Werlinich Asset Management, LLC

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May 19, 2014

Still Climbing That Wall Of Worry

Current Market Analysis
Last Month's Results
Statistics to Watch
Trends To Watch
What I'm Thinking and Doing
News and Notes

Current Market Analysis

As I write this, the Dow Jones Industrial Average stands at 16,511, down a mere 26 points from when I wrote to you last month. This leaves the venerable index about 205 points shy of the all time high registered on just last week on May 13th. On the other hand, the Dow Jones Transportation index registered a new high of 7,906.40 just yesterday, while the S&P 500 is just 12 points away. So as you can see, things are pretty good. Yet if you listen to the news or watch the TV, the mood does not match the reality. It appears to me that the majority of market observers are negative on the market. I think that's good news as the market continues to "climb a wall of worry". If sentiment is this gloomy while the market remains at such lofty levels, I think we have a good rally in our future. 

Indeed, after the battering endured by the biotech and high growth technology sectors, it could be time to nibble at some stocks in those sectors. And it also may be time to look at some downtrodden housing stocks. And the value sector, as represented by dividend-paying, blue chip stocks continues to be a smart place to put your money for excellent long-term returns. 

Looking at the chart of the DJIA, we see a few things. First is the hard floor represented by the teal line at 14,800. To reach that floor would mean a drop of about 12%, so I think that marks our big trading range. As long as the DJIA stays above 14,800, we're ok. Second, you can see a secondary trading range established over the last five months delineated between the red and blue lines. I think that represents short-term trading opportunities. Finally, with RSI and MACD both somewhat quiescent, and the current price above both moving averages, this remains a bullish chart. 

The chart of the Dow Jones Transportation Average looks even better. The trading channel has been in place for over a year, even though I'm showing only the last nine months. Even though the index close at the all time high there is still room to grow, but not before a bit of a pause sometime in the near future. RSI and MACD are a bit extended. But again, this is a very bullish chart. 

After a furious rally for the first four months of the year, the Dow Jones Utility Average is again taking a breather. Watch for a bounce before hitting support at the rising blue line. As interest rates remain historically low the utilities should perform quite well. Personally, I have held my core utility positions through all of the ups and downs over the past few years, and you should have done so as well. This sector shouldn't be traded; we own it for stability and income. With yields 50%-100% higher than treasuries, just buy when the sector is beaten down then hold on until something fundamental changes. 

After peaking at around 3% on December 31st, the yield on the 10-year Treasury has now plunged to around 2.5%. This marks the third time in the past year that rates have fallen this low, and are attempting to pierce a very determined support level at 2.45%. I don't understand the high levels of fear that must be felt by investors to warrant such a move into treasuries, but I'm not moving my clients into this trade. I think this is a "sucker's bet". By the end of the year, investors buying at these levels will likely be feeling the pain of higher rates.

Last Month's Results

The market rebounded a bit in April after a mixed month in March. Value continues to dominate growth, and this trend is accelerating with the continued deterioration of the high multiple "story" stocks in the biotech/high tech sector. Investors fled those risky investments and turn to boring old value stocks, which is right up my investment alley. The most surprising thing to me is that government bonds gained 2.7% through April. And those gains have accelerated even more in May as rates continue to fall. I'll be shocked if those gains haven't reversed before the end of the year. 

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 May 10 was 297,000, a decrease of 24,000 from the prior week's revised figure. The four-week average of 323,250 is about 10,000 higher than the tally from a month ago (thanks to a surprisingly large number in the last week of April). According to the seasonal average, about 2.67 million people continue to collect unemployment insurance, which is 100,000 people less than last month. This is the lowest level for insured unemployment since December 1, 2007.
  • The non-farm payroll employment report in April showed surprising strength as the establishment survey reported that 288,000 jobs were added in the month, while revisions added another 36,000 to prior months. The household survey reported that the unemployment rate dropped from 6.7% to 6.3%, the lowest level since November 2008. The more comprehensive U-6 "underemployment" rate also fell, dropping to 12.3%. "Only" 9.8 million workers were still counted as unemployed, as more people are actually finding work. Even the stubborn labor force participation rate managed to fall to 62.8%.
  • 3.5 million people were counted as being unemployed longer than 27 weeks, a drop of 200,000. The seasonally adjusted number of people who could only find part-time work inched up to 7.5 million and the number of marginally attached workers held at 2.2 million. The number of people holding multiple jobs was steady at 7.1 million. The average hourly wages for blue collar workers was $20.50 while the average work week stayed at 33.7 hours. Overall, this is the third straight month in which more people are entering the work force, finding jobs and working more. 
  • The Congressional Budget Office (CBO) estimated that on a net present value basis, the Treasury reported a federal budget surplus of $116 billion in March, which means that for the first seven months of fiscal 2014 the cumulative deficit is $301 billion, $187 billion less than the same period in the prior year, thanks to an 8% increase in tax receipts and a 3% decrease in government expenditures.
  • The Census Bureau reported that after three straight monthly gains, the U.S. trade deficit of goods and services fell in March from $41.9 billion (revised) to $40.4 billion. If Congress can figure out how to allow the export of our massive energy reserves, this trade gap could shrink very quickly, but I don't think it will happen any time soon.
  • The National Association of Homebuilders/Wells Fargo Confidence Index dropped 1 point to 45 in May from a downwardly revised 46 in April. “After four months in which the HMI has shown little signs of fluctuation, it is clear that builder sentiment is becoming more in line with the market reality of a continuing but modest recovery,” said NAHB Chairman Kevin Kelly, a home builder and developer from Wilmington, Del. "However, builders expressed some optimism that sales will pick up in the coming months.”
  • The Census Bureau reported that privately owned housing starts rose 13.2% in April to a seasonally adjusted annual rate of 1,072,000 units, which is 26.4% higher than a year ago. New building permits rose 8.0% from the prior month and were 3.8% higher than the year before. Maybe this is the beginning of the summer buying season everyone has been waiting for. 
  • The Census Bureau reported that on a seasonally adjusted annualized basis, only 385,000 new homes were sold in March, down a whopping 14.5% from February, and 13.3% from a year ago. This marks sales declines in three of the last four months; not a good sign. The estimate of the number of homes for sale is 193,000, which represents a 6.0 months of inventory at the current rate of sales. The median sales price jumped to $290,000, which is well above the rising 12-month moving average price of $268,383. The harsh weather certainly depressed sales, as I suggested last month it would. The trend should begin to reverse in April.
  • The National Association of Realtors reported that on a seasonally adjusted annualized basis, 4.6 million existing homes were sold in March, essentially unchanged from February and holding around the lowest figure in a year and a half, and 7.5% lower than a year ago. The estimate of homes for sale fell to 1.99 million, which represents 5.2 months of inventory at the current rate of sales. The average selling price surged to $198,500, almost matching the rising 12-month average of $199,575. As I mentioned above, I don't expect any real progress until the improved weather in April.
  • According to the Institute for Supply Management (ISM), economic activity in the manufacturing sector rose in April from 53.7 to 54.9, marking overall growth for eleven straight months. The ISM index of non-manufacturing activity rose to 55.2, which marked growth in the service sector for 51 consecutive months. These results belie the gloom and doom coming from other sectors of the economy. 
  • The Conference Board reported that it's index of Leading Economic Indicators (LEI) increased 0.8% in March, following an increase of 0.5% in February. "The LEI rose sharply again, the third consecutive monthly increase,” said Ataman Ozyildirim, Economist at The Conference Board. “After a winter pause, the leading indicators are gaining momentum and economic growth is gaining traction. While the improvements were broad-based, labor market indicators and the interest rate spread largely drove the March increase..."
  • According to the Bureau of Economic Analysis, the "advance" estimate of GDP growth for Q1 2014 was an anemic 0.1%, which is way below the 2.6% rate of growth earned in Q4 and a far cry from the  robust 4.1% logged in Q3. By comparison, GDP growth was 2.6% in Q2, a meager 1.1% in Q1 and an anemic 0.4% in Q4 2012. This was a surprisingly bad number, although it could be revised higher in subsequent months. 
  • The Federal Reserve reported that in March the amount of total outstanding consumer credit grew at an annualized rate of 5.75%, up to $3.14 trillion. Revolving credit held steady while non-revolving increased a bit.
  • The Conference Board's Consumer Confidence Index, which had increased in March, declined slightly in April from 83.9 to 82.3. Says Lynn Franco, Director of The Conference Board Consumer Research Center, "Consumer confidence declined slightly in April, as consumers assessed current business and labor market conditions less favorably than in March. However, their expectations regarding the short-term outlook for the economy and labor market held steady. Thus, while sentiment regarding current conditions may have slipped a bit, consumers do not foresee the economy, or the labor market, losing the momentum that has been building up over the past several months."

Trends To Watch

For almost nine months the dollar index has moved in a very tight trading range between 79 and 81.50. Three times over the past eight months the index has failed to breach key support at 79 (red line). I continue to be surprised at the weakness of the dollar relative to other currencies. But that weakness supports commodity prices so I'm not complaining. 

So what do we make of the price of gold? My personal opinion is that this is not the time to be a long-term investor in this sector. (Disclaimer - after being a gold bull for about eleven years I sold all my holdings last year.) For now, I think this is a trader's sector. If you're so inclined you could buy below the dotted purple line as long as it doesn't fall below support (blue line). Then sell above the dotted green line, assuming it can't break through resistance (red line).

As you can see below, the price of West Texas crude has found a solid, if broad, trading range. There is major support at around $92 and heavy resistance around $110. Primary trading takes places around $100. Recently there is minor resistance at $105. So for now, energy investors should just sit back and enjoy the profits; life is good in the oil world.

As you can see below, the the financial sector, as represented by the price of the SPDR ETF, continues to power ever higher. Another chance to buy in came just last week as the index bounced off support around 21 and both RSI and MACD were in mildly oversold territory. I'd expect the index to move up toward resistance around 23 within a week or so.

The index for the housing sector, as represented by the SPDR ETF, is in a precarious position. It has spent the better part of the last two months straddling interim support around 195. Should it move lower it is a long drop to support around 166. Personally, I think it will move higher and again test resistance at 210. Last month I said that "we may head a bit lower in the short term, but that a rally is coming, maybe by May." I'll stick with that prediction. 

As you can see below, the index for the developed international markets, as represented by the SPDR ETF,  remains in a general uptrend. Buying opportunities have been presented each time the index falls to support at the blue line or when MACD fell below -0.2. 

As a spectator, the Chinese stock market, as represented by the Shanghai Index, is growing more exciting and more interesting by the month. A clear wedge pattern is being formed by the blue and red lines. As the red line falls closer each month to the blue line, pressure builds. Most technical traders would view this as a bullish pattern because history suggests a greater likelihood of an upside breakout. I'm not suggesting anyone buy this pattern just yet; the pressure still has room to build. I think that by the end of the summer the pattern will burst and the index will move decisively one way or another, and take the global stock markets with it. 

The NYSE Bullish sentiment index dropped again this month, and fell right to support around 63 at the same time the major indices achieved all time high levels. This is very strange, yet I think it is VERY bullish as the market continues to "climb the wall of worry". Watch for the big rally that should come next.

Right now 65% of stocks traded on the New York Stock Exchange are currently trading above their 50-day moving average, which is a bit higher than this time last month. That figure keeps the index right in the middle of the positive area of the chart. This is neither overly bullish nor bearish. RSI and MACD are both sanguine. This complacency allows for the future gains I expect.

Although the short moves in the VIX look more volatile, overall the "fear index" remains in a fairly safe zone. What this tells me is that traders are looking for reasons to sell in the short-term, but in the long-run, they really can't find a compelling reason to leave the equity markets.  

What I'm Thinking and Doing

If you spent a few minutes reading the preceding sections of this newsletter you'll know that I am bullish on the near-term prospects for the stock market. I also believe that the market should end the year higher than it began, perhaps by as much as 10%. With that overarching belief in mind, I remain fully invested in my own accounts and on behalf of my clients. I don't attempt to trade the short-term movements; rather, I look to buy the securities I want when opportunities present themselves. And I only buy things I believe will out perform the broad market for at least the next three- to five years. If I don't have that confidence, I don't buy it. 

Last month I mentioned missing a chance to buy a stock that I had wanted. Well shortly after I published the April newsletter the stock dropped back to my buy price and I was pleased to buy an initial position in this leading financial service and technology leader. I've also continued to fill in existing positions on weakness whenever possible. 

Overall, I'm VERY pleased with our portfolios and how they're performing so far this year. All of the hard decisions I made last year to reshape our holdings are proving correct so far this year. Sometimes you have to make the hard decisions to cull the rotten fruit in order to produce a great harvest, and I believe that's what I have done.  

News and Notes

There are only about three months until the summer National Championships in August. I'm training very hard right now, trying to build a solid base, before moving outdoors for some long course work. I "age up" into the 50-54 age group this year so I'm looking forward to being one of the young guys in the age group. I'm keeping my fingers crossed that I'll swim fast enough to earn one or two Top 10 national rankings. 

It's hard to believe that there's just over a month remaining in the school year. Nola is actually home from college already. Lily and Ezra are entering the home stretch and heading towards finals and some standardized tests. I'm sure everyone, including me, is anxiously awaiting summer fun. 

I recently returned from a trip with a number of my college friends and their spouses during which we celebrated the fact that we all turn 50 this year. It was a very memorable week and is a blessing that almost 32 years after we all met, we remain close friends, even though great distances separate us. Your best friends are the family that you choose, and to my Princeton friends out there, I choose you as my family forever.  

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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