June 15, 2015

As I write this before the market opens for business, the Dow Jones Industrial Average stands at 17,898, down 169 points, or 0.1%, from when I wrote to you last month. The stock market, as defined by the #DJIA, is essentially unchanged for the year. In general, as bonds have finally taken a turn for the worse, it's become even harder for the broadly diversified investor to eke out any profits this year. I expect the market to be basically flat, or even slightly down, over the next few months as we await work from the Federal Reserve on their interest rate policy and as we enter the typically slow summer months. I think solid corporate profits and an accommodative Fed could set the stage for a nice fall rally. And even though we are a month into the "sell in May and go away" time frame, for the second straight year I recommend that my readers sit tight and hold your positions, as I am doing for my clients. There are no big storm clouds on the immediate horizon and there are no better options out there for your money.

The chart of the #DJIA shows basically the same story as last month: that the index remains firmly in an upward trading channel (between the red and blue lines) while concurrently trading in the upper range of a more narrow trading channel (the horizontal green lines) carved out over the last seven months. And within the green trading range, it's bounced off the interim support line (dotted lavender) seven different times. Both RSI and MACD remain quiescent. To me, the big picture is that the index remains solidly bullish and nothing suggests to me an imminent danger as long as the index remains above 17,750. And if it does dip below that level, the more important support comes in at around 17,500.

The Transportation Index represents my biggest worry right now. The other key component of Dow Theory continues to underperform. In fact, the index has fallen below one line of support around 8,700 and has dropped perilously close to the next support level at around 8,200. In addition, the moving averages have formed a "Death Cross", whereby the the 200-day average has moved above the 50-day average. That's not good. If the sector continues to head south it could derail (no pun intended) the entire market.

The Dow Jones Utility Average is sick. Higher rates, and the expectation of a Fed rate hike, has crushed the utility sector. The index has fallen about 14% since peaking in late January, closely tracking the increase in interest rates (see next chart). Most recently the index has fallen below interim support around 570. I've been unwavering in my support of the utility sector all year, and as a result, I've been wrong all year. All utility investors must now hope that the index remains above major support at 530.

After falling to a low of 1.65% in January, the yield on the 10-year Treasury has gained almost 80 basis points as is now bumping against interim resistance at 2.4%. Last month I suggested that "rates will stabilize around 2.0%, at least through the summer months." That's not looking like such a good prediction right now. If rates move too much higher, they could choke the budding gains in housing and stifle growth in the consumer sector. 

Last Month's Results

The results in May were generally quite upbeat. A weaker dollar spurred gains in equities, led by growth stocks. May also marked the nadir of interest rates, which also helped to boost stocks. If history is any precedent, after a month of gains, I would expect some weakness in June. Nothing has happened so far this year that dissuades me from my belief that stocks will finish the year with modest gains.

* 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 6 was 279,000, similar to the prior week and an increase of 14,000 from the prior month's revised figure. The four-week average of 278,750 was the same as the tally from a month ago. About 2.265 million people continue to collect unemployment insurance, slightly less than last month, and continues the recent downward trend.
• The non-farm payroll employment report in May exceeded Wall Street expectations as the establishment survey reported that 280,000 jobs were added in the month, while revisions added another 32,000 from the March and April tallies. The household survey reported that the unemployment rate inched up to 5.5% and the labor force participation rate ticked slightly higher, to 62.9. The reason the unemployment rate moved up is due to more people entering the labor market. The comprehensive U-6 "underemployment" held at 10.8%. A rising 8.7 million workers were counted as unemployed, higher than than last month thanks to an increase in job seekers.
• 2.5 million people remained unemployed longer than 27 weeks, the same as last month. The seasonally adjusted number of people who could only find part-time work rose to 6.7 million while the number of marginally attached workers fell to 1.9 million. The number of people holding multiple jobs decreased to 7.08 million. Average hourly wages for blue collar workers increased to $20.97 while the average work week held at 33.7. While the employment picture appears robust, wage growth remains tepid. I just don't see how the Fed will increase rates before Q4 at the earliest. 
• The Congressional Budget Office (CBO) estimated that on a net present value basis, the Treasury reported a federal budget deficit of $85 billion in May, leaving the eight-month deficit at $368 billion, about $68 billion less than the shortfall recorded in the same period last year. It's anticipated that the full year deficit will be smaller than the deficit of $483 billion from fiscal 2014.
• The National Association of Homebuilders/Wells Fargo Confidence Index decreased two points to 54 in May, marking reductions in four of the last five months. "Consumers are exhibiting caution, and want to be on more stable financial footing before purchasing a home," said NAHB Chief Economist David Crowe.
• The Census Bureau reported that privately owned housing starts jumped 20.2% in April, to a seasonally adjusted annual rate of 1,135,000 units, which was 9.2% higher than a year ago, and a new record high. New building permits popped 10.1% from the prior month and were 6.4% higher than the year before. If this is not simply a one month anomaly, it could portend a robust housing market in the next few months.
• The Census Bureau reported that on a seasonally adjusted annualized basis 517,000 new homes were sold in April, up 6.8% from March, marking growth in four of the past five months, and up 26.1% from a year ago. The estimate of the number of homes for sale is 205,000, among the highest figures in the past year and it represents 4.8 months of inventory at the current rate of sales. The median sales price increased to $297,300, leaving it above the rising 12-month moving average price of $289,750.
• The National Association of Realtors reported that on a seasonally adjusted annualized basis, 5.04 million existing homes were sold in April, a decrease of 170,000, or 3.3%, from March, but still up 6.1% from a year ago. The estimate of homes for sale is 2.2 million, which represents a growing 5.3 months of inventory at the current rate of sales. The average selling price rose for the third straight month to $219,400, which remains above the rising 12-month average of $211,300. Overall, the housing market is showing signs of life.
• According to the Institute for Supply Management (ISM), economic activity in the manufacturing sector increased to 52.8 in May, after a languid prior two months, which marked overall growth for 22 straight months. The ISM index of non-manufacturing activity dipped to 55.7, which still signaled growth in the service sector for 64 consecutive months. These numbers demonstrate consistently modest economic growth which should keep the Fed from raising rates until the end of the year at the earliest.
• The Conference Board reported that its index of Leading Economic Indicators (LEI) increased 0.7% in April, following a 0.4% gain in March (revised higher). "April's sharp increase in the LEI seems to have helped stabilize its slowing trend, suggesting the paltry economic growth in the first quarter may be temporary," said Ataman Ozyildirim, Economist at The Conference Board. "However, the growth in the LEI does not support a significant strengthening in the economic outlook at this time"
• According to the Bureau of Economic Analysis, GDP decreased at an annual rate of 0.7% in Q1 2015 according to the "second" estimate. This is far below the 2.2% increase in Q4 2014 and a substantial drop from the 5.0% and 4.6% growth rates in Q3 and Q2 respectively. It's not too far from the anemic decline of 2.1% in Q1 2014. I doubt anyone really cares about these poor numbers as they were artificially low thanks to the miserable winter weather. Growth is expected to rebound strongly in Q2.
• The Federal Reserve reported that in April the amount of total outstanding consumer credit continued to grow at an annualized rate of 7.25%, up to $3.384 trillion. The amount of outstanding consumer credit has increased every month since July 2012 and is at the highest level since I started tracking this in 2004. At some point this will have to benefit the consumer economy.
• According to the BLS, the seasonally adjusted Consumer Price Index for all Urban Consumers (CPI-U) increased 0.1% in April, a decrease from 0.2% in March. If you strip out food and energy, CPI rose 0.3%. Over the last 12 months, the index declined 0.2%. This is a clear example that the economy is far from overheating, which should help temper the need for the Fed to increase rates.
• The Conference Board's Consumer Confidence Index, which had fallen in April, inched higher from 95.2 to 95.4. "Consumer confidence improved modestly in May, after declining sharply in April," said Lynn Franco, Director of Economic Indicators at The Conference Board. "After a three-month slide, the Present Situation Index increased, propelled by a more positive assessment of the labor market. Expectations, however, were relatively flat following a steep decline in April. While current conditions in the second quarter appear to be improving, consumers still remain cautious about the short-term outlook.”

Trends To Watch

The furious rally in the dollar, which began in the second half of last year, has finally stalled. After peaking earlier this year around 100, the dollar index is now trading around 95. This modest decline has provided some relief to commodity prices and exports. Should the index weaken a bit further we'll see the beneficial effect on Q2 and Q3 earnings, which would help fuel the year-end rally I'm hoping for. 

Looking at West Texas Crude, we can see that the price of black gold has been trading in a very narrow range between $57.50 and $62.50 for the past two months. As more time passes it feels safer to declare that the bottom has been made. I'm also feeling better about my "buy" call in April. I would look for the price to stabilize in the $60 range for a while before moving closer to $70 by the end of the year.

The price of gold remains trapped in a range between $1,140 and $1,215, where it has remained for most of the past eight months. I'll reiterate what I've been saying for months: I don't like gold as an investment right now, but it could be an interesting vehicle for nimble traders looking to profit from short-term moves. As for me, I'm completely out of this sector.

The price of copper has plunged 10% over the past six weeks after peaking at 2.95 in early May. The current price is below both moving averages. The only "good" news is that the index hasn't fallen below the rising support (blue) line. It's hard to make a strong case for a strong global economy until Dr. Copper recovers.

After a very long 15 year wait, the Nasdaq Composite closed at 5,056.06 on April 23, finally eclipsing the previous record closing price of 5,048.62 from March 10, 2000. Since then it has continued to grind inexorably higher as it carves out a beautiful trading channel. Nothing in this picture suggests any danger.

Looking below at the chart of the financial sector, you can see the four "buy" calls I made over the past ten months. Given that the price of the index continues to hug the rising support line (in blue), and remains above both moving averages, I think my last buy call remains in force. There is still room to grow from here.

The housing index simply refuses to break out of the huge ascending triangle formation that has taken about eight and a half years to complete. There simply isn't much room left between the ascending blue support line and the red resistance line. The pressure continues to build and the price must break out, one way or another. My guess is that the index will shortly break above resistance around 240 and achieve a level not attained since the beginning of 2007. I originally thought this would happen before Memorial Day. Since that didn't happen, let's shoot for Independence Day instead.

The biggest surprise to me in the first half of the year had been the strong performance of the developed international markets, as represented by the IEE. I simply did not account for the monetary easing by central banks around the globe just as our Federal Reserve was looking to tighten. Those policies have been rocket fuel to equities around the world as the dollar strengthened against almost every other currency, helping their exports and making their markets more appealing to buy with strong dollars. The index peaked in mid-May and has now rolled over and is approaching support around 65. Should that level be breached, it could be a big fall down to the next support level at 59.

Two months ago, when commenting on the parabolic rise in the price of the Shanghai Index over the past year, I said that "while there is a long way to go to surpass the lofty levels achieved in 2007, the current strength bodes well for continued success. I would expect the index to rest for a bit, but longer term, there's no reason to think it won't go even higher." That statement has proved prescient as the index has roared higher and busted through resistance at 4,500 on the was to surpassing 5,000. Still, I don't trust the Chinese markets, or their accounting, and therefore I haven't put any of my own money into this sector.

It looks to me like the NYSE Bullish sentiment index is setting up for the next buy call. RSI has fallen to oversold levels and the index itself has fallen below interim support. This setup often suggests a rally is forthcoming. The only question is when.

At around 14 the VIX appears to be holding right in the middle of the "new normal complacent" range, which is just fine. Anything in the 14 - 18 range seems to be a sweet spot for the VIX these days. Overall, this picture represents a relatively sanguine view of the market.

I think the stock market is neither over- nor under-priced right now. I would expect the broad market averages to remain in a fairly narrow range for the next few months, perhaps dropping as much as 5%, but not suffering any significant losses. And I still expect the #DJIA to be up 6% - 10% for the full year. In order to achieve these gains  I believe we will enjoy a year-end rally. Therefore, I believe it will be important to be in the market in order to reap those gains. I still believe that the Fed will hold off on increasing rates until the September meeting, at the earliest, and could hold off until next year. Unless interest rates on the 10-year Treasury exceed 3% for any meaningful period of time, the best game in town will continue to be the stock market.

I followed up on my big acquisition spree last month by adding one big new position, a leading media company that I've wanted to own for many years. This means that I have put over $2.25 million into new stocks in the last two months. I am very confident that all of these new positions will generate out-sized profits for my clients for many years to come.

News and Notes

There isn't much news to report right now as it has been a very quiet past month or so. Nola is home from college and hard at work. Lily and Ezra start final exams this week, after which Ezra heads off to camp and Lily to Fiji for two weeks before returning to her job lifeguarding at a local golf club. Kathiryn and I are enjoying some down time from our busy schedules. That being said, we do have a few Broadway shows and concerts to look forward to over the next week or so.

That's it for now. I look forward to writing to you again in July.

Best regards,

Greg Werlinich
President

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