Werlinich Asset Management, LLC

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June 18, 2013

Glad (So Far) We Didn't Sell In May 

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 15,179, down 192 points, or 1.2%, from when I wrote to you last month, but still up 15.8% from the 2012 year-end closing price of 13,104. The market has taken a breather since hitting the high last month, and there's nothing wrong with that. A little pull back and consolidation is natural and healthy. As long as the index remains above the rising blue trendline there is nothing to worry about. A 5% correction would bring the index to about 14,750 so as far as I'm concerned that's the first important support level.

Depending on the timing, investors who followed the old market bromide to "sell in May and go away" have been disappointed (so far). Although there were severe market corrections in the summers of 2010, 2011 and 2012, that doesn't mean there must be a repeat performance this summer. The Fed, in conjunction with central bankers around the world, continues to pursue its policy of monetary easing, forcing up equity prices and punishing bond investors. Indeed, until the Fed removes the stimulus it's unlikely the market will endure any significant downturn, and that question is causing the massive volatility that has engulfed the market over the last few weeks.

So what are the charts telling us today about the state of the markets? As of yesterday's close we've experienced a 2.3% decline from the May high yet the DJIA remains above the rising trendline and both moving averages. The question is whether this is simply a breather before the inevitable resumption of the gains or the beginning of a larger correction. For months I have been predicting that there would have to be a break of some kind in this extended rally. Maybe the usual summer doldrums will provide that pause. Bigger picture, I believe the market will be higher by the end of the year than it is today.

The Dow Jones Transportation Average has experienced a greater decline, measuring 4.1%, between yesterday's close and its May high. This is no big surprise and the transportation average usually experiences greater volatility than the industrial average. Still, the index has violated the trendline, it remains above both moving averages (although not by much). I've identified in green what I believe to be the first important support level around 6,100. Unless the index falls below that level, after which 5,800 would provide the next support level, the market should be ok.

It appears that the correction in the Dow Jones Utility Average may be over. In fact, I think investors have been presented with another chance to buy into higher yielding utility stocks after a significant pull back of about 11.5%. I think this was simply a rotation out of a defensive sector into more aggressive parts of the market during an historic rally. Now that the market is taking a breather, and rates appear to be stabilizing, the utilities could return to favor. Nothing fundamental has changed about the sector. Support around 475 has held and both RSI and MACD have turned up. If Treasury yields remain below 2.3% utilities are a buy.

This could be one of the most important charts, and story lines, in the market today. Ben Bernanke and the Fed is employing every tool in its arsenal to keep interest rates artificially low in order to stimulate the economy. Notice I said "artificially low". Left to their own devices, interest rates would certainly be much higher. And market forces are working to push rates closer to their natural level. So who will win, Bernanke or the market? I think the answer is that Ben wins in the short term but the market wins in the long run. The current rate is right around support/resistance at 2.1% and just below the top of the rising trading range (red and blue lines). The trillion dollar question is when the Fed will begin to reduce, or eliminate, their program of $85 billion a month in bond purchases. All the world waits for that announcement, and so do we.

Last Month's Results

Even with a bit of correction in the end of the month, May still managed to produce solid gains across all the domestic stock market averages. That also meant we've enjoyed five straight months of gains to begin this year. The only fly in the ointment was the downturn in the EAFE. In addition, the bond market continued to slide and is now in the red year-to-date. Interestingly, small growth stocks have taken the leadership position, surpassing the gains in the Dow as riskier assets are enjoying their time in the sun. Should the market stumble, this leadership position will be very short lived.

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 June 8 was 334,000, a decrease of 12,000 from the prior week's revised figure. The four-week average of 345,250 is about 6,000 higher than the tally from a month ago. According to the seasonal average, about 3.0 million people continue to collect unemployment insurance, which is roughly the same as the prior month. Overall, this picture remains modestly positive.
  • Non-farm payroll employment report in May basically met expectations. The establishment survey reported that a solid 175,000 jobs were added in the month, while the figure for March was revised slightly higher and April was revised a little lower for a net loss of 10,000 jobs. The household survey said that the unemployment rate remained essentially unchanged at 7.6%. The 11.8 million workers counted as unemployed was up a bit as more workers appeared to be looking for work, and the labor force participation rate ticked up to 63.4%. The more comprehensive U-6 "underemployment" rate inched lower to 13.8%.
  • 4.4 million people continued to be unemployed longer than 27 weeks. The seasonally adjusted number of people who could only find part-time work held at 7.9 million and the number of marginally attached workers fell to 2.2 million. The number of people holding multiple jobs is 7.1 million. The average hourly wages for blue collar workers inched higher to $20.08 while the average work week increased to 33.8 hours. Overall, the picture remains one of slow, incremental improvements.
  • The Congressional Budget Office (CBO) estimated that on a net present value basis, the Treasury reported a federal budget deficit of $139 billion in May, and $627 billion for the first eight months of fiscal 2013. This is $220 billion less than the record figure reported for the same period of fiscal 2012. This is due to a 15% increase in revenues and a slowdown in the growth of government spending.
  • The Census Bureau reported that the U.S. trade deficit of goods and services was $40.3 billion in April, a slight increase over the prior month, thanks to an increase in imports. This is a nonevent.
  • The National Association of Homebuilders/Wells Fargo Confidence Index had the biggest monthly increase in June since September 2002, rising from 44 to 52. This is the first time the index has been above 50, or in the "healthy" area, since April 2006. This is very bullish news.
  • The Census Bureau reported that privately owned housing starts reversed part of the decline in April, gaining 6.8% in May, leaving them 28.6% higher than a year ago, to a seasonally adjusted annual rate of 914,000 units. New building permits dipped 3.1% from the prior month yet remained 20.8% higher than the year before.
  • The Census Bureau reported that on a seasonally adjusted annualized basis, 454,000 new homes were sold in April, a 2.3% increase after an upwardly revised March, and still 29% higher than a year ago. The estimate of number of homes for sale was 156,000, which represents a tiny 4.1 months of inventory at the current rate of sales. The median sales price jumped to $271,600, which is well above the rising 12-month moving average price of $250,633. Could this mark the price increases I've been predicting as a result of the tight inventory and the beginning of the big selling season? We'll see.
  • The National Association of Realtors reported that on a seasonally adjusted annualized basis, sales of existing homes increased 0.6% in April, to 4.97 million units, and remained 9.7% higher than a year ago. The estimate of homes for sale jumped to 2.1 million as rising prices spurred more homeowners to put their homes up for sale. The median sales price jumped to $192,800, which is well above the rising 12-month average of $181,425. Honestly, the news couldn't be much better.
  • According to the Institute for Supply Management (ISM), economic activity in the manufacturing sector contracted in May for the first time since November 2012 as the index declined to 49. This is the lowest reading since June 2009. On the other hand, the ISM index of non-manufacturing activity was 53.7, which marked growth in the service sector for 41 consecutive months. This type of poor data allows the Fed to continue their program of monetary stimulus.
  • The Conference Board reported that it's index of Leading Economic Indicators increased by 0.6% in April following a 0.2% decline in March. Says Ataman Ozyildirim, economist at The Conference Board: "After a slight decline in March, the U.S. LEI rebounded in April, led by housing permits and the interest rate spread. Labor market conditions also contributed, although consumers? outlook on the economy remains weak. In general, the LEI points to a continuing economic expansion with some upside potential." Says Ken Goldstein, economist at The Conference Board: "The index is 3.5 percent higher (annualized) than six months ago, suggesting expansion. However, the biggest risk right now is the adverse impact of cuts in federal spending. The biggest positive factor is the potential for improvement in the recovering housing and labor markets. The biggest unknown is the resiliency in confidence, both consumer and business."
  • According to the Bureau of Economic Analysis, the "second" estimate of GDP growth for Q1 2013 was 2.4%, a slight decrease from the advance estimate of 2.5% but still a marked improvement over the anemic growth of 0.4% in Q4 2012. For comparison, growth was 3.1% in Q3, 1.3% in Q2 and 2.0% in Q1. Again, this tepid growth won't stir the Fed to reduce their policy of monetary expansion.
  • The Federal Reserve reported in that in April the amount of total outstanding consumer credit was $2.97 trillion, up from the prior month and growing at a 4.75% annualized rate. Consumer credit grew for the ninth consecutive month. When is it going to make a significant impact on retail sales?
  • The Conference Board's Consumer Confidence Index surged to 76.2 in May from 69.0 in April. Says Lynn Franco, Director of The Conference Board Consumer Research Center "Consumer Confidence improved in April, as consumers' expectations about the short-term economic outlook and their income prospects improved. However, while expectations appear to have bounced back, it is too soon to tell if confidence is actually on the mend."
  • According to the FDIC, 4 banks failed in May, bringing the total for the year to 14, versus 24 through the same month last year. I would be surprised if more than 20-25 banks go under this year.

Trends To Watch

The dollar index failed for a second time to pierce resistance just above 84 and has fallen back into the primary trading zone (marked by the red dotted lines). Notwithstanding the recent weakness, the dollar remains a "safe" and desired currency as central bankers around the world fight to the death to devalue their currencies. Going forward, I'd expect to see a resumption of dollar strength.

The trading in gold for the past year has been a painful bloodbath. But what is garnering little notice is that it's possible that the bottom has been made. As you can see below, a floor around $1,340 may have been set. Twice the floor held. Recently the price seems to be consolidating between $1,350 and $1,450. Should gold escape the summer, which is an historically poor time, then it's possible that the price could again rise and try to break through resistance around $1,480. So for now, we wait and watch.

This will be the final month, for now at least, that I'll show the chart of the price of silver. Quite simply, it is so correlated to the price of gold, as you can see by comparing these two charts, that it doesn't make sense to continue showing it. Like gold, silver has managed to remain above a floor price around $20. This is a very important level. Future gains will be made only be piercing resistance below $25.

The price of copper remains depressed and I continue to wonder how the economy, and by proxy, the stock market, can be doing so well while this core industrial component is doing so badly. I think it all comes back to China, which continues to flounder (see below). As I said last month, I wonder if the price of copper is any longer a barometer for the state of the domestic economy. Maybe it's now a better gauge of China's economy. If that's true, I may eliminate this chart.

The price of West Texas crude is holding up better than many other commodities. It is currently trading above both moving averages and heading towards interim resistance at $100 (dotted green line). You can see numerous attempts over the past year that have all failed to breach that barrier. With RSI and MACD both gaining strength maybe it'll break through this time.

The bull market in the financial sectors continues as the index remains above the rising trendline and both moving averages. The recent pause in the upward trajectory is reflected in the slowing RSI and the negative MACD. This could provide a buying opportunity for investors looking for an entry point into this rising sector.

The housing sector looks a little choppier. The current price of the index sits right on the 50-day moving average after tumbling about 13% in the past month. That being said, the overall trend remains bullish so this too could be a possible entry point for investors. If the past is any prelude, and given my expectation of a strong summer selling season, I would expect this sector to move higher over the next few months.

After moving ever higher over the past year, the index for the developed international markets took a breather over the past month, dropping about 6% or so. The current price is slightly below the 50-day moving average but remains above the 200-day average and the rising trendline. RSI has fallen from overbought to mildly oversold. MACD is about to turn positive so we could be ready for the next rally and move to new highs.

The Shanghai index simply cannot get out of its own way. After bouncing off support around 2,135 the index jumped in May before plunging right back back down again in June to again test that support. What is really going on in China? Does anybody know? Are matters worse there than their tight lipped government will admit? Or is there another problem we don't even know about? The weakness in China continues to diminish the price of copper and other base metals. If China were to rally, global equity markets would certainly zoom to new highs.

After again failing to pierce resistance at 80 the NYSE Bullish sentiment index has retreated a bit to a less exuberant level, which is good. The index has spend almost seven months in the trading range between 60 and 80, which is bullish. That's the longest period of consistently bullish sentiment in two years. Notice that after the decline RSI has just turned back up, suggesting the rally likely has more room to go.

Next we see that only about 50% of stocks traded on the New York Stock Exchange are currently trading above their 50-day moving average, down from about 80 last month. This is a good thing has the recent decline has taken some froth out of the market while not causing any real damage. I think the next primary move will take this index higher.

Finally, the VIX, or the "fear index", shows that volatility has returned to the market this year. We've had three spikes so far this year, showing that traders are getting more nervous. And yet these spikes have only brought the index out of complacency and into a more normal trading zone, so I take it as a good thing. There should be a little bit of healthy fear when looking at the stock market.

What I'm Thinking and Doing

Everyone is on Fed watch right now. Instead of what would Jesus do, it's now "what will Ben do" and when will he do it? Or will he do anything at all? Maybe he'll simply retire and leave the mess to his replacement. Market watchers are parsing everything the Fed says, or doesn't say, looking for clues as to when and how the central bank will begin to taper off their QE. Obviously, this has massive implications for the stock and bond markets. Allow me to inject a voice of reason and sanity. The cold hard reality is that should the Fed begin to slowly reduce the amount of bond purchases they make each month, now totaling $85 billion per month, it really shouldn't have that big an impact on our economy. If interest rates move from 2% today to 3% by this time next year, to 4% a year later, would that really cause a problem? Can anyone argue that 4% interest rates would crater our economy? That would still be an historically low interest rate. I think the sooner we begin to normalize interest rates, the better it will be for everyone. But until the Fed telegraphs its intentions, we'll simply wait and watch.

I've been saying for months that I planned to take a little money off the table as the market rallied. In fact, over the past few months, I raised my cash position from 1.5% to 3.5%. I've done this by eliminating small or under performing positions. In some cases I simply gave up on losers and took my lumps. In others I tightened my "mental stop loss" prices and pulled the trigger. In still others I reduced exposures to sectors where the growth prospects have dimmed, like the commodity sector. Until China joins the festivities, base metals will continue to lag.

The main factor holding back my results is clearly my position in precious metals. After having profited for many years by allocating nearly 10% of my holdings to gold and silver, those same securities have been the albatross around my neck for the past year and a half. I honestly never envisioned the depth or length of the downturn that we've been subjected to. So now I'm sitting with my positions, waiting for what I believe will be the inevitable upswing, possibly beginning in the fall as the thesis for owning gold remains intact.

News and Notes

Last week I hosted an event in support of the Westchester Community College Scholarship Foundation. About 45 people enjoyed delicious food and wine then listened to Brandon Steiner of Steiner Sports, one of the premier collectibles companies in the country. All of the proceeds go directly towards scholarships for needy students of WCC. It was a wonderful evening that benefited a very worthy cause.

Next month I plan to throw the 2nd Annual WAM Summer Slam in my backyard. There will again be great music, plenty of wonderful food and drinks, and lots of clients, prospects, colleagues and friends to help celebrate summer. I hope to see some of you here.

As always, I thank you, my readers, and remind you that this newsletter is for you. I have been writing News and Views for over nine years now. If you'd like to read any prior edition, simply go to my website and click on the link to my newsletter archives. I hope you have learned something about our economy and our stock market, and that you will continue to follow along with me in the future. If you have any thoughts or suggestions on how to make it better, please let me know. And if you'd like to speak with me about your investment needs, or if you know 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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