Werlinich Asset Management, LLC

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December 17, 2012

Staring Over The Cliff

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

Current Market Analysis

As the market finished trading for the week, the Dow Jones Industrial Average stood at 13,135, up 547 points, or 4.3%, from when I wrote to you last month, and only about 3.5% from the October 5 closing high of 13,610. The market has managed to recover all of its losses since the election. Given all of the problems we're facing, not the least of which is the looming Fiscal Cliff, it's amazing that the market is doing as well as it is. Should there be a timely resolution to this impasse, the market could quickly soar to new highs. If not, it could just as easily plunge to fresh lows. Choosing which outcome to bet on is the big dilemma facing investors today.

The DJIA has reached the current price five times since May, only once breaking through to a higher level (in September and October). For the next few weeks, at least through the end of the year, I expect it will be a news driven market, swinging wildly on lower holiday volume as news breaks one way or another about the Cliff negotiations. Right now, the chart appears mildly bullish with the price higher than both moving averages. Clearly a break above 13,330 is needed before the DJIA can attempt to surpass the October highs. There is strong downside support around 12,600 or so.

What a difference a month makes for the beleaguered transportation average. It has surged from strong support just below 4,900 to attack resistance around 5,250. This has been a firm trading range for the past eight months. It's unlikely the broader market can move to new highs if the DJTA doesn't break above this resistance level. We'll see if the current momentum can continue.

Last month I suggested that the sudden drop in the Dow Jones Utility Average could be a nice buying opportunity. The DJUA fell a surprising 13% in less than four months, which seemed like an overreaction to me. Since then, the average has gained about 3.2%. While it's a negative that the 50-day moving average has crossed below the 200-day. The good news is that RSI has recovered from its oversold position. Is this the beginning of a broader recovery or a "suckers rally"? Only time will tell, but I still like this sector.

Interest rates continue to trade between 1.4% - 1.9% in the "New Normal" orchestrated by Ben Bernanke and the Federal Reserve. Chairman Bernanke has pledged to keep rates artificially low at least through 2015, or until inflation rises above 2.5%. The current rate increase coincides with the rise in equities, as investors have taken money out of the safe haven of treasuries and moved it into riskier assets like stocks. It would be ironic if the very asset bubble created by the Fed helps drive interest rates higher than their target levels.

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. After a desultory beginning to the month, the sharp recovery helped propel the broad averages to slim gains in November. Riskier growth and technology stocks, which led the earlier decline, were the vanguard of the recovery. Barring a big decline in the last two weeks of the year, some stock investors will enjoy double digit gains this year, depending on the mix of their assets. It has been a crazy roller coaster of a ride this year, once again proving the importance of a firm hand on the steering wheel.

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

* Return numbers include the reinvestment of dividends

Statistics To Watch

  • According to the Department of Labor, the figure for seasonally-adjusted initial jobless claims for the week ended December 8 was 343,000, a decrease of 29,000 from the prior week's revised figure. The four-week average of 381,500 is about 2,000 lower than the prior month's tally. About 3.2 million people continue to collect unemployment insurance, down over 100,000 from the prior month. I just wonder if this is seasonal employment that will be reversed after the holidays.
  • Non-farm payroll employment in November continued to show jagged improvement, but remained a mixed bag. The establishment survey reported that 146,000 jobs were added in the month while the household survey said that the unemployment rate dropped to 7.7%. The jobs added this month were slightly lower than the average of 151,000 for the year, which in itself is slightly lower than the average of 153,000 for jobs added in 2011. The unemployment rate is the lowest since January 2009.
  • Revisions to September and October subtracted 49,000 jobs, after adding them back the prior two months. It's hard to say what the likely direction of revisions will be in the December report. The downward revisions were a surprise. The total number of workers counted as unemployed fell to 12.0 million, which helped lower the unemployment rate. The labor force participation rate fell back to 63.6%. The more comprehensive U-6 "underemployment" rate dipped to 14.4%.
  • 4.8 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 8.2 million and the number of marginally attached workers inched up to 2.5 million. The number of people holding multiple jobs moved up to 7.2 million. The average hourly wages for blue collar workers rose slightly to $19.84 while the average work week rose to 33.7 hours. Overall, this was a modestly good report, but much more is needed.
  • The Congressional Budget Office (CBO) estimated that on a net present value basis, the Treasury reported a federal budget deficit of $172 billion in November, and $292 billion for the first two months of the fiscal year, which is $57 billion more than the same period of fiscal 2012. They claim that without shifts in the timing of certain payments each year, the deficit would have been about $8 billion lower this year. With numbers this large, that's basically a rounding error. Either way, we're headed for another year of $1 trillion deficits.
  • The Census Bureau reported that the U.S. trade deficit of goods and services was $42.2 billion in October, up from $40.3 in August. The trade gap was $52.5 billion in January, so real, if unsteady progress, has been made.
  • The Census Bureau reported that privately owned housing starts increased 3.6% in October, building on the 15.1% gain in September. Housing starts are now a whopping 41.9% higher than a year ago, to a seasonally adjusted annual rate of 894,000 units. New building permits were down a slight 2.76% after the enormous increase the prior month, but still 29.8% higher than the year before. This is a strong sign that the recovery in housing is continuing.
  • The National Association of Homebuilders/Wells Fargo Confidence Index gained 5 points in November to 46. That marks the seventh straight monthly increase and is the highest level since May 2006. Builder confidence is slowly approaching a healthy figure of 50, which is considerable progress from the desultory figure of 19 only one year ago.
  • The Census Bureau reported that on a seasonally adjusted annualized basis, 368,000 new homes were sold in October, roughly the same as the revised figure for September but still 17.2% better than a year ago. The estimate of homes for sale was 147,000, which represents only 4.8 months at the current rate of sales. The median sales price dipped this month to $237,700, which remains just above the rising 12-month moving average price of $234,967. The new home sale market remains very tight, which augurs well for future price increases. Just remember we've hit the seasonally weak time of year.
  • The National Association of Realtors reported that on a seasonally adjusted annualized basis, sales of existing homes were 2.1% higher in October than a revised lower tally for September, to 4.79 million units, and remained 10.9% higher than a year ago. The estimate of 2.14 million homes for sale means there's only an estimated 5.4 months supply on the market. The median sales price rose a smidge to $178,600, which is above the rising 12-month average of $172,758. As with new homes, the existing home market is getting tighter and tighter, which suggests a bright future in the spring.
  • The S&P/Case-Shiller Home Price 10-city index, which uses a three-month moving average to track the value of home prices across the US, rose for the sixth straight month in September, posting a modest 0.3% increase. Prices nationwide were up 3.6% in the third quarter.
  • The Institute for Supply Management (ISM) index of manufacturing activity was 49.5 in November, showing that economic activity in the manufacturing sector contracted for the fourth time in the last six months. The service sector, on the other hand, shows no sign of slowing down. The ISM index of non-manufacturing activity was 54.7, up a bit from October, which marked growth in the service sector for 35 consecutive months.
  • The Conference Board reported that it's index of Leading Economic Indicators increased by 0.5% in October after an increase of 0.5% in September. Says Ataman Ozyildirim, economist at The Conference Board: "The U.S. LEI increased slightly in October, the second consecutive increase. The LEI still points to modestly expanding economic activity in the near term. Over the last six months, improvements in the residential construction and financial components of the LEI have offset weak consumer expectations, manufacturing new orders and labor market components."
  • According to the Bureau of Economic Analysis, the "second" estimate of GDP growth for Q3 2012 was 2.7%, up from the advance estimate of 2.0% and better than the 1.3% growth in Q2 and 2.0% in Q1. Unfortunately, it's still less than the 3% recorded in Q4 2011. We should enjoy whatever growth we can get this year as things could turn ugly quickly in 2013 if all, or part, of the Fiscal Cliff comes to pass.
  • The Federal Reserve reported that in September the amount of outstanding consumer credit was $2.75 trillion, up from the prior month and growing at a 6.25% annualized rate. A third straight month of growth in consumer credit can only be helpful to retail sales, which would boost the economy.
  • According to the Census Bureau, retail trade and food service sales increased 0.3% in October, following a 1.1% increase in September, leaving them 3.7% higher than a year ago. Electronics, autos and building materials sales led the way. More important is what happens in November and December during the holiday shopping season, which is the make or break time for many retailers.
  • The Federal Reserve reported that in November the six month rate of growth in the supply of M-2 (a broader view of money) was 7.7%, up a bit from October. The supply of M-1 (a narrower definition of money), on the other hand, rose a much faster 13.6%. The Fed continues to create a seemingly endless supply of money in an effort to boost the economy. And while it may be helping modestly in the short run, it is likely doing serious damage in the long run.
  • The Conference Board's Consumer Confidence Index increased again in November, rising from 73.1 to 73.7. Says Lynn Franco, Director of The Conference Board Consumer Research Center: "The Consumer Confidence Index increased in November and is now at its highest level in more than four and a half years (76.4 Feb. 2008). This month’s moderate improvement was the result of an uptick in expectations, while consumers’ assessment of present-day conditions continues to hold steady. Over the past few months, consumers have grown increasingly more upbeat about the current and expected state of the job market, and this turnaround in sentiment is helping to boost confidence."
  • According to the FDIC, only 3 banks failed in November, bringing the total number of bank failures so far this year to 05, which is 40 less than this time last year. Clearly there will be far fewer bank failures this year than the 92 banks that failed in 2011, which was a big improvement over the record 160 banks that were either closed or merged into healthier banks in 2010, and 140 in 2009. By comparison, only 26 failed in 2008 and a negligible 3 in 2007. It's likely that only a dozen or so will fail next year.

Trends To Watch

The dollar index has traded in a relatively narrow range (between the blue and dotted red lines) for the past year. It recently moved lower, dropping below both moving averages. The current action suggests it may again test support just below 79. This would likely be a boom to equity and commodity prices.

For the past year the trading range for gold has been between $1,500 - $1,800/oz. During this period, the price has often found interim support or resistance around 1,675 (green dotted line), and it appears that now is another one of those times. I'll reiterate that I think the green line likely offers a great entry point for those seeking to build a position in the yellow metal.

Copper has staged an incredible recovery over the past month after looking very sickly in October. Dr. Copper is again forecasting better economic times ahead. After falling below the interim support/resistance line at $3.50 (green dotted line) it's moved above both moving averages. The falling MACD suggests that the current rally may be a bit long in the tooth. We'll have to keep a close eye on this.

The chart of the price of West Texas crude looks pretty dismal as it has fallen well below interim support and both moving averages. The weakness is likely a reflection of lower global consumption and increased domestic supply. The dramatic increase in natural gas supplies isn't helping either. I think the price will likely move lower before moving higher again next year.

The financial index has failed once again (at least for now) to breach resistance at $16.30. The financial sector is facing some head winds due to an unintended consequence of QE whereby banks see their net interest margin, which is the difference between their borrowing and lending costs, get squeezed, which negatively impacts earnings. So I'm going to maintain my stubborn position of avoiding bank stocks, even in the face of an otherwise very bullish chart. I may simply be the last guy on this train but I simply can't bring myself to get on board just yet.

After an unrelenting rally that lasted about a year, the index of the housing sector has traded sideways for the past three months. Perhaps it's taking a breather to allow the reality of the gains in housing to catch up to the outsized expectations. Either way, based on the data, and the chart, there's no reason to think this bull market has run its course.

After failing multiple times to pierce interim resistance around 56, the index for the developed international markets may have finally broken through, although it will take a week or so to validate the move. If it succeeds, the next resistance appears at 62. Investors who (rightly) bailed on this asset class thanks to the unrelenting bad news emanating from Greece, Spain, France and Portugal (to name a few beleaguered countries) have missed out on this rally. The question remains how lasting this rally will be.

The chart of the emerging markets continues to be virtually identical to the one for the developed countries. I've been waiting for months for this correlation to end and I've been wrong all along. I don't understand why this synchronicity exists and I don't know how much longer it will continue. It just makes no sense. As a result, starting in January, I'm going to eliminate this chart.

The Shanghai index has been a horror show for three years! Each time there's been a hint of recovery it's been quickly squashed, especially over the past two years. Recently the index was in danger of dropping below a critical support level around 1,850. The good news is that support held (at least for now) and a recovery seems to be in progress. I've been asking why the Chinese market has been doing so badly this year when most other markets are doing so well. What's been going on that we don't know about? Maybe the Chinese market simply got too far ahead of itself and had to correct to bring things back to reality. If that's the case, we could see a heck of a rally next year.

Now we come to our three contrarian market indicators. First is the NYSE Bullish sentiment index. This chart suggests that the market is mildly bullish right now as bullish sentiment is almost 64%. RSI has recovered from being oversold and is heading towards overbought territory. If the index moves above 65, I'd expect the market to turn down.

Next we see that about 58% of stocks traded on the New York Stock Exchange are currently trading above their 50-day moving average, up from only 20% just a month ago. I show the "swing line" of interim resistance at 50%. As we're just above that level, we're not overly bullish so I wouldn't expect any correction to be too severe.

Finally, we look at the VIX, or the "fear index". We had a brief rise in the VIX through October, culminating just below 20 in early November. Since then, it's fallen as low as 14.7 before settling around 17. None of this suggests any big move upcoming one way or another. Of course, any big news about the Fiscal Cliff could change that in a hurry.

What I'm Thinking and Doing

As I've been thinking about the Fiscal Cliff quite a bit, whether I want to or not, I'm going to excerpt part of a recent article I posted on my blog as it crystallizes some of my thoughts.

"There are [two] weeks left in the year and the world won't be coming to an end, literally or figuratively, regardless of what the various doomsday prognosticators have to say. It's impossible to turn on the television or open a newspaper without being assaulted [by] dire warnings about the impending disaster that is the "Fiscal Cliff". It's gotten to the point where I can only watch CNBC is when it's on mute.

While I'm growing more and more angry and frustrated (if that's even possible) at the intransigence emanating from both parties in Washington, I honestly don't think the looming fiscal cliff is really the nightmare everyone is saying it will be. It is HIGHLY UNLIKELY that every tax increase and spending cut will, in fact, come to pass. Some compromises will certainly be made by our leaders in Washington, despite the radical bleatings of the far right and far left.

So if we're able to drown out the noise about the cliff, what should you be truly focused on between now and the end of the year? Given all of the current uncertainly, there are no simple answers, but here are a few suggestions for you to ponder:

  1. If you have large unrealized gains, consider realizing some of them this year to take advantage of the low capital gains tax rate, which is likely to rise next year.
  2. If future capital gains taxes aren't really an issue, don't forget to match gains with losses where possible to minimize your tax bill this year.
  3. Check your portfolio to see if your holdings need to be rebalanced. Avoid having any one position be too large a percentage of your overall holdings. I generally like using 10% as a maximum position size. Similarly, either add to, or get rid of, positions that are simply too small to make a difference.
  4. If you have a large estate, consider making gifts of up to $5.1 million before year-end to take advantage of the large estate tax credit that expires this year. Unless a compromise is reached, it reverts back to $1 million next year.
  5. Speak with your adviser to make sure your investments are suitable for your financial objectives and risk tolerances. Times and conditions often change, and our investment approaches sometimes must change as well.
  6. If you don't have a will; write one. If you have a will, but haven't updated it in more than five years, it's probably time to look at it again.
  7. If you haven't already done so, consider giving some of your time and/or money to a worthwhile charity. There are so many organizations out there that desperately need your help, especially during the holidays. So open your heart and your wallet and make a difference for those in need."

After sitting quietly for a couple of months, squirreling cash away for the proverbial rainy day, I finally decided that it was time to put some of those funds to work. I have spent the past week or so reviewing every account I manage. As a result, I've done a little bit of tax-loss selling and quite a lot of rebalancing. I've made the hard decision to eliminate a few more long-held securities while concurrently buying initial positions in three new companies: a leading chip manufacturer in the mobile phone space, a leading payroll company and a top medical device provider. I'm extremely optimistic about the long-term prospects for each stock. By the time I'm finished with this process my accounts will be set to shine in 2013.

Professional News and Notes

This year has been one of transition and change for me. As many of you know, I started writing a blog this fall. For those of you who haven't yet checked it out, please do so and begin a dialogue with me. I've spent a lot of time (and money) updating and upgrading many of my programs and processes, as well as a lot of my hardware. I bought a new computer, a color printer and a new UPS backup battery. I received an iPad as a gift and loaded it with a number of applications that allow me to work while on the go. I invested in a new CRM, a client vault, a social media archiving program and upgraded accounting software. Whew. I'm glad that's all over with. All of these moves were made to keep me streamlined, compliant and better able to deliver top quality service to my clients at a very competitive price. With all of these changes behind me I'm ready to turn the calendar and begin the new year at full speed ahead.

Speaking of updates and upgrades, the work on my new website is also progressing very well. After almost nine years with my current site I felt it was time to "freshen the look" and make it more current and accessible. I hope to have it up and running when we all return to work in January. I'd love to hear what you all think of it.

I had a goal of reaching 500 twitter followers by the end of the year and unfortunately it looks like I'll come up short as I've just surpassed 460. So if you use twitter, please follow me as a way to remain abreast of all the daily news and action in the market.

I've now written over two dozen original articles in my blog and I'm slowly building up a a following, which is extremely gratifying. I hope to pen a couple more entries between now and the end of the year. Then we get to start all over again next year. Towards that end, I'd be very interested in hearing what you have to say. So please check it out and share your thoughts by clicking here. As I'm trying to expand its coverage, I would really appreciate it if you could forward the link to some of your friends and colleagues and comment on one or more of the existing blog posts. It would also be helpful if you could let me know what you'd like me to write about, because after all, it's about your money. If you "follow" the blog, you'll be notified by email any time I post some new copy.

Finally, my next newsletter will be my highly anticipated Fearless Forecasts edition. Every January I make a dozen or so prognostications about the stock market, the economy and even the Super Bowl. In addition, I review, one-by-one, each prediction from the prior year. So stay tuned in early January to see how I did and what I think will happen in 2013.

As always, I thank you, my readers, and remind you that this newsletter is for you. I have been writing News and Views for over nine years now. If you'd like to read any prior edition, simply go to my website and click on the link to my newsletter archives. I hope you have learned something about our economy and our stock market, and that you will continue to follow along with me in 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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