is lining up behind the automakers for a handout. One out of five houses in the US is currently worth less than the value of the mortgage on the house.

Leaning into the face of the economic storm stands Federal Reserve Chairman Bernanke, Treasury Secretary Paulson, FDIC Chairman Sheila Bair and the rest of the current administration. The government is literally doing everything it can, including assuming powers it has never before wielded, to try to stave off the possibility of a deep and prolonged recession, or worse yet, a depression. Only time will tell how successful their efforts will be, but it is very difficult, if not impossible, to forestall the overall trend of the economy and the stock market. And if you are able to temporarily alter its course, chances are you are just delaying the inevitable. One could posit that the problems we're currently experiencing are the natural result of the actions taken by the Fed and the government to minimize the effects of the Tech Bubble Crash in 2000-2002. Had that been allowed to play out to its inevitable conclusion without all of the monetary stimulus of 1% interest rates, many of the problems we are currently dealing with may not have occurred.

So what do investors do now? Anyone with less than a two- or three-year time horizon should be in cash or short-term treasuries. For those with a longer horizon, you should continue to fund your 401k's and IRA's. Sometime in the next few months, and we may already be there, we will have one of those once in a lifetime buying opportunities that creates massive wealth. But in order to earn those riches you have to be willing to be invested during very scary times. I believe the recession is going to last longer than I originally expected. This will mean further volatility in the market, which means further declines. This does not though mean that one should not invest. It just means that you have to invest selectively, and be willing to cut losses more quickly than usual. That being said, I would avoid investing in much of the broad market right now, especially consumer discretionary and anything heavily dependent on global economic growth. It is imperative to have a well-thought out investment strategy, a lot of patience, and the fortitude to stick with your plan. If not, find an advisor to help you. In addition, you should also minimize or eliminate your debt, cut back on discretionary spending and save as much as you can. That is the best advice I can give you.

This past month we made a successful arbitrage trade that netted us a 20% return in about three weeks. We took advantage of the fear in the market to buy a great company that was being taken over for cash at a price far below that takeover value. When the deal closed, we earned our excellent return. Most recently, we took a large stake in a turnaround story that offers us the potential to double our money, or better, in a fairly short period of time. It is not a risk-less trade, but it's one where the risk/reward is in our favor. These two trades notwithstanding, I have raised a lot of cash and remain content to sit with that cash until we can identify a good time to jump back into the overall market.

Personal News and Notes

It's hard to believe that this year is almost over. Tomorrow is Thanksgiving. After we finish digesting that bountiful feast we have to start preparing for Christmas and Hanukkah. Then it will be 2009! And as far as the stock market is concerned, that can't happen soon enough.

Next month my oldest daughter Nola turns 13 and officially becomes a teenager. She's already sleeping longer and more concerned with fashion than ever before, so I'm preparing myself. In January she becomes a Bat-Mitzvah. So we have a lot to look forward to over the next two months.

There isn't much else to say this month. Therefore I'll end this letter as I usually do, by thanking you, my readers and reminding you that this newsletter is for you. If you have any thoughts or suggestions on how to make it even 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. I look forward to writing to you again next month.

Best regards,

Greg Werlinich

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