Werlinich Asset Management, LLC

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May 15, 2017

It's Time For Caution, Not Selling

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

Current Market Analysis

After peaking around March 1, the broad market has spent the last ten weeks consolidating in a fairly tight trading range. Growth stocks, as represented by the Nasdaq 100 are doing a little better than their industrial brethren, but still, most investors have little to be upset about so far this year. Of course, the market trajectory could change quickly due to any number of reasons. But for now, one should be cautious, but remain invested. There is still optimism that the administration will deliver meaningful tax reform and a stimulus plan. Personally, I think that optimism is unfounded. That being said, there is a chance, if Trump is willing to reach out to the other side of the aisle, that a modest agreement on taxes could be reached before the fall. If that happens, it could spur further gains.  

For years I have been urging my readers to ignore all of the "noise" and simply watch the market. Doing that means that you've followed the old Wall St. adage: "Don't Fight The Tape". Basically, that means stick with what's been working and keep riding the primary trend of the market. If you've done that, you should be sitting on very nice gains since the market hit bottom in March of 2009. 

Looking at the chart of the #DJIA for the past fourteen months, we see that the primary trend has clearly been up. There have been a few dips along the way, which were buying opportunities, not times to bail. The current price remains above both the 50-day and 200-day moving averages, and is well above resistance around 20,000. So if Trump can avoid blowing up the economy, or the world, there's no reason to think that the market can't continue to move higher. 

The more economically sensitive Dow Jones Transportation Average is in a bit of a funk right now. Now that it's becoming clear that Trump's $1 trillion infrastructure plan is not likely to happen, the sector is waiting for a different reason to move higher. So for now, I would expect the index to consolidate for a few more months. If it moves much lower it could be a nice buying opportunity. 

The Dow Jones Utility Average has produced outsized gains so far this year as rates remain lower than expected. Indeed, the index absorbed the first Fed rate increase quite well. The question is what happens in June if they increase their lending rate another 25 basis points? For now, I'm holding my positions. 

Key Economic Statistics

  • According to the Department of Labor, the figure for seasonally-adjusted initial jobless claims for the week ended May 6 was 236,000, a number basically in line with the prior week's and the prior month's figures. The four-week average of 243,500 was slightly lower than the figure from last month. 
  • The non-farm payroll employment report in April was above expectations, and a big recovery from the meager numbers in March, as only 211,000 jobs were gained in the month, and 6,000 net jobs were subtracted from the prior two months. The household survey reported that the unemployment rate dropped to a tiny 4.4%, the lowest level in nearly a decade, while the labor force participation rate dipped to 62.9. Average hourly wages for blue collar workers rose to a new high of $21.96 while the average work week inched up to 33.6 hours, the highest level since last July.
  • 7.1 million workers were counted as unemployed, while just 1.6 million people remained unemployed longer than 27 weeks. The seasonally adjusted number of people who could only find part-time work fell to 5.3 million while the number of marginally attached workers dipped to 1.5 million. The number of people holding multiple jobs dropped to 7.61 million. All of this resulted in the U-6 "underemployment" rate plunging to 8.6, which is the lowest level since late 2007.
  • The Congressional Budget Office (CBO) estimated that on a net present value basis, the nation's budget surplus was $179 billion in April, and $72 billion more than a year ago. This resulted in a deficit of $348 billion for the first seven months of fiscal 2017, $5 billion less than the shortfall recorded during the same period last year, but if not for timing shifts, the shortfall would have been much larger.
  • The Census Bureau reported that privately owned housing starts decreased 6.8% in March to 1,215,000, which was up 9.2% from a year ago. The weather in March was pretty poor, so I'm not concerned by this decline.
  • The Census Bureau reported that on a seasonally adjusted annualized basis 621,000 new homes were sold in March, up 5.8% from February, and 15.6% from a year ago. The estimate of the number of homes for sale was 268,000, representing only 5.2 months of inventory at the current rate of sales. The median sales price was $315,100, reversing a few months of declines, and above the 12-month moving average price of $310,767.
  • The National Association of Realtors reported that 5.71 million existing homes were sold in March, up 4.4% from the prior month, and 5.9% from a year ago. The estimate of the number of homes for sale was 1.83 million, representing only 3.8 months of inventory at the current rate of sales. The median price was $236,400, which is roughly equal to the rising 12-month moving average price of $235,800.
  • According to the Institute for Supply Management (ISM), economic activity in the manufacturing sector expanded in April for the eighth month in a row, dipping from 57.2 to 54.8. The ISM index of non- manufacturing activity increased from 55.2 to 57.5, which still signaled growth in the service sector for 87 consecutive months. Almost boringly, the economy continues to expand at a modest pace.
  • The Conference Board reported that its index of Leading Economic Indicators (LEI) was increased 0.4% in March, following a gain of 0.5% (revised) in February and 0.6% in January. "The March increase and upward trend in the U.S. LEI point to continued economic growth in 2017, with perhaps an acceleration later in the year if consumer spending and investment pick up," said Ataman Ozyildirim, Director of Business Cycles and Growth Research at The Conference Board. "The gains among the leading indicators were very widespread, with new orders in manufacturing and the interest rate spread more than offsetting declines in the labor market components in March."
  • According to the "advance" estimate by the Bureau of Economic Analysis, GDP increased at a meager annualized rate of 0.7% in Q1 2017. This compares very poorly with the 2.1% rate of growth from Q4 2016 and the 3.5% rate of growth from Q3, but is only slightly worse than the 1.4% growth rate in Q2. The best we can say is it compares favorably with the mediocre 0.8% growth rate in Q1 2016. This report is unlikely to deter the Fed from implementing their next 0.25% rate hike in June.
  • According to the BLS, the seasonally adjusted Consumer Price Index for all Urban Consumers (CPI-U) increased 0.2% in April, after falling 0.3% in March. Over the last twelve months, the index rose 2.2%, continuing the modest trend that began a year ago. This level is just above the 2.0% target set by the Fed, giving them cover for their next rate increase in June.
  • The Conference Board's Consumer Confidence Index decreased to 120.3 in April from 124.9 (revised) in March. "Consumer confidence increased sharply in March to its highest level since December 2000 (Index, 128.6)," said Lynn Franco, Director of Economic Indicators at The Conference Board. "Consumer confidence declined in April after increasing sharply over the past two months, but still remains at strong levels," said Lynn Franco, Director of Economic Indicators at The Conference Board. "Consumers assessed current business conditions and, to a lesser extent, the labor market less favorably than in March. Looking ahead, consumers were somewhat less optimistic about the short-term outlook for business conditions, employment and income prospects. Despite April’s decline, consumers remain confident that the economy will continue to expand in the months ahead."

Trends To Watch

I think this chart informs part of why the broad market has done so well this year. A weaker dollar has helped  the larger multinational companies and has benefited commodity prices, like oil. I would expect the dollar to improve through the year if the Fed makes good on its promise to hike rates two more times this year, and that could pressure corporate profits in the second half of the year. This will be a key chart to watch this year. 

The yield of the 10-year Treasury bond has traded between 2.2% and 2.6% for the past six months. It's hard to envision a scenario where rates drop appreciably from here, but they could remain range-bound for a few more months. I still think the yield could approach 3% before the end of the year. 

After a painful drop in April, where support held around $43/barrel, the price of West Texas Crude has rebounded a bit in May, and is again seeking $50. It's interesting to note that the price of crude has remained between $43 and $54 for much of the past year. Until the price moves out of the range, one way or another, there is no reason to change my current investment thesis, which is to hold a few core, long-time positions, but otherwise underweight this sector. 

After failing to pierce resistance at $1,300, the price of gold has fallen sharply since mid-April, giving credence to my prediction that there is "a greater chance of it moving below $1,200 than above $1,300". I have to admit, trying to forecast the short-term direction of the price of gold is very difficult. Therefore, I prefer to remain on the sidelines here. 

The Nasdaq Composite continues to be the primary engine of growth for the stock market, and seems to be an unstoppable force. The tech-heavy index remains in a major uptrend and made record levels four days last week. Driving the growth are big names like Apple, Amazon, Microsoft, Alphabet, Facebook and Nvidia, all of which (other than Microsoft) are #WAMHoldings. 


The financial sector continues to show signs of trouble. After enjoying a massive post-election rally, a harsher reality appears to have set in and the index is trending lower. In the short-term, there could be further pain. Looking a bit longer-term, I still think that this is simply a bump in the road, and I would use further weakness as a buying opportunity. Rates will rise and finance companies will benefit, spurring increased profits. 

The sticky low interest rates have continued to benefit the tight housing market. Housing starts, as well as new and existing home sales, are all going strong, with larger year-over-year increases. And we're just now heading into the strong home selling season. There's no reason this sector can't move higher.

The index representing the developed international markets has had a great run over the past six months, performing much better than I had expected. Interestingly, you can see the large intra-day spike from the results of the French election. I made a decision a many years ago to focus, almost entirely, on the domestic stock market as it was easier to research and to understand. As a result, I plan to discontinue showing this chart after this month. 

The NYSE Bullish sentiment index has struggled over the past ten weeks, even though the market has had a general upward bias. I find this action bullish and it potentially sets the stage for the next big rally. 

After spending a couple of weeks in the "balanced" area, the VIX has again returned to absurd levels of complacence. I'm starting to wonder whether or not this index retains any validity as a forward looking indicator. For most of the past six months the index has remained at historically low levels, yet the market has continued to move higher, with few breaks in the upward trajectory. Reason, and the laws of probability, demand that something has to give, that the market will eventually experience a prolonged decline. But until that time, I wonder whether the VIX still has any predictive powers.

What I'm Thinking and Doing

I've decided to refrain from political commentary this month and try to focus on the stock market, although it is very hard to separate politics from the market, as they are very intertwined. That being said, if I'm able to block out the noise coming from the Trump administration and try to home in on what's really going on with the economy and corporate profits, it seems like it's business as usual right now; more of the same Muddle Through that was the norm of the Obama years. Interest rates remain low, economic growth remains slow and steady and inflation is still quiescent. Given all of that, my investment thesis remains in force. I want to be long quality companies, most of whom pay a steady dividend. I also want to mix in some small, fast-growing tech stocks that give me the chance to make multiple of my money if I pick correctly. I also want to hold some defensive stocks, like utilities, large food and beverage companies, and defense stocks. I will continue to be fully invested in stocks until the market tells me to be otherwise. 

When the market is at, or near, all-time high levels, it's difficult to find stocks to buy at good prices. And when that happens, investors need to be careful not to chase rising prices. As a result, I've been mostly on the sidelines for the past few months. I did manage to pick up shares of a major defense contractor on an earnings dip, as well as a couple of micro-cap tech stocks that also dropped for one reason or another. Finally, I took a small position in two new ETFs as a way to take a position in two growth sectors. Overall, with only one or two minor positions, I'm very happy with the overall construction of my portfolio of securities. I think my clients are well-positioned to profit in the months and years ahead.

News and Notes

Amazingly, in just two short weeks, Nola will be graduating from Wesleyan University with a Bachelor of Arts in Theater! We also just found out that she received the Rachel Henderson Theater Prize, given each year to the student who, in the estimation of the theater faculty, has contributed the most to theater at Wesleyan over the course of his or her undergraduate career. We're all very proud of her. It seems like only yesterday that we dropped her off and helped decorate her freshman dorm room. Now, less than two shorts weeks after commencement, she'll be heading to Western Massachusetts for two months, before returning home in August. Then, in September, she'll be moving to Washington DC for a one year Fellowship program. After that, who knows? But whatever she does, and wherever she goes, she's going to be a big success.

I brought Lily home a couple of days ago after she finished her Freshman year at GW, where she is taking courses towards a major in political communications and a minor in history. She aced all of her classes, made some great friendships and enjoyed her first year living away from home. In addition to everything else, she completed an internship with Congresswoman Nita Lowey and has already secured a job in DC this summer. 

Ezra has about six weeks left before finishing his junior year of high school. I think he would agree with me that this was his best year of school yet. And to celebrate, Ezra decided to forgo employment this summer in lieu of traveling the world. He'll spend a month doing incredible things in Iceland and around the French alps. Who's got it better than him? I want his summer. 

Lastly, Kathiryn and I took in a feral mother cat and two VERY little baby kittens, who are now about three weeks old. We intend to wean them from mom in about a week, get her fixed, then put her back out in the wild. We'll then have the kittens for a while as we prepare them to be adopted. If anyone is interested, please let me know. 

In addition, we've got a very busy three or four months coming up during which we'll be going to lots of concerts, baseball games and Broadway shows. Kathiryn will also be performing one or two gigs a month through the end of the summer, giving our friends lots of chances to see her perform. I hope lots of you will come out and support her and her bandmates. If you want, just let me know and I'll add you to the distribution list for all announcements of upcoming gigs.

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

Best regards,

Greg Werlinich

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