February 18, 2014

The Dow Jones Industrial Average closed Friday at 16,154, down 307 points, or 1.8%, from when I wrote to you last month. After the strong rally of the last two weeks the index is now only 2.5% below the all time high of 16,575 set on December 31. It would seem that this was a classic "buy the dip" rally after a quick correction in January. Last month I said that "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." I was right about the impending correction buy wrong about the timing. Either way, it seems to be over, at least for now. Did you buy anything?

I believe the most important factor underpinning this rally continues the Federal Reserve. As long it maintains its accommodative monetary policy, which Fed Chairwoman Janet Yellin most certainly will, then the stock market should continue to move higher. Although the Fed has announced its intention to taper their bond buying program, it has renewed its pledge to keep rates artificially low into 2015 and beyond. Yellin also made it clear the Fed will do whatever is necessary to spur economic growth. That means the party should continue.

Looking at the chart of the DJIA, we see that the 7.5% correction in January did not drag the index down to support just above 15,000. That's very positive. The overall trend remains bullish as the current price has risen above moving averages, RSI is at a reasonable level and MACD has turned positive.

The chart of the Dow Jones Transportation Average is also bullish as it too has recovered after its correction of about 7.6%. Like the Industrial Average the current price is above both moving averages, RSI is at a reasonable level and MACD has just turned positive. Two months ago I suggested that a dip below 7,100 would be a decent entry point. I hope you took advantage of the quick decline. We may not see that level again for a while.

As interest rates have stabilized, the Dow Jones Utility Average continues to improve. The index is now well above both moving averages which are about to form a Golden Cross as the 50-day averages moves above the 200-day. Last month I said '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." That is exactly what happened. The index is currently at resistance at 520. RSI and MACD are both mildly overbought so I wouldn't be surprised to see a small pullback before the next big surge. 

The yield on the 10-year Treasury has for eight months remained in the tight trading range of 2.5% to 3.0% delineated below. I expect rates, at least for the next few months, to remain in this range. By the second half of the year it's possible that rates will rise above 3% and head to more "normal" levels.

Last Month's Results

After the historic gains enjoyed in 2013, trading in January started the new year off with a thud. All of the major averages swooned, with the Dow Jones Industrial Average leading the way, which was a bit of a surprise, as was the fact that the NASDAQ was the best performing average. Usually value holds up best during a correction, but technology continues to lead the way. Not surprisingly, bonds rallied in a flight to safety. I wouldn't expect this dynamic to continue; bond investors can use this opportunity to lighten up as prices have gained, if only temporarily. 

* 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 February 8 was 339,000, an increase of 8,000 from the prior week's revised figure. The four-week average of 336,750 is about 2,000 higher than the tally from a month ago. According to the seasonal average, about 2.95 million people continue to collect unemployment insurance, which is a decrease of over 50 thousand people. That's a start, but one month does not a trend make.
• The non-farm payroll employment report disappointed again in January as the number of jobs created was again lower than expectations. Revisions to the December results added only 1,000 new jobs, while November added an additional 33,000 jobs. The establishment survey reported that a modest 113,000 jobs were added in the month, while the household survey reported that the unemployment rate fell to 6.6%. The more comprehensive U-6 "underemployment" rate dropped to 12.7%. The reality is that many more people are without jobs than the government would like you to believe. 10.2 million workers were counted as unemployed while the labor force participation rate inched up to 63.0%. What this means is that people are finding it next to impossible to find a job and are simply dropping out of the labor force, and therefore not counted as actually unemployed.
• 3.6 million people continued to be unemployed longer than 27 weeks. The seasonally adjusted number of people who could only find part-time work fell to 7.3 million and the number of marginally attached workers rose to 2.6 million. The number of people holding multiple jobs declined to 6.7 million. The average hourly wages for blue collar workers moved higher to $20.39 while the average work week remained at 33.5 hours. Overall, this is a another dismal report and it's hard to see how things will improve much over the next month or so.
• The Congressional Budget Office (CBO) estimated that on a net present value basis, the Treasury reported a federal budget deficit of $10 billion in January, which means that four months into fiscal 2014 the cumulative deficit is $184 billion, $107 billion less than the same period in the prior year, thanks to increased tax receipts and lower government expenditures. The full year fiscal deficit is expected to be $514 billion, about 3% of GDP, compared with a deficit of $680 billion in fiscal 2013.
• The Census Bureau reported that the U.S. trade deficit of goods and services rose to $38.7 billion in December as the growth in imports outpaced exports. Part of this can be attributed to the problems in the emerging economies. As such, it's possible the the trade gap may widen some more over the next few months.
• The National Association of Homebuilders/Wells Fargo Confidence Index fell one point to 56 in January, but remained above 50 for eight straight months. According to NAHB Chairman Rick Judson, "following an unexpected jump last month, builder confidence has essentially leveled out and is holding at a solid level. Many markets continue to improve and this bodes well for future home sales."
• 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, 414,000 new homes were sold in December, down 7.0% after a 3.9% loss in November, but still 4.5% higher than a year ago. The estimate of the number of homes for sale is a modest 171,000, which represents a slim 5.0 months of inventory at the current rate of sales. The median sales price rose by $1,800 to $270,200, which is above the 12-month moving average price of $263,600. I would expect the harsh weather to continue to diminish sales in January, and possibly February.
• The National Association of Realtors reported that on a seasonally adjusted annualized basis, 4.87 million existing homes were sold in December, a 1.0% increase from November, but 0.6% lower than a year ago. The last two months produced the two smallest monthly sales numbers of 2013. It's also worrisome is that the average selling price of $198,000 has declined for five of the last six months, yet remained a slim $2,317 higher than the rising 12-month average of $195,683. The estimate of homes for sale dropped to 1.86 million, which is the lowest number of homes for sale in the year and represents 4.6 months of inventory at the current rate of sales. 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 dropped significantly in January from 56.5 to 51.3, yet it marks overall growth for eight straight months. It's clear that bad weather negatively impacted these figures. On the other hand, the ISM index of non-manufacturing activity rose to 54.0, which marked growth in the service sector for 48 consecutive months.
• The Conference Board reported that it's index of Leading Economic Indicators (LEI) increased 0.1% in December, following a robust 1.0% increase in November. According to Ataman Ozyildirim, Economist at The Conference Board, "Despite month-to-month volatility in the final quarter of 2013, the U.S. LEI continues to point to gradually strengthening economic conditions through early 2014. The LEI was lifted by its financial components in December, but consumer expectations for business conditions and residential construction continues to pose risks."
• According to the Bureau of Economic Analysis, the "advance" estimate of GDP growth for Q4 2013 was a solid 3.2%, but a bit lower than the surprisingly robust 4.1% logged in Q3. Much of this improvement is due to increases in personal consumption expenditures, exports, nonresidential fixed investment and increased state and local government spending. This continues the 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.
• The Federal Reserve reported that in December the amount of total outstanding consumer credit grew at a 7.25% annualized rate, up to $3.1 trillion. This is easily the highest number since I first started reporting this statistic in 2007.
• The Conference Board's Consumer Confidence Index, continued to strengthen in January, increasing to 80.7 from 77.5. Says Lynn Franco, Director of The Conference Board Consumer Research Center "Consumer confidence advanced in January for the second consecutive month. Consumers’ assessment of the present situation continues to improve, with both business conditions and the job market rated more favorably. Looking ahead six months, consumers expect the economy and their earnings to improve, but were somewhat mixed regarding the outlook for jobs."

Trends To Watch

As interest rates have stabilized, and the budget and debt ceiling deals have been agreed to, the dollar index has stabilized into a tight trading range between 79 and 81.50. A weaker dollar helps the trade deficit and props up commodity prices. I'd expect the price of the dollar index to remain relatively stable for a while.

It's looking more and more like my capitulation in December did, in fact, call the bottom in gold. Not my best moment. The price of gold has risen more than $100 since bouncing off support in late December. The big question is where does gold go from here? Can it move through interim resistance around $1,350 and move even higher? Or is this simply a trading rotation into a beaten down sector? Only time will tell. For now, I remain on the sidelines.

Last month I wrote that I didn't understand why the price of West Texas crude had fallen as far as it did. I went on to say that I thought that the price would "likely stabilize around the $100 midpoint of the price range shown below." As the price has quickly moved up as I had expected, I now think the price will remain somewhat stable for the next few months.

The bull market in the financial sector took a short breather in January during the correction. That pause provided a nice buying opportunity for adept traders and smart long-term investors who listened to my advice to buy on weakness. The price of the index quickly moved back above its 50-day moving average and the rising trendline. So for now, this sector remains bullish. 

After five months of gains, the index for the housing sector is now bumping against major resistance at the level last set in May. The 50-day moving average is now well above the 200-day average. MACD has turned up and RSI is positive but not overbought. Watch for the residential housing numbers to turn up in the next month or so. 

The index for the developed international markets dropped in January with the rest of the broad markets, although it did not breach support. And it has recovered in February along with everyone else. The index price is now solidly in the middle of the trading range shown below and traveling an upward path. The chart remains bullish. 

The Chinese economy, and by proxy its stock market, still remains the fly in the ointment of an otherwise worldwide bull market. In January the index again tested support around 1,950 only to bounce higher. Still, this is a sickly chart. The index formed a Death Cross last month that has not been corrected. And the trading channel is narrowing as you can see below. Sooner or later the index will have to move clearly one way or another. Personally, I wouldn't buy this market. 

The NYSE Bullish sentiment index cratered in January during the correction. Even though the chart looks bad, this is actually a good thing. It had been fourteen months since the index fell below support around 63. This drop takes some froth out of the market and prepares it for the next bullish move. Each time RSI fell into wildly oversold territory, like it just did (see the red circles), the markets rose nicely. I don't expect anything different this time. 

Right now 65% of stocks traded on the New York Stock Exchange are currently trading above their 50-day moving average, up from only 32% just two weeks ago. Like the bullish sentiment above, I'm optimistic that the recent move took some of the excess from the market. I think we're full steam ahead from here.&

After a brief but violent spike of volatility last month, the VIX has quickly fallen back into the complacent zone. Last month I wrote that "each time [the VIX] dropped to 12 or below over the past year there has been a spike in volatility, usually coinciding with a drop in the market". Once again, that proved correct. Let's see if this relationship continues in the future.  

I believe the correction in January was just what the market needed. It relieved some pressure from an overly bullish market and provided a buying opportunity for opportunistic investors. I think the conditions are ripe for the market to continue higher. We have a signed budget deal in Washington, as well as an accord on the debt ceiling. We're enjoying a steadily growing economy and a highly accommodative Federal Reserve that will do whatever is necessary to prop up the economy. Corporations are doing deals, buying back their stock and paying increasingly large dividends. 

Because I believe the market remains in a long-term bullish trend for all of the reasons enumerated above, my clients and I remain fully invested. Indeed, I used the pullback to use a part of our small cash reserves to buy even more stock. And those purchases are already nicely profitable. But as always, we're looking for the long term, continuing to buy stocks the will grow steadily, pay sizable dividends and help us build sustainable wealth. 

As I prefer to remain conservatively positioned, our holdings remain tilted more towards value than growth. As a result, I expect to mildly underperform bullish markets while remaining somewhat protected from the full wrath of the Bear. The only way to build real wealth is to avoid big losses and allow your gains to build. Toward that end, I choose to own companies that dominate their sectors, pay above average dividends and can weather any economic crisis. These types of stocks 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? If not, maybe you should give me a call. 

News and Notes

The brutal winter in the Northeast continues with unyielding cold and incessant snow. I continue to dream about Spring and warmer weather. In a couple of days that dream will become a reality as I get out of town for a little while to recharge my batteries. 

It's Winter Vacation for my kids this week and I'm researching our end of summer family vacation. Dreams of warmer weather indeed. Hopefully we can create another memorable trip to rival the one we had last summer on Cape Cod.

I had a great time with my college friends in San Francisco a few weeks ago as we began our year-long 50th birthday celebration. We all turn 50 this year. How quickly that milestone has descended upon us. Round Two is in May. 

I had a few good races in a swim meet on Long Island last weekend. After eight month of very hard training, I'm looking forward to a few more meets over the next month before I take a little break. I'm hoping my efforts results in a few Top Ten times in my last meets in the 45-49 age bracket.  

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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