March 17, 2014

The Dow Jones Industrial Average closed Friday at 16,065, down 89 points, or 0.5%, from when I wrote to you last month. The index, and the market overall, fared poorly last week thanks primarily to the unrest in the Ukraine. The worry is that Russian President Putin is attempting to recreate the old Soviet Union by enticing Crimea to secede from the rest of the Ukraine and then either become an independent state or return to the bosom of mother Russia. This is not making the rest of the world very happy and could potentially escalate to economic sanctions, or worse. This uncertainty is roiling world markets, and various currencies, and could provide the next good buying opportunity. 

Looking at the chart of the DJIA, we see the powerful rally in February, followed by the recent dip (teal circle). And yet, with all of the volatility over the past year, the trading channel remains unblemished. The index has managed to record successively higher highs and higher lows, which is very bullish. Short-term, I the index could move a bit lower before it's likely to recover and move higher. 

The chart of the Dow Jones Transportation Average also remains bullish, hanging just below the all time high. After tracing a clear upward channel a new trading range has appeared (within the teal lines). Twice the index tried, and failed, to break through resistance and below support. As with the DJIA, I'd expect some short-term weakness before the gains continue. 

The Dow Jones Utility Average continues to gain strength. After forming a Golden Cross last month, the index tried, but failed, to pierce major resistance around 537 (red line). Still, the pullback barely dented the momentum as the index bounced off interim support (green line) and headed higher. Given the global unrest right now, which should inspire a flight to bonds, which would lower rates, utilities could enjoy more gains. 

The yield on the 10-year Treasury has, for nine months, remained in a tight trading range between 2.5% and 3.0%. There's no reason to believe anything will change in the immediate future. Last month I said that "by the second half of the year it's possible that rates will rise above 3% and head to more "normal" levels." That can only happen if a peaceful solution is forged in the Ukraine and if China can demonstrate renewed growth.

Last Month's Results

After a miserable January the market recovered very nicely in February with gains across the board. All of the major averages surged with the NASDAQ leading the way, both in the month and year-to-date. Interestingly, the EAFE had a very robust month as investors looked past weakness in China to see hopes for a growing global economy. Even more interesting is that the YTD return on bonds is beating the return on value stocks. I wouldn't bet on that continuing for the balance of the year. 

* 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 March 8 was 315,000, an decrease of 9,000 from the prior week's revised figure. The four-week average of 330,500 is about 6,000 lower than the tally from a month ago. According to the seasonal average, about 2.85 million people continue to collect unemployment insurance, which is a decrease of about 100 thousand people from last month. That's progress.
• The non-farm payroll employment report in February showed surprising strength as the establishment survey reported that a generous 175,000 jobs were added in the month, and revisions added another 25,000 to prior months, while the household survey reported that the unemployment rate was 6.7%. The more comprehensive U-6 "underemployment" rate dropped to 12.6%. 10.5 million workers were counted as unemployed, an increase over the prior month because more people seem to be looking for work, while the labor force participation rate held at 63.0%.
• 3.9 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 7.4 million and the number of marginally attached workers fell to 2.3 million. The number of people holding multiple jobs rose to 7.2 million. The average hourly wages for blue collar workers increased to $20.50 while the average work week dipped at 33.3 hours. Overall, this is a much improved report as it appears that more people are entering the job force and workers are earning more money.
• The Congressional Budget Office (CBO) estimated that on a net present value basis, the Treasury reported a federal budget deficit of $195 billion in February, which means that five months into fiscal 2014 the cumulative deficit is $379 billion, $115 billion less than the same period in the prior year, thanks to increased tax receipts and lower government expenditures.
• The Census Bureau reported that the U.S. trade deficit of goods and services rose slightly to $39.1 billion in January. I suggested last month that due to the problems in the emerging economies the trade gap may widen some more over the next few months and that seems to be coming to pass.
• The National Association of Homebuilders/Wells Fargo Confidence Index plunged ten points to 46 in February, breaking a streak of eight months above 50. “Significant weather conditions across most of the country led to a decline in buyer traffic last month,” said NAHB Chairman Kevin Kelly, a home builder and developer from Wilmington, Del. “Builders also have additional concerns about meeting ongoing and future demand due to a shortage of lots and labor.”
• The Census Bureau reported that privately owned housing starts plunged 16.0% in January to a seasonally adjusted annual rate of 880,000 units, a level 2.0% below a year ago. New building permits fell 5.4% from the prior month and remained only 2.4% higher than the year before. Given the horrible weather conditions this winter, these terrible numbers aren't surprising. 
• The Census Bureau reported that on a seasonally adjusted annualized basis, 468,000 new homes were sold in January, up 9.6% after a 3.8% loss in December, and remains 2.2% higher than a year ago. The estimate of the number of homes for sale is 184,000, which represents a very slim 4.7 months of inventory at the current rate of sales. The median sales price fell by $5,800 to $260,100, which is below the 12-month moving average price of $264,350. I'm surprised by the robust results in January; I expected that the harsh weather would diminish sales in January, and possibly February.
• The National Association of Realtors reported that on a seasonally adjusted annualized basis, only 4.62 million existing homes were sold in January, the lowest figure in almost a year and a half, and a 5.1% decrease from December and a year ago. Sales have fallen by 760,000 since last July and the average selling price has dropped by $25,100 since June to a level almost $10,000 below the 12-month average of $197,183. The estimate of homes for sale increased to 1.9 million, which represents 4.9 months of inventory at the current rate of sales. As I mentioned above, I don't expect any real progress until the weather improves in March or April.
• According to the Institute for Supply Management (ISM), economic activity in the manufacturing sector rose in February from 51.3 to 53.2, marking overall growth for nine straight months. On the other hand, the ISM index of non-manufacturing activity fell to 51.6, a weak number, but one which still marked growth in the service sector for 49 consecutive months.
• The Conference Board reported that it's index of Leading Economic Indicators (LEI) increased 0.3% in January, following no change in December. According to Ataman Ozyildirim, Economist at The Conference Board, "The U.S. Leading Economic Index continues to fluctuate on a monthly basis, but the six-month average growth rate has been relatively stable in recent months, which suggests that the economy will remain resilient in the first half of 2014 and underlying economic conditions should continue to improve."
• According to the Bureau of Economic Analysis, the "second" estimate of GDP growth for Q4 2013 was a weak 2.4%, down from the "advance" estimate of 3.2%, and well below the surprisingly robust 4.1% logged in Q3. The figure was revised lower because the increase in personal consumption expenditures was smaller than previously estimated. By comparison, GDP growth was 2.6% in Q2, a meager 1.1% in Q1 and an anemic 0.4% in Q4 2012.
• The Federal Reserve reported that in January the amount of total outstanding consumer credit grew at a slower 5.25% annualized rate, up to $3.1 trillion. These record levels of debt continue to get higher and higher.
• The Conference Board's Consumer Confidence Index faltered a bit in February, dropping to 78.1 from 79.4. Says Lynn Franco, Director of The Conference Board Consumer Research Center, "Consumer confidence declined moderately in February, on concern over the short-term outlook for business conditions, jobs, and earnings. While expectations have fluctuated over recent months, current conditions have continued to trend upward and the Present Situation Index is now at its highest level in almost six years (April 2008, 81.9). This suggests that consumers believe the economy has improved, but they do not foresee it gaining considerable momentum in the months ahead."

Trends To Watch

For over six months the dollar index has moved in a very tight trading range between 79 and 81.50. Three times over the past year the index has fallen to that key support level at 79 and each time it has bounced higher. What will happen this time? I have to admit I'm surprised the dollar isn't doing better given the global uncertainty and the stable domestic economy and political landscape. My guess is that we'll see the dollar gain strength over the next few months. 

After a multi-year decline that bottomed in December after bouncing off major support at $1,200, the price of gold has surged this year, rising almost $200/ounce in the past three months. The price has already surpassed interim resistance around $1,350 and is headed towards the next level just below $1,490. I have to admit to feeling a little stupid at being on the sidelines after being a gold bull for more than a decade. So like many of you, I'm just watching now. 

Like many other sectors of the market, the price of West Texas crude has been very volatile over the past six months, trading around the interim resistance/support level of 98 (the green dotted line). Looked at over the past year, the broader trading range is delineated by support (blue line at 86) and resistance (red line at 110). Looking forward, I expect the price to remain above $95/barrel and possibly head back towards $110 if things in the Ukraine continue to devolve. 

After the quick and steep decline in January that saw the price fall below the rising trendline, the ETF representing the financial sector recovered quickly, again powering to new highs in early March. If there is another general market downturn, watch for the next buying opportunity below 22.

After briefly breaking through resistance last month to achieve a new high level, the index for the housing sector has fallen back into its upper trading range. Will interim support hold at 195, and if so, will the index again break resistance at 210? I believe the answer to both questions is yes. 

The index for the developed international markets remains in a general uptrend. You can see below where I've circled in red the times that the index dropped to, or below, the rising blue trendline. Each time the index subsequently bounced higher. Watch to see if the unrest in the Ukraine provides another buying opportunity.

The Chinese economy, and by proxy its stock market, continues to be in a solid downtrend. This multi-year downward spiral cannot seem to right itself. And should the market continue to head lower, China could drag down the rest of the world's markets. The index formed a Death Cross in January that continues to widen. RSI is mildly oversold and MACD is negative. As the trading channel narrows pressure will build. Sooner or later the index will have to move clearly one way or another. Personally, I wouldn't buy this market right now.

The NYSE Bullish sentiment index cratered in January during the correction. I then wrote last month that "even though the chart looks bad, this is actually a good thing. . . . 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." Bingo. 

Right now 64% of stocks traded on the New York Stock Exchange are currently trading above their 50-day moving average, about the same as this time last month. Like the bullish sentiment above, this index recovered quickly from its rapid slide. I'd expect to trade sideways for a while, until there is some type of result ion in the Ukraine. 

After a brief but violent spike of volatility in January, the VIX quickly dropped back into the complacent zone, before rising again last week. The chart is beginning to look a little choppy, which is hinting at a return to more volatility, which suggests a more turbulent market may lie ahead. 

After the end of the January correction I thought the stage was set for a rally that would take the broad market averages to record high levels. Indeed, the S&P 500 did establish record highs, along with the Dow Jones Transportation Average. The Industrial Average though stubbornly refused to join the party. Then last week the market turned lower again thanks to the threats of violence in the Ukraine and the resulting economic sanctions against Russia. That story could take weeks, or months, to resolve. Therefore, I think we've got choppy waters ahead. That being said, I still believe the market will move generally higher as too many factors are in favor of the Bulls. 

Because I believe the market remains in a long-term bullish trend, my clients and I remain fully invested. And I remain on the lookout for my next purchases. I have a long "buy" list, just waiting for prices to fall so I can scoop up some of my favorite targets. We need down periods, like January, to be opportunistic. It's been tough to be a buyer the past year or so with the market up so much. Remember, it's best to buy when others are fearful. We'll likely have another chance sometime in the next six months. 

I reduce cash by over $800,000 in January, and another $325,000 in February, taking advantage of the drop in the market. I bought a few growth stocks in the tech sector and added to other existing holdings. Over the past six months I have added a bit of growth tilt to our portfolios, without altering the fundamental nature of our holdings. I'd much rather remain conservatively invested, giving up some of the potential gains during a bull market in order to lose less during a correction or a bear market. 

News and Notes

This coming weekend I'm heading to Boston where I'll be competing in a three-day swim meet at Harvard University. This is my "big" meet of the season. After nine months after pretty grueling training I'm hoping for some fast swims, and maybe even a Top 10 ranking in a couple of events, although as the oldest guy in my age group, the deck is stacked against me. But watch out next season!

In two weeks I return to Nashville for HI Connect, a unique event created by Hotel Interactive, one of my private equity companies. This is the third year we will host this groundbreaking trade show. I'm very much looking forward to seeing the growth of the event, and enjoying a weekend of great bars and bands in Music City.

Hopefully Spring is just around the corner. I've noticed a few optimistic crocuses and daffodils blooming in my backyard. Hopefully they will survive the remaining cold nights. And finally, I want to wish everyone a Happy St. Patricks Day. Very careful with your celebrations today and avoid the green beer.

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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