Werlinich Asset Management, LLC

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January 21, 2014

The Bull Should Keep On Running

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

Current Market Analysis

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.

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 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. 

Fearless Forecasts - Looking Back and Gazing Ahead

Each year in the January newsletter I make a number of predictions about the stock market, the domestic economy and maybe a few key trends. At the same time, I use this opportunity to review the accuracy, or lack thereof, of my Fearless Forecasts from the prior year. So first, let's see how my prognostications from last year panned out. The forecasts are in black and what really happened is in red.

  1. I think the broad markets will be only modestly higher in 2013. Put me down for an 8% gain for the Dow Jones Industrial Average, which means a closing price of 14,156. That, coincidentally, would be six points below the all time high of 14,164.53 from October 9, 2007. I think the S&P 500 will lag the Dow this year, limiting the S&P to a gain of only 6%, which means a closing price of 1,508. As usual, the market will not rise in a straight line. Indeed, there will likely be two corrections of between 5 - 10%. But again, investors who hold tight will be rewarded. I was right about the direction of the market, but not the magnitude. The DJIA finished up 26.5% and the S&P 500 ended up 29.6%. There were three corrections of between 5 - 10% (they were each around 6%). Buy and hold was definitely the way to go.
  2. I'm confident the Fed will leave short term rates unchanged for the entire year; they've already declared as much. I also believe that there will be no more "quantitative easing" plans as the risks of inflation outweigh the concerns about deflation. I think the yield on the 10-year Treasury will stay in a range of 1.50% - 2.00% and the 30-year bond will remain roughly 1.00% higher than the 10-year. Mixed result here. I was correct that the Fed would leave short term rates unchanged and that there would be no more QE. The 10-year Treasury broke above 2% in June, establishing a new trading range between 2.5% - 3.0%. The 30-year bond yield did indeed remain about 1% higher than the 10-year. 
  3. I think the value of the dollar will be lower by the end of the year, after finishing 2012 around 80. Countries all over the world are attempting to devalue their currency in order to bolster their exports and the U.S. is no exception. I expect the dollar index to trade between 73 - 83. I wasn't too far off. The dollar finished the year right where it started, around 80, after trading as high as 85 and as low as 89 with a primary trading range between 79 and 83. 
  4. I think slower global economic growth this year will limit demand for West Texas Crude, thereby keeping the price down a bit. That being said, I think the price of WTIC will stay for much of the year between $80 - $100, although it wouldn't surprise me to see it briefly drift as low as $70. This prediction was reasonably accurate as the price traded between $90 - $100 for much of the year, with a three month spike during the summer. There was very little downside movement.
  5. The price of gold has moved higher in each of the last 12 years, even as the rate of growth slowed a bit last year, and I'm confident it will go higher again this year. My upside target is about $1,850 per ounce while the downside is about $1,600. The primary trading range will probably be something like $1,650 - $1,750. I think the price of silver could test $40 per ounce again, but will likely remain in a tight trading range between $26 - $36. I don't see silver going much lower than $25. Unfortunately, I could not have been more wrong with my predictions for the precious metals sector, which completely tanked last year, as the price of gold plunged almost 30%. Silver fared even worse, finishing the year down about 40% from the high. This one hurt.
  6. The housing market will continue to rally in 2013. Average prices will slowly rise throughout the year as inventory remains very tight. Interest rates will remain historically low, although they will likely be higher by the end of the year. This was mostly correct. The housing market, as represented by the HGX housing index rose 23% in the year. Housing starts increased 11%. New home sales rose 17% but existing home sales were flat. Prices in both new and existing markets rose nicely. Interest rates, although higher than 2012, did remain historically low in 2013.
  7. I think the average rate of GDP growth over the next four quarters will be around 2.0%, which is slightly lower than 2012. Q4 2012 may be the high water mark as the first half of 2013 could struggle to reach 1.75%. The average rate of growth of GDP for the last four quarters was exactly 2.0%, although the good news was that the rate of growth increased all four quarters, accelerating nicely in the second half of the year after a very laggard first half. 
  8. For the third year in a row, job growth, or the lack thereof, will continue to be one the most important domestic stories of the year. The unemployment rate will likely top out around 8.0% and will fall to only 7.5%. The U-6 measure for unemployment, a more accurate gauge of the true unemployment situation, will likely remain in the 14%-15% range. The other big story will of course be the federal deficit. There was solid improvement on the employment front last year. The unemployment rate fell from a high of 7.9% to a low of 7.0% in November, while the U-6 fell from 14.4% to 12.7% over the same period. And the fight over the deficit caused a government shutdown. 

All in all, my forecasts were a bit of a mixed bag, but except for the horribly wrong forecast for gold  I wasn't too far off last year. And remember, I have no formal training in economics. I'm just someone who closely observes what is happening in the world and tries to apply that knowledge to my investment management business. Anyway, last year is history now; it's time to look forward, which means a new set of Fearless Forecasts. So without further ado, here we go:

  1. I think the broad markets will again finish higher in 2014. Put me down for a 12% gain for the Dow Jones Industrial Average, which means a closing price of 18,565. I think the S&P 500, with a greater emphasis on tech and growth, could do a little better, finishing up 14%, for a closing price of 2,106. As usual, the market will not rise in a straight line. I expect there will be two or three corrections of between 5 - 10%. One could even be worse than that. But investors who hold tight will be rewarded.
  2. For the second year in a row I believe the Fed will leave short term rates unchanged. I also think the Fed will reduce their bond buying program to at least $40 billion a month by year-end. If they economy is strong enough, they could have it down to zero. The yield on the 10-year Treasury will remain in a relatively tight range of 2.75% - 3.25%.
  3. For two years the dollar index has traded between 79 and 85 and closed the year around 81. Given the reduction in QE, a falling deficit and trade gap, I expect the dollar will be 5% higher, or about 85, by the end of the year. 
  4. I think an improved global economy this year will increase demand for West Texas Crude, putting upward pressure on the price. On the other hand, increased supplies from shale drilling will be a drag on prices. Therefore, I expect the price for a barrel of oil to remain relatively range-bound in the $90s for most of the year, with a low of $85 and a high of $105. 
  5. After 12 straight years of increases the price of gold fell last year, and fell hard, finishing around $1,200/oz. Longer term, meaning over the next few years, I think gold will move higher. Before that however I think gold will drop below support at $1,200, falling to as low as $1,000. The yearly high is tougher to judge, but I'll estimate the high to be no better than $1,400.
  6. I expect the housing sector to continue to rally in 2014, albeit at a measured pace as slightly higher interest rates inhibit a faster rate of growth. The volume of new and existing home sales will rise by no more than 5% and average prices will gain slightly less as inventory rises.
  7. I think the average rate of GDP growth over the next four quarters will be around 3.0%, a marked increase from the prior four quarters. I expect the first two quarters to have a higher rate of growth than the second two.
  8. Real job growth, or the lack thereof, will continue to be one the most important domestic stories of the year. The headline unemployment rate could fall as low as 6%, and will likely be no higher than 7%. The U-6 measure for unemployment, a more accurate gauge of the true unemployment situation, will likely remain in the 12.5%-13.5% range. The bigger problem is the dismal labor participation rate, which has fallen to a thirty-five year low of 62.8. That measure must improve in 2014. 
  9. Finally, I don't believe the mid-term elections will do much to change the political landscape. Congress will likely remain divided. I do expect the The Tea Party to be marginalized as the electorate realizes that a hyper-polarized Congress cannot govern at all. 

What I'm Thinking and Doing

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

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