Current Market Analysis

Happy Thanksgiving to all of my readers!! It's hard to believe this year is already coming to a close, and it can't do so fast enough for me as it's been a very difficult year on so many levels. In my 20 years in this business I can't remember another year with such month-to-month, or even day-to-day, volatility in the stock market. I don't think we've ever had such strong links between international markets so that local political, economic or even meteorological events ripple to every corner of the globe with lightning speed. This means that world markets are increasingly correlated (meaning that they go up or down together), making it very difficult for investors to find an edge.

It has only been six weeks since the recent low was made on October 3. Time will tell if that was indeed "The Bottom", but at least for now, it appears to be an interim bottom that has held up well. Last month I mentioned that in the near term I was guardedly optimistic and for the most part, I remain so. Longer term I am very concerned about the global debt situation. But I'll cover that in greater depth in the coming months.

So what do we see when we look at a chart of the Dow Jones Industrial Average? The Dow had a great run the month of October, breaking through resistance before closing well above 12,200. Unfortunately, the good times didn't last too long and the index has sold off a bit, down to support at around 11,750. If that doesn't hold, 11,500 or so would be the next support. If it can rally from here, clearly 12,284 would be the next resistance level. Some good news on the debt front here in the US or in Italy could be all the push we need.

The chart of the transportation average looks very similar to the industrial average. Last month I wrote that "it will be very important for the transports 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." Well, that's exactly what happened. And now, like the Industrial average, the index has backed off a bit and is consolidating above support at 4,800. A move above 5,000 in conjunction with the Industrials moving above 12,280 would be very constructive.

Last month I introduced a chart of the Dow Jones Utility average to demonstrate a major bull market in the utility sector. Very quietly, and with almost no coverage in the media, utilities traded up to multi-year highs 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. Yet they've backed off a bit in the past few days, but still remain just above the 50-day moving average. This is a great sector for income-loving investors.

As long as the Federal Reserve continues its war on high interest rates, and investors continue to show a willingness to accept zero or near zero yields to escape the risk of equities, Treasury yields will remain artificially low for an extended period of time. 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 in October, investors sold bonds, helping to drive the yield up to about 2.2%. As equities fell in November, bond yields again moved lower, back to around 2.0%. I'm sticking with my prediction that yields will generally remain between 2%-3% through at least the end of 2012 before slowly rising, as market forces dictate they eventually must. There is a limit to how long the Fed will be able to keep expanding their balance sheet before they're forced to stop buying treasury and agency bonds. At that point, rates will move higher. But for now, don't fight the Fed.

Last Month's Results

• According to the Department of Labor, the figure for seasonally-adjusted initial jobless claims for the week ended November 12 was 388,000, a decrease of 5,000 from the prior week's revised figure. The four-week average of 396,750 continued the overall trend of moving lower. About 3.6 million people continue to collect unemployment insurance, again, slightly lower than the prior month.
• Non-farm payroll employment increased by a somewhat disappointing 80,000 in October. Chances are this number will be revised higher in subsequent months. Over the past twelve months, job increases have averaged about 125,000 per month, which is the minimum needed to keep up with the growth in population. The largest gains occurred in business and professional services, leisure and hospitality and health care, while the government continued to pare jobs. Almost 100,000 jobs were added in the prior two months thanks to upward revisions to the August and September figures. The total number of workers counted as unemployed dipped to 13.9 million helping to move the unemployment rate down to 9.0%. The more comprehensive U-6 rate, which was 16.7% in June, moved down to 15.3%.
• A slightly lower 5.9 million people continued to be unemployed longer than 27 weeks. The seasonally adjusted number of people who could only find part-time work fell to 8.9 million and the number of marginally attached workers held at 2.6 million. The number of people holding multiple jobs held at 6.99 million. The average hourly wages for blue collar workers inched up to $19.53 while the average work week moved to 33.7 hours. So overall, this report showed decent improvement, but wages and hour worked remain stagnant and 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 $1.3 trillion for the full fiscal year of 2011, which is roughly the same as the record levels from a year ago. To kick off fiscal 2012, the Treasury reported a deficit of $95 billion, which was $46 billion less than last year. This improvement was largely the result of higher tax receipts.
• The Census Bureau reported that the U.S. had a trade deficit in goods and services of $43.1 billion in September, down from the revised lower figure in August, as exports grew faster than imports.
• The Census Bureau reported that privately owned housing starts remained flat in October, after increasing by a revised lower 7.7% in September, but was 16.5% higher than a year ago, to a seasonally adjusted annual rate of 628,000 units. The monthly results continue to fluctuate wildly from month to month, so a reliable trend is not yet in evidence. New building permits were up 10.9% from the prior month and 17.7% from last year. Like starts, the number of permits are fluctuating wildly from month to month, so no discernable trend is yet in evidence.
• The National Association of Homebuilders/Wells Fargo Confidence Index in October rose to 20 from 17 in September, marking the highest level since May 2010. While these are still very low numbers, we now have two months of solid increases; let's hope this continues for the rest of the year.
• The Census Bureau reported that on a seasonally adjusted annualized basis, sales of new homes in September rose 5.7%, breaking a streak of four straight months of lower sales. But at 313,000 units, sales were actually 0.9% lower than the depressed level of a year ago. The estimate of homes for sale was only 163,000, which represents 6.2 months at the current rate of sales. The median sales price of $204,400, was the lowest level in more than a year, and well below the 12-month moving average price of $223,217. While the rising number of home sales is good news, and probably due in part to the better weather, the falling average sales price continues to be worrisome.
• 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 fifth consecutive month in August, increasing very 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 except to note that this is a very lagging number.
• 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 50.8 in October. This marked the twenty-seventh consecutive month of expansion in the manufacturing sector, but was also the fourth straight month of being dangerously close to the magic number of 50, below which indicates a contraction. The ISM index of non-manufacturing activity was 52.9. This marked growth in the service sector for twenty-two consecutive months. These numbers demonstrate that while business is still growing, with service leading the way, 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 "advance" estimate of GDP growth in Q3 was 2.5%. This is an improvement on weak Q2 GDP growth of 1.3% and the putrid Q1 GDP growth of 0.4%. This compares with 2.3% in Q4, 2.5% in Q3, 3.8% in Q2 and 3.9% in Q1 of 2010. The evidence would suggest that while (at least for now) we have avoided the "double-dip recession", the economy continues to sputter.
• The Federal Reserve reported that in September 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, which seems to be helping retail sales a bit.
• According to the Census Bureau, retail trade and food service sales were up 0.5% in October, and were 7.2% higher than a year ago. This marks the second straight months of solid gains in retail sales. Electronics and appliances, followed by sporting goods and building materials led the way.
• The Federal Reserve reported that in October the supply of M-2 (a broader view of money) continued to explode higher, up a stunning 14.5% over the prior six months. The supply of M-1 (the most narrow definition of money), on the other hand, rose a whopping 26.6% over the same six months. Where is all this money going, other than to the reserves at your local bank or sitting on the balance sheet of the Fed? It seems clear to me that this subtle, and dangerous policy of monetary expansion is doing little good to the economy but will likely do much greater harm in the future.
• After rising slightly in September, the Conference Board's Consumer Confidence Index dropped again in October, falling from 46.4 to 39.8. This is the lowest number since the recession of March 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, 88 banks had failed through November 15, compared with 149 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

The value of the dollar is one of the most important factors determining the direction of our stock market today. If the dollar goes up, the market goes down, and vice versa. If you superimposed this chart on top of the Dow Industrials, you'd see they are almost mirror images. While that makes for an interesting academic study it makes for a difficult investing environment because of that dreaded correlation. Almost all sectors trade down when the dollar rises. And again, this is not a statement about the absolute health of the greenback, but rather a comment on the relatively dismal status of many other currencies, especially the Euro. So, again for now, it's better to own dollars.

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, nor did it send the price of gold below its 200-day average. Last month I wrote that "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." While the price hasn't yet hit $2,000/oz, there has been a very nice rebound in the price, bringing solid profits to anyone who bought some gold subsequent to my suggestion.

Similar to the moves in gold, after the big September selloff, the price of silver has recovered some of the losses. Last month I wrote that "at around $30 silver looks to be an excellent buy." I still feel this way, In fact, I think that, on a percentage basis, silver will likely outperform gold over the next 12 months.  

Unlike the price of gold and silver, the price of copper greatly concerns me, although the recent action offers some relief. The almost unrelentingly downward action on the price of copper as certainly confirmed the weak global economy this year. Could it be that Dr. Copper now forecasts a bit of recovery, or is this just a Dead Cat Bounce? We'll now in another month or so.

This price of West Texas Crude has exploded higher over the past month, rising back above $100/barrel earlier this week before settling at $97.50 today. That's quite a rally from $75 at the end of October. Longtime readers know I've been an oil bull for over a decade, and I'm not changing my opinion now. Last month I wrote that "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 with prices at this level." I certainly didn't expect a rally so soon, but my clients and I will be happy to profit from it, although I do expect the price to fall and consolidate a bit before rising any further.

I've written about my bearishness on the financial sector every month since early 2008 so I'll spare you any further discussions this month. What I want to point out is the strong rally in October which seems to have evaporated in November almost as quickly as it began. After briefly rising into its old trading range, the index is trading back below the key support/resistance at 13. It's hard to imagine any substantial and prolonged gains in the banking sector until the world solves its various debt crises and the US fixes its housing mess. Good luck with that.

I have been equally bearish on the housing sector since 2007, so I wasn't surprised that the price of the index fell steadily before inevitably breaking below major support around 86. What is surprising is how powerful the rally has been over the past six weeks without any tangible progress in the housing market. Is the index forecasting the recovery that hasn't happened yet, or is this simply a false rally that is doomed to quickly fail? We'll know more in a couple of months.

The equity markets of the developed international countries have, not surprisingly, taken a beating. The good news is that support held around 46 and the index is today trading right around the 50-day moving average. It's still an ugly chart, but it could have been worse. Like many other charts, just consolidating for a bit, without weakening further, would be very constructive. A prolonged rally above $54, which looks to be the next level of resistance, would be bullish. But it's hard to imagine any sustained rally until the ECU is on more stable footing.

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. Over the past couple of months the index dropped well below its moving averages and a two-year old support level. Then last month it brushed against major support just north of 2,300 before rebounding a bit and moving about the 50-day moving average. It is VERY important for the Chinese stock market to stabilize and recover as that will indicate a resumption of their economic growth.

Three 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. Two months ago I said that "the index remains below the "normal" sentiment range, suggesting that the rally could have some legs." After a brief downturn, that too proved correct as the stock market, and sentiment, all moved higher and back to a more normal range. Last month I admitted to being "cautiously bullish". This month, I want to remain so but the morons in Washington are doing everything in their limited power to screw things up, which is about all they're good for these days, so my optimism is tempered.  

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. The extreme bearishness of late summer suggested the strong rally that followed. Now after a few good months, the chart is rolling over and indicating a bit of a pullback. Hopefully this will be a brief downturn followed by a solid year-end rally. 

Finally we have the "Fear Index". This year we had spikes in the VIX due to the tsunami in Japan, the initial Greek debt crisis, then the fears about the collapse of the EU then finally the Italian debt crisis. Now are facing renewed volatility thanks to the aforementioned morons in Washington. If they don't get a debt deal done to reduce the deficit by $1.4 trillion then we could see another downgrade of US sovereign debt, at which point the VIX could spike over 40. That would not be good for the stock market, which prefers the VIX to be below 30. Is anybody in Washington paying any attention at all? And if so, do they even care? 

What I'm Thinking and Doing

The global economic malaise and political uncertainty continues to make for a very difficult and unsettled investment landscape. While it appears that (at least temporarily) the European Currency Union is not going to blow up and the United States is not going to fall back into the dreaded double-dip recession, it hardly means "all clear ahead". As to the latter, I said last month that I don't think we're headed for a full-scale recession, but rather that we're going to slog through a period of below-average growth. I think this will likely be the case at least through the election next year. As to the former, it appears that the crisis in Greece has found an interim solution and Italy is headed for the same as both countries have new leaders that seem to embrace the austerity that is their future. This is not to say that the problems have been solved. Rather, they've just been forestalled a bit. The days of reckoning, for Europe and the United States, are still in front of us. And if the world leaders don't pull their collected heads out of their collected rear ends, we all face devastating consequences to horrible to even contemplate. The "leaders" of the United States in particular seem to be truly deaf, dumb and blind. The image of Nero fiddling while Rome burns comes to mind. Let's hope that they can do what is needed to help this country avert Rome's fate.

I'm going to repeat something that I wrote last month because it's really important for every investor to understand, especially during these times of extraordinary volatility and periods of fear and uncertainty. The best time to buy stocks 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. If you have questions or doubts, make sure to talk about it with your financial advisor.

Over the past few weeks I have begun the process of tweaking for portfolios to prepare for year-end. This has included matching gains and losses where possible in taxable accounts to minimize taxes. It also means paring some under-performing securities in favor of some stronger holdings. I hope to substantially complete this process for all clients before Thanksgiving so as to avoid the Christmas rush of tax-loss sellers.

Professional News and Notes

I finally got around to posting the audio files of five of my six radio appearances from the summer (one was lost). I recommend you listen to them as I covered a lot of good information each week. You'll find them all in the "WAM in the Media" section of my website - or you can simply click here. You'll also find a couple of new articles from the Structured Products News in which I was quoted.

If it's the end of November, that means that it time for my annual compliance review. Fun times! My excellent compliance consultant will be spending the day with me on Monday to ensure that I continue to do all the right things the right way as I uphold the highest fiduciary standard. Every penny I spend with him is money well spent.

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 265 followers, up from 250 just last month. My goal is to surpass 300 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
President

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