January 21, 2014

The Dow Jones Industrial Average closed Friday at 16,458, just below its all time high and 237 points, or 1.5%, from when I wrote to you last month. In fact, most of the major averages are at or near record levels. For the last few months I've written that I believe the rally will continue, and there's nothing to dissuade me from that opinion right now. This rally certainly won't last forever, and we're destined for a correction at some point, but I think that correction remains at least a few months away. So my suggestion is to stay invested and enjoy the ride. 

I believe the most important factor underpinning this rally is the Federal Reserve. As long it maintains its accommodative monetary policy, the stock market should continue to move higher. Although the Fed has announced its intention to taper their bond buying program, the more important detail is that it has renewed its pledge to keep rates artificially low into 2015 and beyond. That means the party should continue. 

As we look at the chart of the DJIA, there doesn't appear to be anything to worry about. The trend is wildly bullish yet RSI is at a reasonable level and MACD is turning positive. Support would come in at the last peak, around 16,145. 

The chart of the Dow Jones Transportation Average looks even better as it continues its upward trajectory with ever higher highs after modest dips. This is an almost perfectly bullish chart. And yes RSI is not oversold and MACD too is reasonable. Last month I suggested that a dip below 7,100 would be a decent entry point. The way things are going, I'd say to be a buyer if it falls to around 7,200. 

Now that interest rates, at least temporarily, have stabilized, the Dow Jones Utility Average has recovered a bit and has moved just past the midpoint of the recent trading range. Last month I said 'it's not time to abandon utilities just yet as support hasn't been broken." If you took that advice you made some money. It looks to me now like the index is primed to head even higher. If bond yields (see below) stay under 3.0% I think the utility average could test resistance at 510.

As you can see, as the year ended the 10-year Treasury yield tried again, and failed again, to pierce resistance at 3.0%. Looking ahead, I have no doubts that the yield will continue to rise, but it might take a little while for that to happen. In the near term, probably through the first quarter or two, I'd expect rates to remain in the trading range delineated below. The only thing that changes this thesis is if the Fed changes their interest rate policy sooner than expected. 

Last Month's Results

2013 was an historic year for the stock market as the broad averages achieved record high levels and percentage gains not seen since the 1990's. Not surprisingly, in a year of such spectacular results, growth outpaced value and small caps outperformed large caps. Even Europe and the rest of the developed world enjoyed gains of better than 20%. The only laggard was the bond market, with actually lost 2% for the year. Anyone who was paying attention, or reading this newsletter every month, knew that was coming. I expect we'll see more of the same in 2014.

* 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 11 was 326,000, a decrease of 2,000 from the prior week's revised figure. The four-week average of 335,000 is about 10,000 lower than the tally from a month ago. According to the seasonal average, about 3.03 million people continue to collect unemployment insurance, which is an increase of about 170 million people. That's a little disturbing.
• The non-farm payroll employment report in December was a huge disappointment as the number of jobs created was far below expectations. I expect these numbers were anomalous and will be revised significantly higher over the next two months. The establishment survey reported that a paltry 74,000 jobs were added in the month, while an additional 38,000 jobs were added through revisions to the results for November. The household survey reported that the unemployment rate fell to 6.7% while the more comprehensive U-6 "underemployment" rate rose to 13.0%. 11.0 million workers were counted as unemployed (about the same as the prior month) while the labor force participation rate fell to 62.8%, matching the lowest level since February 1978. What this means is that people are finding it impossible to find a job and are simply dropping out of the labor force.
• 3.9 million people continued to be unemployed longer than 27 weeks, and since they didn't get jobs it appears they've simply given up trying to find work. The seasonally adjusted number of people who could only find part-time work inched up to 7.8 million and the number of marginally attached workers rose to 2.4 million. The number of people holding multiple jobs declined to 6.9 million. The average hourly wages for blue collar workers moved higher to $20.35 while the average work week dipped to 33.6 hours. Overall, this is a much more dismal report than I'd expected after a number of promising months in a row. We'll see if this is the beginning of a new trend or simply a one-off outlier. I expect it's the latter, and things will improve next month..
• The The Congressional Budget Office (CBO) estimated that on a net present value basis, the Treasury reported a federal budget surplus of $44 billion in December, which means that three months into fiscal 2014 the cumulative deficit is $182 billion, $111 billion less than the same period in the prior year, thanks to higher tax receipts (up 8%) and lower government expenditures.
• The Census Bureau reported that the U.S. trade deficit of goods and services was $34.3 billion in November, a decrease of $5.0 billion from the prior month. This is the smallest monthly trade deficit since October 2009. I've been saying for a while that I expected the improving economy to help the deficit, and if Congresss would approve the exportation of petroleum products, we could potentially have a trade surplus.
• The National Association of Homebuilders/Wells Fargo Confidence Index gained four points in December to reach 58. The index rose eleven points from the beginning of 2013 to the end, and has remained above 50 for the past seven months. According to NAHB Chairman Rick Judson, "this indicates that an increasing number of builders have a positive view on where the industry is going."
• The Census Bureau reported that privately owned housing starts fell 9.8% in December, after surging 23.1% in November (revised), to a seasonally adjusted annual rate of 999,000 units, leaving them only 1.6% higher than a year ago. New building permits fell 3.0% from the prior month but remained 4.6% higher than the year before. The trend is beginning to move in the wrong direction. 
• The Census Bureau reported that on a seasonally adjusted annualized basis, 464,000 new homes were sold in November, down 2.1% from the huge gains posted in October, but still 16.6% higher than a year ago. The estimate of the number of homes for sale is a slim 167,000, which represents a puny 4.3 months of inventory at the current rate of sales. The median sales price rose by $10,700 last month to $270,900, which is above the 12-month moving average price of $262,408. I would expect harsh weather to diminish sales in December and January. 
• The National Association of Realtors reported that on a seasonally adjusted annualized basis, 4.9 million existing homes were sold in November, a decrease of 4.3% from October which was also 1.2% lower than a year ago, which is disturbing. It's also worrisome that existing home sales, and average selling prices, have declined for five months in a row. The estimate of homes for sale held steady at about 2.1 million, which represents 5.1 months of inventory at the current rate of sales. The median sales price dipped to $196,300, which is below the still rising 12-month average of $209,217. As I mentioned above, I don't expect any real progress until the weather improved in March or April.
• According to the Institute for Supply Management (ISM), economic activity in the manufacturing sector expanded in December for the seventh straight month as the index dipped slightly to 57.0, still among the highest levels of the year. At the same time, the ISM index of non-manufacturing activity fell to 53.0, which still marked growth, albeit slightly slower, in the service sector for 47 consecutive months.
• The Conference Board reported that it's index of Leading Economic Indicators (LEI) increased 0.8% in November, following a slim 0.1% increase in October. According to Ataman Ozyildirim, Economist at The Conference Board, "The LEI continues on a broad-based upward trend, suggesting gradually strengthening economic conditions through early 2014. Improving labor markets and new orders in manufacturing, combined with strong financial indicators, drove November's gain. However, consumers' outlook for the economy and the drop in housing permits continue to pose risks in 2014."
• According to the Bureau of Economic Analysis, the "final" estimate of GDP growth for Q3 2013 was a surprisingly robust 4.1%, up from the advance estimate of 2.8% and second estimate of 3.6%. Much of this improvement is due to large inventory build ups, a benefit that's unlikely to be repeated in future quarters, and an increase in state and local government spending. Still, this is a solid improvement over 2.6% growth achieved in Q2, the meager 1.1% growth generated in Q1 and the anemic 0.4% growth in Q4 2012. It even managed to surpass the robust 3.1% growth from Q3 2012.
• The Federal Reserve reported that in November the amount of total outstanding consumer credit grew at a slower 4.75% annualized rate, holding at around $3.08 trillion. This is, by far, the highest number I've noted since I first started reporting this statistic in 2007. And it appears that the money may finally be trickling down to parts of the retail sector, which is showing signs of life. 
• The Conference Board's Consumer Confidence Index, which had declined for three months in a row, rebounded strongly in December, gaining over six points to finish the year at 78.1. Says Lynn Franco, Director of The Conference Board Consumer Research Center "Consumer confidence rebounded in December and is now close to pre-government shutdown levels (September 2013, 80.2). Sentiment regarding current conditions increased to a 5 1/2 year high (April 2008, 81.9), with consumers attributing the improvement to more favorable economic and labor market conditions. Looking ahead, consumers expressed a greater degree of confidence in future economic and job prospects, but were moderately more pessimistic about their earning prospects. Despite the many challenges throughout 2013, consumers are in better spirits today than when the year began."
• According to the FDIC, one lonely bank closed in December, bringing the total for the year to 24, versus the 51 bank closures in 2012. That's pretty darn close to my target of 25. I would expect even fewer closings in 2014, therefore I'll likely stop publishing this statistic as it no longer has any bearing on the economy or the stock market.

Trends To Watch

The dollar index has begun heading higher over the past month and appears ready to again attack resistance at 81.5. The announcement of the taper, as well as a budget deal, has boosted the greenback a bit. And as the economy continues to gain strength, albeit slowly, the dollar may gain a bit more strength. Still, I don't expect it to get anywhere near the high from last July. 

Was my proclamation last month that the bull market in gold was finally over actually calling the bottom of the gold plunge, or is it really over? Is the current upward move simply a dead cat bounce or was $1,200 the bottom? Only time will tell for sure. I do think that the price of gold will be higher a few years from now, but in the near term, I think the price of gold moves lower. 

The price of West Texas crude has plunged so far this year, and to be honest, I'm not sure why. Interestingly, the major energy companies, like Exxon, Chevron, ConocoPhilips, Schlumberger and others continue to do quite well, regardless of the fluctuating price of crude. That tells me that the price will likely stabilize around the $100 midpoint of the price range shown below.  

The bull market in the financial sector continues unabated. The price of the index remains above both moving averages and refuses to drop below the rising trendline (in blue). All I can do is reiterate what I've been saying for the past year: buy on weakness, which would be between 21 and 21.5. 

After four months of gains, the index for the housing sector finally broke through resistance and approached the high level set last May. Another positive factor is that the 50-day moving average finally move higher than the 200-day average creating the "golden cross", which is very bullish. This is all interesting in light of the fact that the housing statistics don't paint quite as rosy a picture. So what's right, the statistics or the chart? 

After taking a breather in December, the index for the developed international markets is again moving higher. It has matched the high set in late October and appears poised to best that level. Last month I wrote that the chart indicated "that the index could be prepared to move higher again." That's proved correct as the chart remains bullish. 

The Chinese economy, and by proxy its stock market, remains the fly in the ointment of an otherwise worldwide bull market. Each time the index seemed poised to move higher, like September and December, the market simply falls right back down. And this time it has fallen close to support at the June low of around 1,850. After forming a Golden Cross only a month ago the moving averages immediately formed a Death Cross just a few weeks ago. Unless you're looking for a way to part with your money I'd stay away from this market. 

The NYSE Bullish sentiment index is still in solidly bullish territory, yet not wildly so. It's been fourteen months and counting since the index last fell into the bearish range below 63. I'm remain comfortable with sentiment in the mid-70s because it isn't wildly optimistic, leaving room for further growth. With RSI holding at 50 there doesn't appear to be much to worry about right now. In fact, as I've been writing for months, it seems there is more room for this bull to run.

Right now 71% of stocks traded on the New York Stock Exchange are currently trading above their 50-day moving average, which is not a low number, but not an overly high one either. From this level there's an equal chance of going higher or lower. Either way, I don't see anything ominous on the immediate horizon.    

The VIX is slowly falling to levels of extreme complacency. Each time it's dropped to 12 or below over the past year there has been a spike in volatility, usually coinciding with a drop in the market. Notwithstanding the fact that the VIX has stayed in the complacent end of the trading range for most of the past year, this is something to keep our eyes on. 

You should have a pretty good idea of what I'm thinking right now. I believe the market is headed higher, albeit in fits and starts. I think a budget deal, some stability out of Washington, a growing economy and an accommodative Federal Reserve will all conspire to keep the bull market powering ahead. Add to that the healthy corporate balance sheets and a generally good business climate, and you have a recipe for stock market gains. 

Following that thinking, my clients and I finished the year virtually fully invested, with only about 3% in cash. And since year-end I've put another $300,000 of cash to work buying one new stock and filling in a few other existing positions. The new stock is a leading food retailer that's dropped 20% recently. I thought it would make a wonderful addition to our portfolios. Our holdings remain tilted more towards value than growth, so we expect to mildly underperform bullish markets while capturing most of the gains. On the flip side, we should be more sheltered from some of the downside. I'm happy to make that deal. I prefer to own companies that dominate their sectors, pay above average dividends and can weather any economic crisis. Owning those stocks will tend to generate solid returns year in and year out. Our portfolios are built to last for years, if not decades. My clients and I will be able to sleep well at night with our stocks; can you say the same?

News and Notes

It has been a brutal winter so far in the Northeast and I'm already dreaming about Spring and warmer weather. As I finish writing this we're preparing for another winter storm and arctic blast. It has been no fun around here since Thanksgiving. I'm heading to San Francisco this weekend to celebrate the 50th birthday of one of my great college friends. We all turn 50 this year. How quickly that milestone has descended upon us. Next weekend I'm competing in a local swim meet. Then in February I'll get out of town for a bit to a warmer destination. I'm counting the days until that trip. 

That's it for this month. As always, I thank you, my readers, and remind you that this newsletter is for you. I have been writing News and Views for ten 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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