Werlinich Asset Management, LLC

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January 12, 2015

Hold On For More Gains in 2015, plus Fearless Forecasts

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

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. 

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 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!"

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 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 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. I was absolutely correct about the direction of the market, and that buy and hold would be rewarded, but I ended up a bit over-optimistic about the ultimate gains. The DJIA finished up only 7.5% while the S&P 500 ended up a better 11.4%. The results would have been better if not for the plunge in oil prices. There were four corrections of between 5 - 10% (they each lasted less than a month). 
  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 the 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%. This proved fairly accurate. The Fed did not adjust rates and it did end the bond buying program. The yield on the 10-year Treasury spent most of the year between 2.5% and 3.0% before dropping lower in the fourth quarter, ending the year around 2.2%. 
  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. I was right about the trend being higher, but was wrong about the magnitude. After trading in a tight range between 79 and 81 for seven months, the dollar surged higher for the rest of the year, finishing around 90.5, for a gain of about 13%. 
  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. This prediction was dead on, for six months, when it traded as high as $108 and as low as $91. Then it all went horribly wrong as excess domestic and global production, combined with worldwide economic slowdown, conspired to crush prices, which finished the year around $53.
  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. This was a very accurate prediction. The price of gold finished the year at $1,183, almost exactly where it started. During the year, the price did indeed fall below $1,200 to as low as $1,130. The high in March was just a shade under $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. This proved reasonably accurate. The housing market, as represented by the HGX housing index, 5% in the year, albeit with very significant volatility during the year. Housing starts fell 2.5% (through November). New home sales rose 3% and existing home sales rose 8% (also through November). New home sale prices rose a bit more than 10% whereas existing home sale prices rose only 5%. 
  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. I wasn't far off with the average GDP growth rate, which ended up being around 2.5%, although that was very negatively impacted by a decline of 2.1% in Q2. And the second half of the year ended up being much better than the first half. 
  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. I captured the trend, but fell a bit shy of the improvement. The headline unemployment rate fell from 6.7% to 5.8% (through November) while the U-6 dropped from 13.1% to 11.4% over the same period. And the labor participation rate held stubbornly at 62.8.
  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. I got this one wrong. The mid-term elections did change things. The Republicans gained both sides of Congress and the Tea Party remains powerful. The reverberations will be felt all the way through the 2016 elections.

All in all, my forecasts weren't too bad, and if it wasn't for the crash in the oil market, my predictions would have been quite accurate. 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 2015, although not without some greater pain, and with less of a gain. I think the best case scenario puts the Dow Jones Industrial Average up 8%, but could be as little as 5-6%. Let's say the year-end price will be around 18,750. Like last year, I think the S&P 500, with a greater emphasis on tech and growth, will do a little better, finishing up as much as 10%, for a closing price of 2,200. I expect a tough year getting to those gains. We should have four or five declines of more than 5%, with one or two of those being more than 10%. But as last year, buy and hold will be the way to go.
  2. I expect that 2015 will be a difficult year for foreign markets. Look for the developed world, as represented by the MSCI EAFE index to be in negative territory for the year. I also anticipate that the recent gains in the Shanghai index will be reversed next year. And at least one member of the European Union, if not two, will default on a loan.
  3. This is the year the experts believe the Fed will begin to raise rates, and the consensus is sometime this summer. I think the Fed will hold off raising rates longer than anticipated, and once they begin, will raise less than expected. I believe they won't raise before Q4 at the earliest, and if they do raise, they won't increase by more than 25 basis points during 2015. The yield on the 10-year Treasury will remain likely hit a high of 2.25% and could go as low as 1.5%.
  4. The dollar index will continue to move higher in 2015. In fact, I think we could see a gain of about 10%, bringing the index close to 100 for the first time since 2003, and closer to parity with the falling Euro.
  5. What happens to the price of West Texas Crude this year will be one of the biggest stories of 2015. The price has already plunged 50% and it will likely fall further before hitting bottom. I think it could go as low as $40, or even briefly to a quick panic sell off of $35. At that point, the energy sector will be the buy of the year, or of multiple years. It's hard to pick a possible high price, but I'll say $75. 
  6. It's tough to make a call on gold for this year. A stronger dollar and lack of inflation should hurt the price. But heavy buying by Russia, China and India, among others, will help prop up the price. In addition, expected stock market turmoil should increase interest in gold. So I'll leave the median price around $1,250 with a low of $1,100 and a high of $1,350.
  7. I expect the rally in the housing sector to peter out in 2015. I think the rate of growth in new homes will slow considerably, to less than 5% at best, or a drop of 5% at worst. Existing homes will do a little better because they cost less. The HGX will likely be flat for the year, with the first half performing better than the second.
  8. I think the average rate of GDP growth over the next four quarters will be between 2.75% and 3.00%. Falling oil prices will curb growth in the energy sector and a strong dollar will hurt exports. Concerns about global deflation will also limit GDP growth overall.
  9. The headline unemployment rate in 2015 could fall as low as 5.4%, and will likely be no higher than 6%. The U-6 measure for unemployment will likely range from 11% - 12%. The labor participation rate is unlikely to move appreciably. Wage growth will continue to be weaker than needed.

What I'm Thinking and Doing

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

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