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Werlinich Asset Management, LLC
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greg@waminvest.com
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March 21, 2013
We've Achieved All-Time Highs: Now What?

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 I write this before the market opens for trading, the Dow Jones Industrial Average stands at 14,511, up 535 points, or 3.8%, from when I wrote to you last month, and up 10.7% year-to-date. Most importantly, after struggling with resistance for months, the venerable index finally achieved its all time high on March 3rd and has marched ever upward since then. It has taken five and a half years to surpass the old level, and what a ride it's been. At the same time, the Transportation average has also continued to zoom to new peaks. As the two averages have concurrently made new highs, this marks a bullish confirmation according to Dow Theory. So for now, even with the bad news out of Cyprus, it appears that the market is likely to continue even higher.

This month, I'm showing a chart of the DJIA dating back to October 2007, the last time the index reached an all time high. Clearly, the first thing that strikes you is the precipitous plunge, thanks to the financial crisis, that reached its nadir in March 2009. Four years later, we've reached the promised land. Interestingly, there were market corrections in the summer of 2010, 2011 and 2012. Hmmmmmm. The summer of 2013 is just around the corner. That should give one pause.

Last month I wrote that the market was taking a little breather before it was likely to move up. Indeed, I said that "I wouldn't be surprised to see the new high before the month is over." I was only off by three days. Given the accommodative Federal Reserve (as well as most central banks around the globe) I expect the rally to continue, at least for another month or so. Come summer, we may see our next correction.

The Dow Jones Transportation Average has maintained its parabolic rally. RSI continues to trade in overbought territory but may be correcting as we speak (thanks to a huge earnings miss by Fed Ex yesterday). A modest correction would not derail this rally, and indeed by provide the spark for the next move higher.  


Has anyone in the mainstream press mentioned that the Dow Jones Utility Average has recovered the entire correction from last fall and is poised to push through resistance around 500 to new record levels? As far as I can tell, I'm about the only one talking about it. It's a very positive development that the moving averages have made a "Golden Cross" as the 50-day average has moved above the 200-day. Relative strength might be a bit extended, suggesting a small correction could be coming up, but I think there's room for more gains.


I'm not sure what to make of the chart of the 10-year Treasury. Clearly, Ben Bernanke and the rest of the Federal Reserve is fighting tooth and nail to keep a lid on interest rates. Yet over the last seven months the yield has jumped from 1.4% to around 2.0%. Below you can see the two principal trading ranges outline by red and blue lines, and the resistance line at 2.1% (dotted green). Three times in the past couple of months the yield failed to pierce that resistance. The recent four month trend of 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. I'll reiterate what I've been saying for months: bond investors should prepare for lean times.


Last Month's Results

The solid results in February followed the superb gains in January. And the market has continued higher to-date in March. All of the domestic averages has posted solid gains so far this year, although the NASDAQ is a conspicuous laggard. Value is trumping growth as investors search for yield to replace income lost in fixed income. The Dow continues to surpassed both the S&P and the NASDAQ, reversing the results from last year. Note that bond investors were basically flat for the year. A lot of people are going to realize, too late I'm afraid, that you can in fact lose money in bonds.

Name of Index

Feb

QTD

YTD

Description

S&P 500

1.4

6.6

6.6

Large-cap stocks

Dow Jones Industrial Average

1.8

7.8

7.8

Large-cap stocks

NASDAQ Composite

0.8

4.9

4.9

Large-cap tech stocks

Russell 1000 Growth

1.2

5.6

5.6

Large-cap growth stocks

Russell 1000 Value

1.4

8.0

8.0

Large-cap value stocks

Russell 2000 Growth

1.1

7.7

7.7

Small-cap growth stocks

Russell 2000 Value

1.1

7.2

7.2

Small-cap value stocks

MSCI EAFE

-0.9

4.3

4.3

Europe, Australia, Far East

Barclays Aggregate

0.5

-0.2

-0.2

US government bonds

Barclays High Yield

0.5

1.9

1.9

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 March 16 was 336,000, an increase of 2,000 from the prior week's revised figure. The four-week average of 339,750 is about 11,000 lower than the prior month's tally. According to the seasonal average, about 3.0 million people continue to collect unemployment insurance, a drop of about 100,000 from the prior month.
  • Non-farm payroll employment in February, for the most part, was reasonably positive. The establishment survey reported that 236,000 jobs were added in the month, a huge jump from January, while the household survey said that the unemployment rate fell to 7.7%. Revisions to December added 23,000 more jobs while January revisions subtracted 38,000, for a net loss of 15,000. The total number of workers counted as unemployed remained at 12.2 million and the labor force participation rate remained stable around 63.5%. The more comprehensive U-6 "underemployment" rate dipped to 14.3%.
  • 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 held at 8.0 million and the number of marginally attached workers fell to 2.6 million. The number of people holding multiple jobs jumped to 7.4 million. The average hourly wages for blue collar workers rose to $20.04 while the average work week inched up to 33.8 hours. Overall, the job increases are solid, and above estimates, but there are still far too many people who can't find a highly paid full time job.
  • The Congressional Budget Office (CBO) estimated that on a net present value basis, the Treasury reported a federal budget deficit of $205 billion in February, and $495 billion for the first five months of the fiscal year, which is $86 billion less than the record figure reported for the same period of fiscal 2012. The CBO anticipates a full year deficit of $845 billion, assuming no new tax legislation, or about $240 billion let than last year. 
  • The Census Bureau reported that the U.S. trade deficit of goods and services was $44.4 billion in January, up almost $6 billion from December, after falling in November. In general, the trade deficit should continue to fall through the year. 
  • The Census Bureau reported that privately owned housing starts inched up 0.8% in February, still far below the five year high set in December. Housing starts are now 27.7% higher than a year ago, to a seasonally adjusted annual rate of 917,000 units. New building permits rose 4.6% from the prior month, and were 33.8% higher than the year before, to easily the highest level in more than a year. The recovery in the housing market continues.
  • The National Association of Homebuilders/Wells Fargo Confidence Index dropped for the second straight month in March, to 44. This remains near the highest level since May 2006. A healthy figure would be around 50 or above. It's odd that builder confidence is shrinking in the face of a surging housing market.  
  • The Census Bureau reported that on a seasonally adjusted annualized basis, 437,000 new homes were sold in January, a huge 15.6% higher than the December totals and 28.9% better than a year ago. This was the highest figure since August '08. The estimate of number of homes for sale was 150,000, which represents a tiny 4.1 months of inventory at the current rate of sales. The median sales price dropped to $226,400, which is well below the rising 12-month moving average price of $241,758. Even though the average sales price dropped this month, likely reflecting an increase in short-sales, the overall trend remains good and a tight market augurs well for future price increases as we move towards the spring selling season and continue to reduce the inventory of foreclosures and short-sales.
  • The National Association of Realtors reported that on a seasonally adjusted annualized basis, sales of existing homes were virtually flat in January, at 4.92 million units, but remained 9.1% higher than a year ago. The estimate of only 1.74 million homes for sale means there's only a tiny 4.2 months supply on the market. The median sales price dropped to $173,600, which is still above the rising 12-month average of $177,025. 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, inched slightly higher in December. The composite posted a 5.9% gain for the year. Before any strong momentum begins, I'd expect some weakness again based on the February housing numbers.  
  • The Institute for Supply Management (ISM) index of manufacturing activity was 43.2 in February, indicating that economic activity in the manufacturing sector was more robust in the month. In addition, the ISM index of non-manufacturing activity was 56.0, which marked growth in the service sector for 38 consecutive months.The service sector continued its unabated expansion and the manufacturing sector is looking a bit better. These were positive reports.
  • The Conference Board reported that it's index of Leading Economic Indicators increased by only 0.2% in January following a healthy 0.5% gain in December. Says Ataman Ozyildirim, economist at The Conference Board: "The U.S. LEI rose again in January, pointing to a slow but continued expansion in economic activity in the near term. Despite continued weakness in manufacturers? new orders and consumer expectations, improvements in housing permits and financial components helped boost the LEI." Says Ken Goldstein, economist at The Conference Board: "The indicators point to an underlying economy that remains relatively sound but sluggish. Credit use has picked up, driven in part by relatively strong demand for auto loans. The biggest positive factor is housing. The housing market is now at twice the level reached during its recessionary lows, and will likely continue to improve through the spring, delivering some growth momentum to the labor market and the overall economy. The biggest risk, however, is the adverse impact of cuts in federal spending."
  • According to the Bureau of Economic Analysis, the "second" estimate of GDP growth for Q4 2012 showed an anemic growth of 0.1%, which was better than the decline of 0.1% in the advance estimate. for comparison, growth was 3.1% in Q3, 1.3% in Q2 and 2.0% in Q1. It is also far worse than the 3.0% growth recorded in Q4 2011. The decrease primarily reflected negative contributions from private inventory investment, government spending and exports. This doesn't portend a likely increase in the final estimate coming up next week.
  • The Federal Reserve reported in that in January the amount of outstanding consumer credit was $2.79 trillion, up from the prior month and growing at a 7.0% annualized rate. Consumer credit grew for the sixth consecutive month, which should help retail sales, which in turn, would boost the economy.
  • According to the Census Bureau, retail trade and food service sales increased a solid 1.1% in February, and 4.6% year over year. Gas stations, general retail stores, food service and auto dealers led the way. This is the first month where the increase in consumer credit appears to be spurring higher retail sales. We'll see if this can continue in the coming months.  
  • The Conference Board's Consumer Confidence Index soared in February, making up for the losses in previous months, rising to 69.6 from 58.4. Says Lynn Franco, Director of The Conference Board Consumer Research Center "Consumer Confidence rebounded in February as the shock effect caused by the fiscal cliff uncertainty and payroll tax cuts appears to have abated. Consumers? assessment of current business and labor market conditions is more positive than last month. Looking ahead, consumers are cautiously optimistic about the outlook for business and labor market conditions. Income expectations, which had turned rather negative last month, have improved modestly"
  • According to the FDIC, only 1 bank failed in February, versus the 4 that failed last February, bringing the total for the year to 3. I would be surprised if more than 25 or 30 banks go under this year.

Trends To Watch

The dollar index recently broke out of the tight range between 78.5 and 81.75 (the two dotted red lines) and is once again headed towards resistance around 84. I wrote last month that "most of the world is in a race to devalue their currencies, so I wouldn't expect the dollar to get much weaker any time soon." That's proven to be the case. The dollar remains a "safe" currency in the face of global uncertainty, no matter how hard we try to kill it. The government keeps pushing into the future the fight over the debt ceiling and the federal budget as the fear of the "sequester" fades from view. Look for the dollar to move higher.

Other than looking ugly, the short term chart for gold doesn't really tell us anything. The "death cross" of the moving averages is a negative. The price trading below the interim resistance band (green lines) is negative. The distance from the peak around $1,800 is a negative. Yet support around $1,525 has held and $1,600 has been achieved, and that's positive. So we sit and wait to see if it can move north of $1,625.

Since the short term chart isn't speaking to me, let's look at something a little longer. Below you'll see a chart of the price of gold going back over four years. You'll notice that gold has been consolidating for more than a year, during which time a declining triangle pattern has formed (red lines) and is tightening each month. While this is normally a bearish trend I expect a powerful reversal to occur at some point this year, after which the price will move sharply higher. This could happen when the equity markets finally correct, or if the problems in Cyprus spill over into the rest of Europe.

Like gold, the short term chart of the price of silver is ugly as it has fallen below interim resistance at 30 and a "death cross" has occurred. Neither RSI or MACD are telling us much. I expect when gold starts moving higher that silver will likely follow.

What a difference a month makes. The price of copper has plunged about 10% in the last six weeks. Part of that can be explained by the increase in the value of the dollar, and part is suggested by weakness in China (see below). Either way, Dr. Copper is flashing a warning sign that all is not well. RSI is very oversold, indicating that we might see a rebound shortly.

The price of West Texas crude is sitting right on its interim resistance around $93 (green dotted line) and just below the 50-day moving average. The recent "golden cross" signal (red circle) suggests that the price could move higher, if the strong dollar doesn't get in the way.

The financial index continues to move onward and upward to new highs as the bull remains solidly in control. The current price remains well above the trendline and both moving averages. It seems that only the government can get in the way of this rally.

The housing index is also solidly bullish as the price remains above the trendline and both moving averages and just surpassed the February peak to make a new high. 200 is just ahead. 

The index for the developed international markets continues to move higher. Once again it is poised to attack resistance at 62, a high achieved almost two years ago. With RSI calm and the current price above both moving averages, the chart looks bullish.

What happened to the recovery rally in the Shanghai index? After failing to breach resistance at around 2,478, the price has fallen about 8.5% in the past month or so. The decline would certainly put pressure on the prices of base metals like copper. Look for support around 2,135.

Now we come to our three contrarian market indicators, which are a mixed bag. The NYSE Bullish sentiment index shows too much bullishness right now, although RSI is no longer wildly overbought, and is heading lower. History shows that when bullish sentiment gets this high, a correction isn't far behind.

Next we see that only about 70% of stocks traded on the New York Stock Exchange are currently trading above their 50-day moving average, down from almost 90% two months ago. This is good; it shows that some of the froth has been taken out of the market, even though it's moved higher. It does though suggest the rally has been a bit narrow. As long as the index remains above 50%, we'll be ok. Below that and we'd likely be in the midst of a decent sized correction.

Finally, the VIX, or the "fear index", shows an almost complete absence of fear. This is utter complacency. The VIX hasn't been this low since early 2007, shortly before the DJIA reach the last peak. That's something to keep in mind. It won't take much to see the index jump as I suspect traders have a short fuse right now.


What I'm Thinking and Doing

Right now, like many of you, I'm enjoying the rally and rooting for it to continue ever higher. But I know that all good things come to an end, and extended stock market rallies are no exception. So while the market appears "reasonably priced" and the Fed remains highly accommodative, it wouldn't take much to turn things negative. The fragile economies of Europe could quickly turn down, possibly led by the solvency crisis in Cyprus. I'm also concerned about what's really going on in China and why their market is doing poorly while much of the rest of the world is soaring. And we still have our own flat economy, and the negotiations over the debt ceiling and the budget, to deal with. So all in all, I'd say I'm cautiously optimistic for the next month or so but concerned about the possibility of another summer correction to follow.

So where does all of that leave me and my investors? Pretty much the same as the last few months as we remain fully invested and enjoying the rally, although to be honest, we've under performed a bit thanks to our 10% position in gold. But I've got a feeling that before the year is over, we will again be pleased with that allocation. I'm also looking to raise a bit of cash from a few of my smaller positions, and some of my commodity holdings, so that I have some purchasing power during the next downturn. The strong dollar is causing some headwinds in commodity sector.  

Professional News and Notes

I'm very pleased to announce that my new website is finally up and running. As with any new site, there will likely be a few kinks to work out and a few bugs to fix. But I'm very excited with its look and feel and I'm anxious to hear what you have to say. So please take a moment to visit the site and let me know what you think by clicking here.

I was recently interviewed by Greg Brown for a piece he wrote in the February edition of Newsmax entitled "After the Gold Rush". In the article I discussed my positive long-term view of the price of gold and gold mining stocks. You can read the entire article in the "Media" section of my website.

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, or if you know someone that might benefit from my guidance, 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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