January 12, 2015

As I write this before the market opens for business, the Dow Jones Industrial Average stands at 17,737, up a modest 141 points from when I last wrote to you. We've had only six trading days so far this year, five of any consequence, and the volatility has been astonishing. Last week we experienced losses of 331, 130 and 170 points surrounding gains of 212 and 323 points. That turbulence is great for professional traders but not much fun for normal investors. Unfortunately, I think we should get used to erratic price action as the market becomes more and more controlled by algorithmic index traders and even less by traditional investors. As a result, investors will have to become even more patient, and willing to sit through the roller-coaster daily and weekly fluctuations in the market. 

So let's take a look at the charts and see what they tell us. When looking at the chart of the #DJIA, the first thing that jumps out at me is the extreme volatility over the past six months, following six relatively smooth months earlier in the year. As I said in the first paragraph, I think this is a sign of things to come. We should get used to large, rapid price swings. In addition, the price of the index remains in the middle of the trading range and above both moving averages. I've drawn the first line of support (beige line) at around 17,350, about 400 points below the current price. So for now, things remain ok.

While the Industrials remains in a bullish trend, how about the Transportation Index, the other key component of Dow Theory? The chart suggests that the #DJTA is still bullish, but not wildly so. The current price has fallen below the 50-day moving average, but is holding above the 200-day average. Importantly, the current price is within the trading range and just above support around 8,700 (pink line). Clearly falling oil prices and deflationary pressures are having a deleterious effect on this group, but I think this remains a core sector for investors.

The #DJUA continues on its slow and steady bull run. Utilities are not, nor have they ever been, a sexy asset class. Yet it was one of the best performing sectors last year. And if you took my advice last year and bought, or held on, you are sitting on solid gains with your holdings.The current price is above both moving averages and trading in the upper end of the trading range. I recommend you hold on because low interest rates will likely fuel further gains in 2015.

Finally, we have the great puzzle that is the yield on 10-year Treasury, which confounded most experts by refusing to rise as expected last year. As we can see, it did just the opposite, falling in almost a straight line throughout the year. The current yield is around 2.0%, or right on the pink support line. I now believe that yields will fall even further, perhaps even challenging the historically low yields from 2012. Amazingly, the bull market in bonds is not over yet.

Last Month's Results

By most measures, it was a good year for investors in 2015, even with a desultory December. Large cap stocks earned 10%-15% in 2014, small-cap stocks gained 4%-5.6% and government bonds brought in another 6%. Only the EAFE lost money last year, dropping 4.5%. I think 2015 will follow a similar pattern with large beating small, domestic trouncing foreign and bonds being a safe haven. 

* 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 January 3 was 294,000, an decrease of 4,000 from the prior week's revised figure, and similar to the figure from this time last month. The four-week average of 290,500 is about 8,000 lower than the tally from a month ago. About 2.45 million people continue to collect unemployment insurance, which is very similar to the tally from last month. Limited progress continues to be made.
• The non-farm payroll employment report in December beat expectations as the establishment survey reported that 252,000 jobs were added in the month, while revisions added an additional 50,000 to the prior two months. The household survey reported that the unemployment rate dropped to 5.6%. The more comprehensive U-6 "underemployment" rate fell to 11.2%. A reduced 8.7 million workers were still counted as unemployed (four hundred thousand less than last month). The labor force participation rate dipped to 62.7%. That key metric simply refuses to rise in any meaningful way.
• 2.8 million people remained unemployed longer than 27 weeks, slightly better than last month. The seasonally adjusted number of people who could only find part-time work dropped to 6.8 million but the number of marginally attached workers increased to 2.3 million. The number of people holding multiple jobs fell to 7.31 million. Oddly, the average hourly wages for blue collar workers fell to $20.68 while the average work week held at 33.8. So jobs are being created, but they are low paying or part-time jobs. I don't think this report will nudge the Fed into raising rates any time soon.
• The Congressional Budget Office (CBO) estimated that on a net present value basis, the Treasury reported a federal budget surplus of $3 billion in December, leaving the three-month deficit at $175 billion, about $3 billion more than the shortfall recorded in the same period last year. Revenues and expenditures were both higher than at the same point last year.
• The National Association of Homebuilders/Wells Fargo Confidence Index dipped one point in December to 58. “Members in many markets across the country have seen their businesses improve over the course of the year, and we expect builders to remain confident in 2015,” said NAHB Chairman Kevin Kelly, a home builder and developer from Wilmington, Del.
• The Census Bureau reported that privately owned housing starts fell 1.6% in November, to a seasonally adjusted annual rate of 1,028,000 units, which was 7.0% lower than a year ago, but still near their highest levels of recent years. New building permits also fell 5.2% from the prior month and were down 0.2% from the year before. Overall, these seemingly weaker numbers notwithstanding, housing starts have been solid for the past year, suggesting that the housing market should remain stable, for now.
• The Census Bureau reported that on a seasonally adjusted annualized basis,438,000 new homes were sold in November, down 1.6% from October and a similar 1.6% from a year ago. The estimate of the number of homes for sale is 213,000, which represents 5.8 months of inventory at the current rate of sales. The median sales price fell to $280,900, a drop of $10,000 from last month, but still near the highest level recorded in the past 10 years, and roughly equal to the 12-month moving average price of $279,142.
• The National Association of Realtors reported that on a seasonally adjusted annualized basis, 4.93 million existing homes were sold in November, a drop of 320,000, or 6.1%, from October but still up 2.1% from a year ago. The estimate of homes for sale is 2.1 million, which represents only 5.1 months of inventory at the current rate of sales. The average selling price dropped for the fifth straight month, falling to $205,300, which is not equal to the rising 12-month average of $205,667.
• According to the Institute for Supply Management (ISM), economic activity in the manufacturing sector dipped at bit again in December to 55.5, but still ;marked overall growth for nineteen straight months. The ISM index of non-manufacturing activity also dipped, down to 56.2, which still signaled growth in the service sector for 59 consecutive months. These middling numbers demonstrate continued growth, albeit modest, in the economy.
• The Conference Board reported that its index of Leading Economic Indicators (LEI) increased 0.6% in November, following a gain of 0.6% (revised) in October. "The increase in the LEI signals continued moderate growth through the winter season," said Ken Goldstein, Economist at The Conference Board. "The biggest challenge has been, and remains, more income growth. However, with labor market conditions tightening, we are seeing the first signs of wage growth starting to pick up."
• According to the Bureau of Economic Analysis, GDP increased at an annual rate of 5.0% in Q3 2014 according to the "third" estimate, a big improvement over the second estimate of 3.9%, and slightly better than the estimate of 4.6%& in Q2. That remains far beyond the anemic decline of 2.1% in Q1 and "normal" growth of 2.6% in Q4 2013. By comparison, GDP growth was 4.1% in Q3 2013. It is extremely unlikely that this type of growth will continue much longer.
• The Federal Reserve reported that in November the amount of total outstanding consumer credit grew at an annualized rate of 5.0%, up to $3.298 trillion. The amount of outstanding consumer credit has increased every month since July 2012 and is at the highest level since I started tracking this in 2004. With interest rates near zero there is simply little incentive these days for anyone to save. The only benefit is that consumers continue to pump money into the retail sector.
• According to the Bureau of Labor Statistics, the Consumer Price Index for all Urban Consumers (CPI-U) declined 0.3% in November on a seasonally adjusted basis. Over the last 12 months, the index increased a modest 1.3%. The sharp decline in gasoline, fuel oil and natural gas prices helped cause the drop, even as the cost of food, shelter, medical care and travel all increased.
• The Conference Board's Consumer Confidence Index, which declined in November, rose again in December from 91.0 to 92.6. Says Lynn Franco, Director of The Conference Board Consumer Research Center, "Consumer confidence rebounded modestly in December, propelled by a considerably more favorable assessment of current economic and labor market conditions. As a result, the Present Situation Index is now at its highest level since February 2008 (Index, 104.0). Consumers were moderately less optimistic about the short-term outlook in December, but even so, they are more confident at year-end than they were at the beginning of the year."

Trends To Watch

In order to put the gains enjoyed by the dollar into the proper perspective I have had to broaden the time frame to thirteen years. Doing so allows us to see that the dollar index hasn't been this high since the end of 2005. And I think the dollar will continue to outperform most other currencies this year, which means this index will continue to appreciate. And that could have negative repercussions for commodity prices (oil, precious and base metals) as well as the fortunes of companies that earn the preponderance of their sales overseas. This will continue to be a very important investment theme this year.

Here is the other incredibly important chart. The price of West Texas Crude remains in free fall and it's dragging the entire energy sector down with it. In late December the price dropped right through the second support (blue line) at $60. The final, crucial support level is the post-financial crisis price of around $40 (or $35 if you really want to get picky). While I don't think the price will fall that far, if it does, I think that could be the capitulation bottom and it's where I will be an active buyer. For now, as long as prices keep falling, I'm not ready to jump in quite yet.

The price of gold may be showing some life right now. With deflation rearing its ugly head in many places around the globe, more and more central bankers are contemplating quantitative easing programs, thereby debasing their currencies in order to jump start their economies. This will be good for gold. Should the price get above $1,225 it might be a signal for traders to buy. 

The strong dollar is certainly no friend to the price of copper. It has fallen, for the fourth time in the past five years, to major support at $2.80. It hasn't been below that price since recovering from the financial crisis level of $1.25 at the end of 2008. Even though the fundamental situation with copper shouldn't be as dire as it was in 2008, I'm still very concerned about this picture. If the dollar doesn't alter its upward trajectory, copper will continue to suffer.

The Nasdaq Composite is continuing its inexorable climb to surpass the record closing price of 5,048.62 from March 10, 2000. As of this writing, the index is only 344 points, or about 7%, below the record. It has been a VERY LONG road to get to this point. I expect the tech-heavy index to finally push through that level sometime in the first half of next year. Accordingly, I have been increasing the tech exposure in my portfolios.

I made two "buy" calls on the financial sector last year, both of which were fortunately well timed. Since then, I've recommended that investors simply sit tight and wait for the next pullback. Nothing in the chart suggests to me that I change my stance. I'm still bullish on this sector long-term, but I'm not ready to add new funds right now as the index remains higher than moving averages and above the center of the trading range. If the price approaches 23.5, I might add to my positions.

Last month I wrote that the "moving averages had just formed a "Golden Cross" whereby the 50-day moving average moves higher than the 200-day average. This is generally viewed as a very bullish price formation. So perhaps this dip will be temporary, setting the stage for a definitive move higher than 215." The index did, in fact, trade higher. The current price is just below a resistance level not seen since before the financial crisis. The index has increased more than four-fold since the depths of the crisis. Will it now surpass the old highs, or will it roll over and break below the rising trendline? Time will tell. 

The index for the developed international markets has fallen about 15% since its peak in July. The current price has fallen below support at 60 and is well below both moving averages. The next support comes in around 55, which if attained, would put the index solidly in bearish territory. This is not a pretty chart, and given the currency troubles plaguing much of the rest of the world, as well as deflationary pressures, I don't expect things to improve any time soon. I'm reiterating the call I made last month to stay away from this sector.

The Shanghai Index has gone parabolic, and I just don't understand why. The price has jumped almost 78% in just over six months, and amazingly, its happening in a vacuum. Are you reading any headlines about it? Can you imagine the media frenzy if the S&P 500 jumped almost 80% in six months? I wish I could say I bought a Chinese ETF and booked some big gains, but no, I didn't believe in the rally. And looking at the chart now, seeing both RSI and MACD both extremely overbought, I would sit and wait for the inevitable correction. Because when it comes, it's going to be a doozy. 

The NYSE Bullish sentiment index proved to be a very good contrary indicator last year. If you bought near the bottom of each of the four declines you would have done very well. Timing the tops would have been far more difficult. Looking ahead, the market could go either way in the near-term, so I wouldn't be a buyer or a seller right now.  

The index that tracks the percentage of stocks on the New York Stock Exchange that are currently trading above their 50-day moving average dovetails very nicely with the Bullish Sentiment. So much so that I'm going to stop producing this one after this month. Suffice it to say, like the chart above, this chart doesn't suggest a near-term direction right now.  

Finally, we can see "A Year In Volatility", as represented by the VIX. My feeling is that this index will spend more time above 22 this year than last, with the bulk of the time in 2015 in the 16 - 22 range as volatility increases with uncertainty. To paraphrase something Bette Davis once said,"Fasten your seat belts, it's gonna be a bumpy ride!"

There isn't much else I can say about what I'm thinking that I didn't cover above. I think "the market" will end 2015 5% - 10% higher than it begins. I expect a number of dips along the way, with at least one 10% correction. The trend towards indexing will continue as people read the stories that a smaller and smaller percentage of professionals are "beating the market". And while that may be true, it doesn't tell the whole story. Few investors have the discipline to buy the index on January 2 and sit with it until December 31, thereby earning the entire return. But that's another story for another day. I think the Fed will decide to leave short-term rates unchanged for most, if not all the year. In the same vein, I think rates will fall lower than anyone expects. As a result, interest rate sensitive sectors like REITs and utilities will continue to do well. 

So what am I doing right now? Nothing. I'm holding my existing positions, collecting my dividends, and waiting. I'm in no hurry to buy anything, nor am I compelled to sell anything. In which case, the best thing is to wait and watch, building up some cash. Then, when the time is right, I'll be ready to act. I expect sometime in the next six months I'll be ready to jump into the energy sector and buy some great companies at bargain basement prices. But as long as oil prices keep sliding, I'll wait and watch.

News and Notes

For me personally, 2014 was a great year. I got married to a fantastic woman with whom I've begun the life partnership I've always dreamed about. My kids are all doing well and thriving. I trained long and hard in the pool which led to some fast swims and a couple of Top 10 times. My clients were rewarded by my stewardship and patience with strong returns, and I'm optimistic about another solid year in 2015. I even manged to turn 50 with only a few minor aches and pains. Importantly, I made philanthropy a much more important part of my life last year, with both my time and my money. Going forward, that commitment will only become more important and more meaningful. Among the biggest recipients of my time and money is the Food Bank for Westchester. There are few things that you can do for another human being more important than provide food to those in need, and that is the mission of the Food Bank. If you'd like more information, simply click here.

In the face of turmoil around the world, examples of man's inhumanity to his fellow man, Ebola outbreaks, global economic malaise and anything else you can think of, I remain optimistic. I think we're on the cusp of great achievements in technology and medicine that will create great wealth and help alleviate suffering around the globe. I believe the ubiquity of the internet and the immediate dissemination of information will slowly (very slowly in some cases) help improve the human condition around the globe. We just all need to step outside of our own selfish needs and try to help those less fortunate and make a difference in the lives of those around us. If we each do that, in ways large and small, we can all play a part in improving all of our lives.

That's it for this month. As always, I thank you for reading. If you'd like to speak with me about your investment needs, or if you know of 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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