NEWS AND VIEWS
Werlinich Asset Management, LLC
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greg@waminvest.com
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February 13, 2017


The Party Continues . . . But Danger Lurks

Current Market Analysis
Key Economic Statistics
Trends To Watch
What I'm Thinking and Doing
News and Notes



Current Market Analysis

What can I say about the state of the stock market except "wow". The Dow Jones Industrial Average, S&P 500 and Nasdaq Composite are all at record high levels. Interest rates have leveled off, and even fallen a bit. The price of oil is comfortably over $50/barrel. Investor optimism is high and volatility is low. Corporate earnings for Q4 have come in better than expected and analysts are cautiously optimistic that they'll get better as the year progresses. 

So that means it's full steam ahead with no worries, right? Not exactly. There are potential storm clouds ahead. And the biggest and baddest of those dark clouds resides, part-time anyway, at 1600 Pennsylvania Avenue. But for now, I'll leave you with an old adage that seems very timely right now: "don't fight the tape".

Let's take a look at the chart of the #DJIA. Last month I predicted that we would "see #Dow20k sometime in January." That ended up being spot on as the venerable index passed 20,000 on January 25 in the midst of a powerful post-election surge that has taken the average from 17,883 to the close of 20,269 on Friday. That's a 13.3% gain in only three months. Even more impressive is the 31.2% return in just the past year. That doesn't begin to describe the almost 210% gain in the past eight years since the bottom of the financial crisis. Enjoy the gains while they last; the day of reckoning is coming - sooner or later.  

Even though the Dow Jones Transportation Average has recently achieved a record high, the index continues to underperform its industrial sibling. If #Trump is able to enact a viable infrastructure stimulus plan I would expect this average to jump to new heights. Until that time, I wouldn't be surprised to see a period of consolidation. 

The Dow Jones Utility Average has continued to strengthen over the past few months, perhaps riding the coattails of the broad market rally, but also enjoying a period of somewhat lower interest rates. Now let's see if the index can surpass the green resistance line before the Federal Reserve enacts its next rate increase.

Key Economic Statistics

  • According to the Department of Labor, the figure for seasonally-adjusted initial jobless claims for the week ended February 4 was 234,000, a decrease from the prior week, and about the same as the prior month's figure. The four-week average of 244,250 was a  decrease of about 12,000 from the prior month.
  • The non-farm payroll employment report in January far surpassed expectations as 227,000 jobs were gained in the month, but 39,000 net jobs were subtracted from the prior two months. The household survey reported that the unemployment rate ticked up to 4.8%, but that isn't a bad thing as evidence suggests more people are entering the labor force, which is why the labor force participation rate inched up to 62.9. Average hourly wages for blue collar workers rose to a new high of $21.84 while the average work week has remained stuck at 33.6 hours for eleven of the last twelve months.
  • 7.6 million workers were counted as unemployed, and 1.9 million people remained unemployed longer than 27 weeks. The seasonally adjusted number of people who could only find part-time work rose to 5.8 million while the number of marginally attached workers ticked up to 1.8 million. The number of people holding multiple jobs dropped to 7.41 million. All of this resulted in the U-6 "underemployment" rate falling rising 9.4%, just off the lowest level in a decade.
  • The Congressional Budget Office (CBO) estimated that on a net present value basis, the nation's budget surplus was $49 billion in January, resulting in a deficit of $159 billion for the first four months of fiscal 2017, roughly in line with the deficit for the same period last year.
  • The Census Bureau reported that privately owned housing starts increased 11.3% in December to 1,226,000, which was up 5.7% from a year ago. It was also the largest total since the end of 2007.
  • The Census Bureau reported that on a seasonally adjusted annualized basis 536,000 new homes were sold in December, down 10.4% from November, and basically the same figure as a year ago. The estimate of the number of homes for sale was 259,000, representing 5.8 months of inventory at the current rate of sales, the widest gap in the year. The median sales price was $322,500, well above the rising 12-month moving average price of $308,942.
  • The National Association of Realtors reported that 5.49 million existing homes were sold in December, off the highest level of the year, which was down 2.8% from the prior month, and up 0.7% from a year ago. The estimate of the number of homes for sale was 1.65 million, representing only 3.6 months of inventory at the current rate of sales. The median price was $232,200, which is right on the rising 12-month moving average price.
  • According to the Institute for Supply Management (ISM), economic activity in the manufacturing sector expanded in January for the fifth month in a row, rising from 54.7 to 56.0. The ISM index of non- manufacturing activity dipped to 56.5, which signaled growth in the service sector for 84 consecutive months. These are solid numbers, suggesting the economy is humming right along.
  • The Conference Board reported that its index of Leading Economic Indicators (LEI) was increased 0.5% in December, following a gain of 0.1% in November. "The U.S. Leading Economic Index increased in December, suggesting the economy will continue growing at a moderate pace, perhaps even accelerating slightly in the early months of this year," said Ataman Ozyildirim, Director of Business Cycles and Growth Research at The Conference Board. "December’s large gain was mainly driven by improving sentiment about the outlook and suggests the business cycle still showed strong momentum in the final months of 2016.
  • According to the "advance" estimate by the Bureau of Economic Analysis, GDP increased at a tepid annual rate of 1.9% in Q4 2016. This compares poorly with the 3.5% rate of growth from Q3 but is slightly better than the 1.4% growth rate in Q2 and 0.8% in Q1. It is also slightly better than the 1.4% from Q4 2015. This report should help the Fed hold off on implementing the next rate increase until sometime in the second quarter.
  • According to the BLS, the seasonally adjusted Consumer Price Index for all Urban Consumers (CPI-U) increased 0.3% in December, after a 0.2% increase in November. Over the last twelve months, the index rose 2.1%, which is basically right on the 2.0% target set by the Fed.
  • The Conference Board's Consumer Confidence Index dipped to 111.8 in January from 113.3 (revised) in December. "Consumer confidence decreased in January, after reaching a 15-year high in December," said Lynn Franco, Director of Economic Indicators at The Conference Board. "The decline in confidence was driven solely by a less optimistic outlook for business conditions, jobs, and especially consumers’ income prospects. Consumers’ assessment of current conditions, on the other hand, improved in January. Despite the retreat in confidence, consumers remain confident that the economy will continue to expand in the coming months.

Trends To Watch

Following an inexorable climb during the second half of 2016, the value of the dollar index has taken a hit during 2017, which has provided a little relief to companies with significant overseas revenues. It's also helping the price of commodities like oil and gold. As always, the relative movement of the dollar will be a very important trend to watch this year.

Looking at the chart of the yield on the 10-year Treasury bond, we can see two failed attempts to pierce resistance at 2.6%. As I've said for the last few months, I don't think we'll surpass 3% in the near term, but I do expect to see rates at that level in the second half of the year.

The price of West Texas Crude is consolidating at a new resistance level around $54 per barrel. These slightly higher prices are generating nice gains in the stock prices of companies throughout the energy sector. Should the price remain in the $50s, or even move up to $60, I would expect to see businesses in the oil patches start hiring again as they attempt to bring increased production back online. That would eventually put a cap on the price as increased production would drive the price of oil back down. But for now, we enjoy the gains. 

The action on the price of gold continues to be a traders dream and an investors nightmare, with wild swings but no sustained direction. After it cratered through resistance just below $1,200 per ounce, the price has surged higher, blowing right back through resistance. Honestly, I have no idea what's next, but my guess is there's a greater chance of it moving below $1,200 than above $1,300. 

The good times continue to roll for the tech sector, as evidenced by the chart below, showing the tremendous gains in the Nasdaq Composite. Investors continue to focus on the growth and the earnings potential of these stocks. I do, though, expect a little breather in the weeks or months ahead, bringing the index back down to meet the rising (purple) trendline, which may offer another good buying opportunity. 

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After enjoying a huge post-election run-up, the financial sector continues to take a much needed breather as the index consolidates just below resistance at 24. I think everyone is simply waiting to see if the Trump administration is able to follow through on its goal to repeal Dodd-Frank, and perhaps other governance, thereby releasing banks from some of their regulatory shackles. In addition, the market is anticipating higher interest rates, which will result in higher lending margins, which will boost earnings. I remain bullish. 

The housing index is now making a third attempt to breach resistance around 255. I continues to expect the index to remain in the trading range outlined between the dotted purple and solid red lines for at least the first quarter, after which the next rate increase could send the index lower.

The index representing the developed international markets continues to be range-bound, as it has been for most of the past year. Looking ahead, I see no reason for optimism.

The NYSE Bullish sentiment index has remained in a narrow range for the last eleven months, most recently hugging the resistance line around 72.5. I would normally be very wary of this level of bullishness. The fact that RSI has declined precipitously calms my fears a bit, yet I am still concerned. 

Finally, the price of the VIX remains at absurdly low levels, suggesting way too much complacency among investors, and that makes me nervous. We're due to have something happen. The abnormally low levels of volatility, combined with the high levels of bullishness, leave me very concerned that a correction of some sort could be coming in our near future. 



What I'm Thinking and Doing

I've had a few clients reach out to me since #Trump took office, wondering what effect he might have on the market and our portfolios. My basic answer is that in the short-term, his campaign rhetoric, and early executive actions, have appeared to be positive for business, and therefore good for the stock market. He's talking about infrastructure, tax cuts, regulatory reform and "bringing jobs back to America". And that all sounds great. The problem is that the devil is in the details, and there have been no details provided by this administration as to how of of these, or any, initiatives are to be implemented or funded. So for now the market is rejoicing in collective optimism. Sooner or later reality must set in and then we'll see what happens to the stock market.

I have to admit it's difficult to invest in the face of so much uncertainty. As a result, I've decided to simply follow my normal strategy of owning the best companies in growing sectors, collecting dividends and cutting losses quickly when an idea goes against me. This strategy has served me well over the past two decades and I see no reason to change my ways now. 

So far in 2017 I eliminated one position in the pharmaceutical industry and added a few new ETF holdings. By the end of last year I had completely eliminated all of my mutual fund holdings. Those portfolios had been my worst performers over the last couple of years and I decided that the time was right to shift those holdings from mutual funds to ETFs. I expect better performance, for lower cost, going forward, with greater flexibility. 

Philosophically, as I mentioned above, I prefer to let my winners run while minimizing my losses. There are stocks in my own account that I've owned for more than 20 years and have no plans to ever sell. That is the way to build wealth. The only time I sell something is if it gets to be too big as a percentage of the overall portfolio, or if the fundamental reason why I bought it in the first place has changed. Otherwise, I prefer to buy and hold indefinitely, thereby eliminating trading costs and taxes. 

When I buy a new stock, I do so with the belief that it is a leader in its sector, it has strong competitive advantages, it is growing, profitable and generating positive cash flow, and that all things being equal, I intend to own it for at least three to five years. I try to avoid deeply cyclical industries, fads, or "story stocks". I'm investing money for my clients and my family and I take that responsibility very seriously. I want to help my clients build wealth over time, not "get rich quick". That's why I'm still here, in business serving my clients for twenty years, and still going strong.

News and Notes

We'd just finished digging out from the winter storm that blanketed much of the Northeast on Thursday when we were hit with an ice storm last night, followed by heavy, gusting winds today. Clearly Mother Nature had not forgotten about us during a very mild start to winter. I'm already sick of the cold, dark days and ready for Spring. I'll have to accept instead a few, all-too-brief, trips to warmer climates until the sun is strong enough locally to warm my bones.

Kathiryn has started playing locally with a new band called Merlin. If you live in, or near, Westchester County, you should join us at their next gig in March when they're playing in Port Chester. If you want more information, either check out their Facebook page or email me for the details. 

I'm very blessed that my kids are all thriving. Nola graduates college in just a few months. Lily is getting more active in social justice and women's rights as a freshman at George Washington University. Ezra just passed his driver's test and is having his best year ever in school. Kathiryn and I keep busy on our not-for-profit Boards and with the constant stream of kittens that we've fostered over the past few years. I think we've now placed more than two dozen kittens into wonderful, loving homes. 

That's it for this month. I look forward to communicating with you in the months ahead. If you have any questions, please don't hesitate to contact me. 

Best regards,


Greg Werlinich
President


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