Werlinich Asset Management, LLC

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June 13, 2017

Hold Your Ground

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

Current Market Analysis

After hitting a new high around March 1, the Dow Jones Industrial Average spent the next three months consolidating in a fairly tight range before exploding to another new record high as I write this. Most sectors of the market are rallying, delivering big profits to the patient investors who managed to ignore all of the noise from Washington. As I said last night, one should be cautious, but remain invested; you should hold your ground.

Looking at the chart of the #DJIA for the past seven months, we see a very bullish primary trend. The rally that began in March 2009 continues in force with fresh new records being recorded yesterday and today. The current price is well above both the 50-day and 200-day moving averages, and is well above interim support around 20,400. So if Trump and his administration can avoid alienating all our allies and blowing up the economy, there's no reason to think that the market can't continue to move higher, at least for now. 

Even the more economically sensitive Dow Jones Transportation Average is joining the party. Last month I suggested that if it moved any lower it would be a buying opportunity. Within a day or so of writing that, the index turned higher. It would be a very bullish indicator if the index would hit a new high at the same time as the industrial average.  

The staid Dow Jones Utility Average has produced remarkably outsized gains so far this year as rates remain lower than expected. The question is what will happen if/when the Fed increases its lending rate by 25 basis points this week. Will Treasuries move higher, or will the yield curve flatten? The answer to that question will go a long way towards deciding the fate of the utility sector. 

Key Economic Statistics

  • According to the Department of Labor, the figure for seasonally-adjusted initial jobless claims for the week ended June 3 was 245,000, which is on the high end of the same range of figures we've seen all year. The four-week average of 242,000 continues the gentle downward trajectory.
  • The non-farm payroll employment report in May was well below expectations, as only 138,000 jobs were gained in the month, and even worse, 66,000 net jobs were subtracted from the prior two months. The household survey reported that the unemployment rate dropped to a tiny 4.3%, the lowest level in a decade, while the labor force participation rate fell back to 62.7. Average hourly wages for blue collar workers rose to a new high of $22.00 while the average work week held at 33.6 hours.
  • Only 6.9 million workers were counted as unemployed, while 1.7 million people remained unemployed longer than 27 weeks. The seasonally adjusted number of people who could only find part-time work fell to 5.2 million while the number of marginally attached workers remained at 1.5 million. The number of people holding multiple jobs dropped to 7.58 million. All of this resulted in the U-6 "underemployment" rate falling to 8.4, which is the lowest level since late 2007. Overall, this was a pretty mediocre report, showing that it isn't so easy to create new jobs in this country right now.
  • The Congressional Budget Office (CBO) estimated that on a net present value basis, the nation's budget deficit was $87 billion in May, and $35 billion more than a year ago. This resulted in a deficit of $432 billion for the first eight months of fiscal 2017, $26 billion more 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 2.6% in April to 1,172,000, which was up only 0.7% from a year ago. The crappy weather from March continued in April, so I'm not concerned by this decline. Indeed, a nasty May will likely also produce poor numbers.
  • The Census Bureau reported that on a seasonally adjusted annualized basis, only 569,000 new homes were sold in April, down 11.4% from March, and basically flat from a year ago. The estimate of the number of homes for sale was 268,000, representing 5.7 months of inventory at the current rate of sales. The median sales price was $309,200, just below the 12-month moving average price of $311,350. These mediocre numbers are consistent with the poor housing start numbers. I would expect more of the same next month, thanks to the lousy weather.
  • The National Association of Realtors reported that 5.57 million existing homes were sold in April, down 2.3% from the prior month, yet still up 1.6% from a year ago. The estimate of the number of homes for sale was 1.93 million, representing only 4.2 months of inventory at the current rate of sales. The median price was $244,800, which is above the rising 12-month moving average price of $236,975. Again, poor sales totals, yet rising prices, evidenced the poor weather but a tight market.
  • According to the Institute for Supply Management (ISM), economic activity in the manufacturing sector expanded in May for the ninth month in a row, inching up to 54.9. The ISM index of non-manufacturing activity decreased 56.9, which still signaled growth in the service sector for 88 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 0.3% in April, following a gain of 0.3% (revised) in March and 0.5% in February. "The recent trend in the U.S. LEI, led by the positive outlook of consumers and financial markets, continues to point to a growing economy, perhaps even a cyclical pickup," said Ataman Ozyildirim, Director of Business Cycles and Growth Research at The Conference Board. "First quarter’s weak GDP growth is likely a temporary hiccup as the economy returns to its long-term trend of about 2 percent. While the majority of leading indicators have been contributing positively in recent months, housing permits followed by average workweek in manufacturing have been the sources of weakness among the U.S. LEI components."
  • According to the "second" estimate by the Bureau of Economic Analysis, GDP increased at a modest annualized rate of 1.2% in Q1 2017, up from the meager 0.7% advance estimate. 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 later this month.
  • 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 117.9 in May from 119.4 (revised) in April. "Consumer confidence decreased slightly in May, following a moderate decline in April," said Lynn Franco, Director of Economic Indicators at The Conference Board. "However, consumers' assessment of present-day conditions held steady, suggesting little change in overall economic conditions. Looking ahead, consumers were somewhat less upbeat than in April, but overall remain optimistic that the economy will continue expanding into the summer months."

Trends To Watch

The value of the dollar index continues to weaken, as you can see below. A cheaper dollar has likely helped drive additional profits to the bottom lines of large multinational companies. I would expect the dollar to improve in the next six months if the Fed makes good on its promise to hike rates two more times this year, and that could impact corporate profits in the second half of the year. Stay tuned. 

The yield of the 10-year Treasury bond has traded between 2.2% and 2.6% for the past seven months. As I've said before, it's hard to envision a scenario where rates drop appreciably from here, but they could remain range-bound for a few more months, even when the Fed increases their lending rate this week..Still, I still think the yield could approach 3% before the end of the year.

The price of a barrel of West Texas Crude is clearly having trouble finding a stable level, as it swings between $45 and $55. 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 only a couple of core, long-time positions. Otherwise, I am underweight this sector.

While the price of gold again failed to pierce resistance at $1,300, it is trading near the top of the range established over the last six months. Given all the uncertainty around this trade, I still prefer to remain on the sidelines.

The Nasdaq Composite, led by the FAANG stocks, continued to power record highs before a brief two-day decline. It is not time to get off this train. 

Trading in the financial sector has been range-bound for the past six months, as you can see below. Five times the index has fallen to, but not through, support around $23. My bet is that we'll see the index move above resistance around $25.25 before falling below support. 

Sticky low interest rates continue to benefit the tight housing market. And now that the weather has finally warmed up, heading into the strong home selling season, there's no reason this sector can't move even higher.

The NYSE Bullish sentiment index continues to weaken, as it has for most of the year, even while the stock market has moved ever higher. That is very bullish and suggests that the market could move even higher.

It really appears that the VIX has lost much of its predictive powers. No matter how little volatility there is, the stock market just continues on its merry way. Even the brief spikes of volatility, like in mid-May, prove meaningless. I may have to stop showing this chart in the coming months.

What I'm Thinking and Doing

For my purposes, it's basically business as usual right now. Presidents come and go, as do Congressmen and Senators (although many of them seem to hang on until eternity). But the economic cycle will outlast them all. And right now, we are in the midst of an historic period of relatively stable but modest economic growth. Interest rates remain historically low, corporate profits are steady and predictable and inflation is quiescent. Given all of that, my basic investment thesis is had it has been since 2009: be fully invested in the stocks of quality companies, most of whom pay a steady dividend. I've also chosen 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 have also chosen to hold some defensive stocks, like utilities, large food and beverage companies, and defense companies. Owning this mix of stocks has helped me and my clients profit from this very long bull market and I so no reason to change anything now.

As I've said for most of this year, when the market is at, or near, all-time high levels, it's difficult to find stocks to buy at good prices. And that, after all, is the entire key to investing: buying good stocks at great prices. As a result, thanks to new record high prices for much of the stock market, I've been mostly on the sidelines for the past few months. I did buy a sizable position in a major defense contractor on an earnings dip. I have also added smaller positions in half a dozen small- and micro-cap tech stocks in the hopes that I might find the next Nvidia. Overall, I think my clients are well-positioned to profit in the months and years ahead.

News and Notes

There's not much new to discuss with respect to the family this month. Nola is in Western Massachusetts for the next two months. Lily is in DC and Ezra is getting ready to head to Iceland in two weeks. The only really news is that I had surgery on my right shoulder last week; three years after I had the same procedure on my left one, giving me a matching set. It hasn't been a pleasant few days, but I'm getting better every day. 

Kathiryn and I continue to be very busy with 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. If you want, just let me know and I'll add you to the distribution list for all announcements of upcoming gigs. I also continue to be very busy with my responsibilities to the Food Bank for Westchester. I would encourage each and every one of you to find something that matters to you, something you believe in strongly, and do something to give back to your local community. 

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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