Werlinich Asset Management, LLC
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Email: greg
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December 13, 2010

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

The "Santa Claus Rally" started early this year. Barring an unlikely downturn in the final two weeks of the year, there won't be coal in the stockings of any investors other than the short-sellers. 2010 will end up being a solid, if unspectacular year, following a very good year last year. And I believe we are setting up for another good year in 2011.

As I write this on Monday afternoon, the Dow Jones Industrial Average is trading at a new high above 11,460. There is  a lot of optimism in the market. Which means, of course, that we are set up for one of those rally-killing corrections. And while it certainly will happen at some point, as corrections always happen, I don't think it will happen in the next two weeks. Right now, other than too much exuberance, all the technical indicators are positive.

The daily chart of the Industrial Average right now is very bullish. After breaking above the May high in early November, and returning to the level set before the collapse of Lehman Brothers in October '08, the market experienced a quick 3% correction. Just as quickly, we've again approached those early November high levels. The next resistance level should come in just north of 11,700. Just because I like round numbers, I'd love to close the year above 11,500.

Like the Industrial average, the Transportation average has broken to new highs, confirming an interim bull signal according to Dow Theory. The index is also trading above both moving averages and the 50-day is higher than the 200-day average. All of this is bullish. The next resistance level come in just below 5,300.

From May '09 to June '10 the yield on the 10-year treasury traded between 3% and 4%. Each attempt to break above or below the range failed. Then as the market turned negative in the second quarter, and investors fled stocks for Treasuries, the yield started to fall, culminating with an unbelievably low yield of around 2.4% for most of the third quarter. Since then, the tide has turned, sending equities higher and bond prices lower. Over the past couple of months I suggested that yields would "continue to rise back towards 3%." In the past two months, the yield on the 10-year Treasury has spiked from 2.3% to 3.3%. Who said investing in bonds was not risky?

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, not including dividends. As you can see by the results below, the broad market averages suffered a minor pullback, thanks mostly to problems in the Euro Zone, after a strong rally in September and October. What has not gotten much press is that small-cap stocks have been, by far, the best performers so far this year. I must admit, I kind of missed this too. Not surprisingly, the European index suffered the worst losses in the month. Even bonds took a minor hit last month. As I've been writing, stocks continue to outperform bonds in the second half of the year.

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

Barclays Aggregate




US government bonds

Barclays High Yield




High-yield corporate bonds

Statistics To Watch

  • According to the Department of Labor, the figure for seasonally-adjusted initial jobless claims for the week ended December 4 was 421,000, a decrease of 17,000 from the prior week's revised figure. The four-week average down to 427,500, the lowest figure since August 2008. The actual, unadjusted, initial claims were much higher, at 582,000, an increase of a huge 169,085 from the prior week. I'm not sure how to interpret that massive difference. But the general trend in seasonally-adjusted claims shows some real, if modest, improvement in the job market right now. Let's see if this trend can continue through the remainder of the year.
  • Non-farm payroll employment increased by a meager 39,000 in November, while another 38,000 were reported as added through upward revisions to September and October. Gains in private sector jobs were offset by losses in government positions as federal, state and local governments continue to trim their workforces. Average hourly wages for blue collar workers were up to $19.19, and the average work week inched down to 33.5 hours. This picture continues to be muddied.
  • In November, the total number of workers counted as unemployed rose to 15.1 million. The unemployment rate increased to 9.8%. It is virtually guaranteed that the reported unemployment rate will rise back above 10% in the coming months as more people look for work as their unemployment benefits expire. The more comprehensive U-6 rate jumped from 15.9% to 16.4%. 6.3 million people continued to be unemployed longer than 27 weeks. The seasonally adjusted number of people who could only find part-time work dropped to 9.0 million and the number of marginally attached workers dropped to 2.5 million. The number of people holding multiple jobs held at 6.8 million. Overall, the employment picture remains poor and is somewhat stagnant.
  • The Congressional Budget Office (CBO) estimated that on a net present value basis, the Treasury reported a federal budget deficit of $142 billion in November, leaving us with a deficit of $282 billion for the first two months of fiscal 2011, which is $14 billion less than the same period a year ago.
  • The Census Bureau reported that the U.S. had a trade deficit of $44.0 billion in September, down from $46.5 billion in August. And the deficit with China is now a staggering 63%. This means, among other things, that we are in no position to dictate terms to the Chinese about their currency.
  • The Census Bureau reported that privately owned housing starts were dropped 11.7% in October, after falling 4.2% in September, and were down a modest 1.9% from a year ago, to a seasonally adjusted annual rate of 519,000 units. New building permits were flat from last month and down 4.5% from last year. Housing remains very weak.
  • The National Association of Homebuilders/Wells Fargo Confidence Index rose 1 point in November to 16, its highest level since June. While this is nothing to write home about, there appears to be "flickers of interest" among home buyers.
  • The Census Bureau reported that on a seasonally adjusted annualized basis, sales of new homes in October fell 8.1% from the prior month, and remained down 28.5% from the same period last year, to 283,000 units. The estimate of homes for sale was 202,000, which represents 8.6 months at the current rate of sales. The median sales price was a much lower $194,900, which is well below the 12-month moving average price of $218,200.
  • The National Association of Realtors reported that on a seasonally adjusted annualized basis, sales of existing homes decreased 2.2% in October, following a 10.0% increase in September, and remained 25.9% lower than a year ago, to a projected 4.43 million units. The estimate of homes for sale, at 3.86 million represents a declining 10.5 months of supply at the current rate of sales. The median sales price fell to $170,500, which is slightly lower than the 12-month average of $172,619. The lower prices certainly reflect the amount of short and distressed sales.
  • 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, fell slightly again in September, giving further evidence of the trend of falling home prices. It's likely that prices were negatively impacted by the expiration of the first time home buyer tax credit and the huge inventory of distressed and foreclosed properties.
  • According to RealtyTrac, the number of foreclosures in October decreased 4.4% from the prior month, but were virtually the same as a year ago. “October marks the 20th consecutive month where over 300,000 U.S. homeowners received a foreclosure notice,” said James J. Saccacio, CEO at RealtyTrac. “The numbers probably would have been higher except for the fallout from the recent 'robo-signing' controversy — which is the most likely reason for the 9 percent monthly drop in REOs we saw from September to October and which may result in further decreases in November."
  • The Institute for Supply Management (ISM) index of manufacturing activity was 56.6 in November, down fractionally from 56.9 in October. This marked the sixteenth month in a row in which the manufacturing sector expanded. The ISM index of non-manufacturing activity was 55.0, up slightly from the prior month. This marked growth in the service sector for eleven consecutive months.
  • The Federal Reserve reported that in October, capacity utilization in the industrial sector held steady from the prior month at 74.8%. Capacity utilization is now 6.6% higher than the June low but still 5.8% below the average level of the period from 1972 through 2008.
  • The Conference Board reported that it's index of Leading Economic Indicators increased by 0.5% in October, following increases of 0.5% in September and 0.1% in August. Says Ataman Ozyildirim, economist at The Conference Board: “The LEI remains on an upward trend, suggesting the modest economic expansion will continue in the near term. The LEI’s growth has been slowing this year, but gains in the financial components helped its pickup in October.”
  • According to the Bureau of Economic Analysis, the "second" estimate of GDP growth in the third quarter was a slightly better 2.5%, versus the "advance" estimate of 2.0%, and higher than the disappointing 1.7% rate of growth in Q2. GDP growth in Q1 was an artificially inflated 3.7%. The slight increase this quarter was due in part to increased government spending and personal consumption, as well as a build in corporate inventories.
  • The Federal Reserve reported that in October the amount of outstanding consumer credit increased at an annualized rate of 1.75% from the prior month, to $2.4 trillion. The amount of revolving debt has been falling steadily, while non-revolving portion has remained fairly consistent. The amount of overall consumer credit is at the lowest point since the end of 2006.
  • According to the Census Bureau, retail trade and food service sales increased 1.2% in October, and were 7.3% higher than a year ago. While the past few months have shown some modest improvements in retail sales, I continue to believe that until the employment numbers show some sustained growth, retail sales will continue to lag.
  • The Federal Reserve reported in that in October the supply of M-2 increased slightly from the prior month and was up 6.5% during the prior six months. The supply of M-1, on the other hand, rose an even faster 9.2% over the same six months. It is growing more clear that the rate of monetary expansion is again increasing. Now the country needs to demonstrate that this money will begin to circulate through the economy more quickly in order to stimulate business.
  • The Conference Board Consumer Confidence Index increased a healthy 4.2 points in November to 54.1. This is the highest level in five months. I don't believe that any real progress will be made here until a significant number of jobs are created.
  • According to the BEA, the personal savings rate in October rose to 5.7% from 5.6% in September. I would expect the savings rate to again trend lower thanks to a rising stock market and historically low interest rates on savings.
  • According to the FDIC, 149 banks have failed so far this year, through November 13. This means that the number of bank failures this year exceeded the prior record of 140 banks that were either closed or merged into healthier banks in 2009. By comparison, 26 failed in 2008 and only 3 failed in 2007. I expect this trend to continue into 2011 thanks to the mortgage crisis.

Trends To Watch

If you don't like roller coasters, you should stay away from the dollar index as it is not for the faint of heart. Over the past two years, the dollar has plunged and soared twice. Right now, the dollar index is sitting midway between the high around 88 and the low of 74. And as the dollar goes, so (oftentimes) goes the market, in an inverse relationship. I had expected the dollar to fall to new lows, but that was before the return of problems in the Euro-zone, and the post-election results and subsequent deal extending the "Bush tax credits". Each of these items have helped to bolster the Greenback. In the short-term, I'd expect further strength in the dollar before turning back down again sometime early in 2011.

As an investor, I have been riding the golden bull market for eight years now. I have championed the long term benefits from owning gold in virtually every issue of this newsletter. And I see no reason to change my tune now. I would look for some consolidation between $1,300 - $1,400/oz before the yelllow metal resumes its inevitable path to even higher prices.

While gold gets most of the headlines, silver continues to do equally well, if not better. Indeed, after consolidating around $18/oz for the first two thirds of 2010, the price of silver has exploded to a new high over $30/oz. I started taking positions in silver a few years ago. I was a bit early. But now that decision is bearing fruit as my silver positions are surging higher. And like gold, I'd expect some consolidation before resuming its upward march.

The price is copper has broken above a year-long trading range and is now trading at almost exactly the same level as before the fall of Lehman Brothers, which is, in fact, the all time. Like all commodities, copper is benefiting from a generally weak dollar and strong international demand. Remember, copper is often thought of as a proxy for economic growth. So this chart is telling us that the prospects for future growth look good.

For more than year, the price of West Texas Crude built a rising triangle pattern. Then in May the price of "black gold" collapsed, thanks in large part to BP. Now, after consolidating in a clear trading range for five months, the price of crude has broken above that trading range, and past the April high of about $87 per barrel. Last month I wrote that "It's bullish that the price is higher than both moving averages and that the 50-day has just crossed above the 200-day. Look for the price of crude to go higher between now and the end of the year." At around $90/barrel, the price of oil is trading at its highest price ever, not including the late 2007-early 2008 bubble period in which oil got as high at $147/barrel. So how high could it go now? I don't know for sure, but I don't think $100 is out of the question next year.

For the most part, the financial sector has remained in a tight trading range for more than a year and a half. The price is now sitting right on the resistance line, above both moving averages. It will be interesting to see if it can break above that resistance, and stay there. I have been negative on the financial sector since the Lehman failure in '08, and given the ongoing problems in the housing sector and the foreclosure mess, I'm still not convinced that this sector has gotten healthy. The next few months will tell the tale.

Like the financials, the housing sector has traded in a narrow band for the past year and a half. After advancing slowly over the past few months, it now has moved to the mid-point of that range. I am even less convinced of the health of this sector. I think it will be years before the housing woes are really behind us, so I will continue to avoid stocks in this sector.  

Last month I wrote that "the crisis in the Euro already seems like a distant memory, even though the problems that caused it in the first place all still exist. I don't believe the crisis is over by any means, but for now, things look more sanguine." Before the figurative ink was dry on that newsletter, the Euro was right back in crisis, but the European market has held up fairly well. Until the currency problems of the various Euro-zone constituents are resolved, which could be years (if ever), it will be difficult for the developed markets to make any significant, lasting gains.

The health of the Chinese economy, and by proxy, it's stock market, is very important to the world's economy as they buy much of the world's output of raw materials and produce most of the goods sold to the world. Given the robust results from the US and Europe, you might think the  Shanghai Composite would also be hitting new highs, but that's clearly not the case. The index is now trading around the middle of the range, slightly higher than the 200-day average, but below the 50-day average. As you can see, the index is very volatile. It's hard to gauge the trend here. To get bullish, I'd like to see the average north of 3,000.

The NYSE Bullish Percent Index represents the percentage of stocks listed on the NYSE that signal a buy. Contrarians would argue that extreme levels of exuberance is a bearish indicator, and vice-versa. That type of thinking would suggest that the market is set for a correction because of the high levels of optimism right now, or at the very least, a period of consolidation to allow some of the exuberance to wear off. This would not be a bad thing as it would allow investors to put some money to work at better prices.

Finally we have the VIX, or the "Fear Index". As you can see, there is virtually no fear in the market right now. The election is over, Q3 earnings were solid, a deal to extend the Bush tax cuts is being voted on as we speak and the Fed is working to keep rates down (which isn't working so well right now). Barring unexpectedly bad economic or political news, or very bad Q4 pre-announcements in the next two weeks, I would expect the VIX to remain relatively quiescent for the rest of the year as the market drifts modestly higher heading into 2011.

What I'm Thinking and Doing

If you eliminate the "noise" from the market this year, and simply look at where we started and where we are finishing, it has been a pretty good year for the market. The broad averages will all be solidly profitably for the year (barring a huge sell off between now and the end of the year), with some indices being up double digits. The economy is certainly better than it was a year ago, even if the recovery remains somewhat tenuous. And importantly, some of the uncertainty has been removed from the political landscape; and we all know how the stock market hates uncertainty. So I believe we end the year on a positive note and that 2011, at least initially, looks promising.

I have been saying for some time now that I believed that things were looking better and that I thought the market would move higher. That belief has been rewarded as my clients and I have profited from from this extended rally. We have especially benefited by the tremendous move in precious metals and commodities (including crude oil, base metals and agricultural products). We have avoided the problems in the financial and housing sectors, among others. And most importantly, we did not panic and sell during the spring sell off or the two summer swoons. Indeed, we had the courage to buy during those pullbacks. Indeed, we reduced our cash position from $4.3M at the end of February to about $1.5M today. Only time will tell if our timing was good, but the short term results so far are very much in our favor.

Finally, I have used this rally to sell a some of my weaker holdings in order to redirect those funds to stronger positions. I've also culled some of my losses in order to offset any capital gains so that my clients will pay little to no taxes come next April. I hope each of my readers have done the same in their own accounts.

Personal News and Notes

It's hard to believe that it's December, that this is my last newsletter of the year and that it will be 2011 in just a couple of weeks. That means it's almost time for my annual Fearless Forecasts edition, where I look back on my predictions for this year, and make some new ones for next year. As always, the January edition of News and Views is not to be missed.

For some of you, Hanukkah, the festival of lights, is over. For others, Christmas is just around the corner. Either way, this is a time of family, friends, giving and togetherness. So please allow me to extend my warmest wishes to my readers of every race, color, creed and belief. From my family to yours, I wish for all of you the best of health, happiness and prosperity. May 2011 be a great year for all of us.

Don't forget that you can friend me on Facebook, connect with me on LinkedIn, or follow me on Twitter. I try to "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 been using these three sites because I'm actively seeking to make new business connections as well as maintain contact with friends old and new. So please look for me out in Cyberspace, and ask your colleagues, friends and family members to do the same.

That's it for this month, and this year. 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

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