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

Current Market Analysis

I wrote last month that as long as the Dow Industrials remained above 12,000, the bullish trend would likely continue. Indeed, that is just what happened. After getting as low as 12,072, the bull as again picked up steam and is heading towards 12,500 after closing yesterday at 12,421. The Dow has risen an astonishing 1,800 points from trough to peak in the past six months. 

A few things concern me, and with this concern, I'm in the distinct minority right now. After a parabolic rise such as we've had over the second half of this year, there is bound to be a correction sometime. The question is obviously when, and I just don't know. What I do know is that I don't want to be in its way when it happens. Also, the fact that the Dow Transports, pictured next, simply refuse to confirm the rising Industrials. That is very worrisome. What are the Transports telling us about the state of the economy, and the future of the market, that the Industrials are not?

As I mentioned last month, in classic Dow Theory, for a bull market to be confirmed, the Dow Industrials and the Dow Transports should be hitting new highs at the same time. As you can see from the chart below, that is still not the case. In fact, the picture has worsened in the past month as the Transports have now fallen about 470 points below the May high. Something is very wrong here, and the market is likely to tell us what that problem is sooner rather than later.

And what is the bond market telling us? To be honest, I'm not entirely sure. Yields have started to rise in the past couple of weeks as bond prices have sold off a bit. That could indicate rising inflationary fears or concerns about the weakening dollar. It could be money rotating out of bonds into equities. It could be a lack of foreign buyers. Or it could be something else entirely. I don't think anyone really knows for sure. Even with the higher yields, 10 year Treasuries are trading below their moving averages and within the recent trading range. If yields were to break above 4.6%, I would start to worry.

While I continue to be a bit mystified as to the reasons behind the astonishing bullishness in the market right now, I also see no reason for things to change dramatically between now and the end of the year, barring any external shocks. I expect trading volume to subside next week due to the holidays. Barring some kind of disaster, the broad market averages should end the year much higher than last year.

Last Month's Results

As always, I provide the following chart to show the raw results for the month, the quarter-to-date and the year-to-date. While the results in November were not quite as good as those in October, they continued and impressive run of positive results. After eleven months, it appears that all of the broad averages will finish the year with double-digit gains. Assuming that nothing horrible happens in the final two weeks of the year, investors will have a lot to cheer about as they ring in the New Year.

What I'm Doing Now

I have spent the better part of the past month honing my portfolios for year-end. This has meant selling the occasional losing position to either raise some cash or to offset gains taken earlier in the year. I have also added to some existing holdings to make them a more meaningful positions within some portfolios. I also bought a new consumer durable company which is a great company, pays a solid dividend, and appeared to be undervalued. In other words, a solid, conservative stock with excellent growth potential that can prosper in good times and weather the bad times. That is exactly the type of company I like to buy right now.

I tend to err on the conservative side for my clients. I'd rather do nothing and hold onto cash, rather than impulsively chase a quick trend or a trade. I am an investor, not a trader. My long-term view and general patience, in addition to my occasional good ideas, is why my clients pay me to manage their money. My natural conservatism and patient stewardship allows them to sleep at night knowing that their money is in good hands. I'm not looking to make a quick buck; I want to build wealth for my clients that endures for generations.

Statistics To Watch

• The most recent four-week average for initial jobless claims, for the week ended December 16, rose to 326,500, which is only fractionally higher than the average for the year of 312,446.
• According to the Department of Labor, non-farm payroll employment rose 132,000 in November, after October was revised down to a meager 79,000. I am more convinced than ever that these labor numbers are mere guesswork at best, or clear obfuscation at worst. But I'll continue to print them each month as they are reported breathlessly by the press each month. Average hourly wages inched up to $16.94 from $16.91. The average workweek remained flat at 33.9 hours. The number of people holding multiple jobs was also flat at 7.86 million.
• The number of unemployed workers rose to 6.8 million in November. The seasonally adjusted number of people, who for economic or business reasons, could only find part-time work, fell to 4.2 million and the number of marginally attached workers fell to 1.4 million. My Comprehensive Labor Index™ fell to 8.48% while the unemployment rate reported by the government moved up to 4.5%.
• The Conference Board reported that it's index of Leading Economic Indicators increased 0.1% in November after a revised 0.1% gain in October. Increased claims for unemployment insurance and declining housing permits were the biggest negative contributor. The Leading indicator continues to point towards a slowing economy.
• The University of Michigan Consumer Confidence Index dropped back slightly to 92.1 after surging to 93.6 in October.
• According to the CBO, the government posted a budget deficit of $73 billion in November after a $49 billion deficit in October. The good news is that after two months, the deficit is $9 billion less than the same period last year.
• According to the Census Bureau, the U.S. trade deficit in October fell for the second straight month to $58.9 billion from $64.3 billion in September as imports fell again, likely due to the cheaper dollar making imports more expensive.
• The Labor Department reported that on a seasonally adjusted basis, the CPI for urban consumers was flat in November while the "core" CPI, which excludes food and energy, was also flat. Falling gasoline prices, which offset rising housing (rental) costs help keep the CPI down.
• The Federal Reserve reported that the amount of outstanding consumer credit remained essentially unchanged in October at $2.378 billion from a revised $2.379 billion in September. Look for this number to rise in November and December thanks to holiday shopping.
• According to the Census Bureau, retail trade and food service sales rose 1.0% in November, and were up 5.6% from a year ago.
• The Census Bureau reported that after plunging in October, privately owned housing starts in November rose 6.76%, but were still down 25.5% from the same period last year, to a seasonally adjusted annual rate of 1.59 million units. Similarly, building permits were down 3% from October and 31.3% from last year and new construction was also lower.
• The housing numbers don't come out until next week and I won't try to speculate as to what they'll look like. But the anecdotal evidence of a generally weak housing market continues to come in. Late payments on sub-prime loans have soared to their highest level in a decade as lenders relaxed their standards over the past few years.
• In their latest US Foreclosure Market Report, RealtyTrac reported that 120,334 properties nationwide entered some stage of foreclosure during November, a 4.0% increase from October and a 68% increase from a year ago.
• According to the Mortgage Bankers Association in their weekly mortgage applications survey, for the week ended December 15, loan application volume decreased 10.2% from the prior week but was up 13.9% from the same period a year ago.
• The Institute for Supply Management (ISM) index of manufacturing activity declined to 49.5 in November. This ended the streak of 41st consecutive 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. That the ISM fell below 50 should not surprise any observers.
• The Bureau of Economic Analysis announced that the "final" calculation of GDP growth for the third quarter of 2006 is 2.0%, which is lower than the "preliminary estimate" of 2.2% but higher than the "advance estimate" of 1.6%. This is also lower than the 2.6% reported for the second quarter and the 5.6% from the first quarter. My guess is that the fourth quarter will come in around 1.75%. 
• Also according to the BEA, personal savings was estimated to be negative $95 billion in November, or 1.0% of personal disposable income. The percentage of negative savings has ranged between 0.7% and 1.6% so far this year.
• The Fed increased M-2 by 0.5% in November, or a 6% annualized rate. The supply of M-2 has increased by 6.7% in the last three months and 5.1% in the last twelve months as the Fed attempts to stave off the possibility of deflation. The rate of increase in M-2 is growing. I'm sure this increase in the money supply is one of the reasons for the rise in the stock market. The Fed is pumping the market right now. So much for inflation fears.

Trends To Watch

I want to again show you the "Big Picture" of the market by looking at the weekly chart of the Wilshire 5000 covering the past six years. The first thing to notice is that the index has almost returned to its all time high of 14,991, set in early 2000. From a technical standpoint, you should note the almost every time the RSI hits or passes 70, there is a correction and if it gets down to 30 there is always a rally. Similarly, when the MACD rises above +100 the index usually declines, whereas moves below -100 presages a rally. Well, the RSI is now at 70 and the MACD is just below +100 right now; so beware.

The decline in the price of West Texas crude that lasted about three months, followed by another three months of price consolidation, may have ended. It's too soon to say definitively if prices are headed back up, but the the chart shows a clear upward trend. We'll see if that continues, and if it does, what affect it has on the overall stock market.

The price of gold appears to have broken out of its consolidation and is now moving upward, albeit in fits and starts. Interestingly, gold at about $621 per ounce is perched right around both the 50- and 200-day moving averages. Regardless of the short-term moves, I believe the long-term action is going higher. And as I have written over and over, since I consider my investments in gold to be partially "portfolio insurance" or hedges against "what if?", I'm perfectly happy to sit with my positions for the foreseeable future, regardless of the short- or medium-term moves.

I have updated both the short-term and long-term charts of the dollar. In the first chart, you can see that the dollar has rallied recently, concurrent with the rise in interest rates and is no longer oversold. It's hard to see how this bounce will last for too long.

The second chart, which takes a longer view, shows the dollar to still be close to its support level. As I said last month, I believe it would be a very bad thing If the dollar falls below 80. Interest rates would have to rise further to attract foreign investments which could crush the housing market. If the housing market goes, it will likely take the housing market with it.

Speaking of housing, the rally continues much to my surprise. So I guess I must admit that I was dead wrong about this one, at least for now. Time will tell, but I'm still betting that we haven't seen the worst for this sector yet.

Finally, let's look at the inverted yield curve below. The Fed Funds lending rate is still 5.25%. 6-month t-bills yield 5.07% (down from 5.12% last month), 2-year Treasury yields have moved up to 4.72%, 10-year Treasury yields are up to 4.62% and 30-year Treasury yields are up to 4.76%. So while the inversion remains, it has tightened just a bit. It won't be long before we see if my prediction for a slowdown or recession in the first quarter of next year comes true.

Personal News and Notes

Well, this about wraps up 2006. Please forgive me if there are any typos this month. I'm rushing to finish so I can go home to celebrate the last night of Hanukkah with my wonderful girlfriend and three terrific children. I would also be remiss if I didn't offer a very Happy Birthday to my daughter Nola, who turned 11 two days ago.

It has been a great year for me and for Werlinich Asset Management. Our business is growing and we are now working with about 40 clients and we have over $55 million of client and family assets under management. That's a far cry from 10 years ago when I started this business from scratch. I invite you to contact me in 2007 to see how I may be able to help you and your family develop, implement and monitor an investment plan that will help you achieve your financial goals.

Greg Werlinich
President

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