NEWS AND VIEWS
Werlinich Asset Management, LLC
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July 13, 2015


The Market Is Just Fine, Thank You

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 halfway through the trading day, the Dow Jones Industrial Average stands at 17,939, about 40 points higher than when I wrote to you last month. The stock market, as defined by the #DJIA (or the S&P 500), is essentially unchanged for the year. The market has been choppy this year, as you can see below, because investors are focusing more on short-term news and events rather than the long view, which is how I prefer to look at things. But that is the way it alway is; traders look at next week and investors look at next year and beyond. If you've been reading this newsletter long enough, you have hopefully learned to take a longer view of the stock market, which in turn should have allowed you to earn better returns. 

My biggest themes continue to be that our economy remains in slow and steady mode, that corporate balance sheets are in great shape, that domestic corporate profitability is solid, that the Fed is unlikely to change their position on rates this year and that the equity markets are the best, and only, way for most investors to generate an income that beats taxes and inflation. If these themes are valid and correct then equities should outpace money market savings accounts, CD's and bonds and generate positive, if somewhat modest, returns by year-end. I continue to 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 the rapid decline, beginning in mid-June, that pushed the index below interim support around 17,800. It also shows the quick recovery, which doesn't include the gains from today. I won't become concerned unless the index falls below support around 17,100. I'm still bullish on the market, even though the transports and utilities are weak.

The Transportation Index continues to underperform the broader market. It is very worrisome that the #DJTA has fallen through another support line at 8,200 The good news is that after hitting a low just above 7,900, the index has bounced back up to what is now resistance at 8,200. It would be very bullish if that level could be pierced. Overall, this is a bad chart, but there is a spark of hope in the current action. 


Like the transportation average, the Dow Jones Utility Average has been a miserable performer this year. The specter of a Fed rate hike, as well as increased Treasury rates, have simply crushed this sector. But like the transports, the index has shown some life recently, rising above resistance 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. But as I don't believe we'll have a Fed rate hike this year, I think we could see a move back into utilities over the next few months.


It's been a poor year for bond investors as rate increases have meant losses. Remember, interest rates move in the inverse direction of bond prices. The current yield of around 2.4% is straddling resistance (green dotted line). If the equity markets continue to improve, I would expect rates to stabilize, or drop a little as money moves out of bonds into stocks.  


Last Month's Results

The roller coaster continued in June where the broad market declined after generally upbeat results in May. Much of the weakness in the market can be attributed to concerns about Greece defaulting on its debts and potentially pulling out of the European currency, and to the precipitous drop in the Chinese stock market. The latter is probably a larger long-term problem for our markets. As you can see below, only small-cap stocks were spared losses in the month. It's interesting to note that equities and bonds both lost money in June. I think it will be harder and harder to make money in bonds going forward.

Name of Index

Jun

QTD

YTD

Description

S&P 500

-1.9

0.3

1.2

Large-cap stocks

Dow Jones Industrial Average

-2.1

-0.3

0.0

Large-cap stocks

NASDAQ Composite

-1.6

2.0

5.9

Large-cap tech stocks

Russell 1000 Growth

-1.8

0.1

4.0

Large-cap growth stocks

Russell 1000 Value

-2.0

0.1

-0.6

Large-cap value stocks

Russell 2000 Growth

1.3

2.0

8.7

Small-cap growth stocks

Russell 2000 Value

0.1

-1.2

0.8

Small-cap value stocks

MSCI EAFE

-2.8

0.8

5.9

Europe, Australia, Far East

Barclays Aggregate

-1.1

-1.7

-0.1

US government bonds

Barclays High Yield

-1.5

0.0

2.5

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 July 4 was 297,000, which is the fourth straight weekly increase, as well as an increase of 15,000 from the prior week and an increase of 18,000 from the prior month's figure. The four-week average of 279,500 was roughly the same as the tally from a month ago. About 2.334 million people continue to collect unemployment insurance, about 70,000 more than last month. I wonder if the last four weeks is an aberration or an indication of a more worrisome trend. 
  • The non-farm payroll employment report in June was slightly weaker than expected as the establishment survey reported that 223,000 jobs were added in the month, but revisions subtracted 60,000 jobs from the April and May totals. The household survey reported that the unemployment rate dropped to 5.3% but the labor force participation rate fell to 62.6, the lowest figure in many years. About 432,000 people left the labor force in June, leaving 8.3 million workers being counted as unemployed. Where are the job-seekers? The comprehensive U-6 "underemployment" fell to 10.5%. 
  • 2.1 million people remained unemployed longer than 27 weeks, down 400,000 from last month. Is seems these people are simply giving up hope of ever finding a job. The seasonally adjusted number of people who could only find part-time work fell to 6.5 million while the number of marginally attached workers held at 1.9 million. The number of people holding multiple jobs decreased to 7.03 million. Average hourly wages for blue collar workers increased to $20.99 while the average work week held at 33.6. Wage growth remains tepid at around 1% so far this year and those who can't find work are giving up hope. 
  • The Congressional Budget Office (CBO) estimated that on a net present value basis, the Treasury reported a budget surplus of $51 billion in June, leaving the nine-month deficit at $314 billion, about $52 billion less than the shortfall recorded in the same period last year. It's a very good thing for the country that the federal deficit continues to shrink.
  • The National Association of Homebuilders/Wells Fargo Confidence Index increased five points to 59 in June, breaking a streak of losses in four of the previous five months. "The HMI indices measuring current and future sales expectations are at their highest levels since the last quarter of 2005, indicating a growing optimism among builders that housing will continue to strengthen in the months ahead" said NAHB Chief Economist David Crowe.
  • The Census Bureau reported that privately owned housing starts fell 11.12% in May, after jumping 22.1% in April, to a seasonally adjusted annual rate of 1,036,000 units, which was 5.1% higher than a year ago. New building permits popped 11.8% from the prior month and were 25.4% higher than the year before. The general trend in starts and permits seems positive.
  • The Census Bureau reported that on a seasonally adjusted annualized basis 546,000 new homes were sold in May, up 2.2% from April (revised higher), marking growth in five of the past six months, and up 19.5% from a year ago. The estimate of the number of homes for sale remained steady at 206,000, representing only 4.5 months of inventory at the current rate of sales. The median sales price dipped to $282,800, leaving it below the 12-month moving average price of $289,367.
  • The National Association of Realtors reported that on a seasonally adjusted annualized basis, 5.35 million existing homes were sold in May, a jump of 260,000, or 5.1%, from April, and 9.2% higher than a year ago. The estimate of homes for sale is 2.29 million, which represents only 5.1 months of inventory at the current rate of sales. The average selling price rose to $228,700, the higher level since July 2007 and well above the rising 12-month average of $212,633. Again, the housing market looks pretty healthy to me. I think part of the activity is concern over the potential for higher rates in coming months spurring higher levels of buying now while rates are still low.
  • According to the Institute for Supply Management (ISM), economic activity in the manufacturing sector increased to 53.5 in June, marking overall growth for 23 straight months. The ISM index of non-manufacturing activity inched up to 56.0, which signaled growth in the service sector for 65 consecutive months. Again, we have slow, steady, unspectacular growth. 
  • The Conference Board reported that its index of Leading Economic Indicators (LEI) increased 0.7% in May, following an 0.7% gain in April. "The U.S. LEI increased sharply again in May, confirming the outlook for more economic expansion in the second half of the year after what looks to be a much weaker first half," said Ataman Ozyildirim, Economist at The Conference Board. 
  • According to the Bureau of Economic Analysis, GDP decreased at an annual rate of 0.2% in Q1 2015 according to the "third" estimate. While this was slightly better than the earlier estimate of an 0.7% decrease, it was still 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 was 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 May the amount of total outstanding consumer credit grew at an annualized rate of 5.75%, up to $3.4 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. This particular statistic seems to me less and less relevant, therefore I'm going to stop showing it beginning next month. 
  • According to the BLS, the seasonally adjusted Consumer Price Index for all Urban Consumers (CPI-U) increased 0.4% in May, but unchanged for the past 12 months. If you strip out food and energy, CPI rose only 0.1%. It is abundantly clear to me that economic growth is tepid, at best. I remain convinced that the Fed will continue the current interest rate policy for the remainder of the year.
  • The Conference Board's Consumer Confidence Index, which had fallen in April, inched higher from 95.2 to 95.4. "Consumer confidence improved further in June, following a modest gain in May," said Lynn Franco, Director of Economic Indicators at The Conference Board. "Over the past two months, consumers have grown more confident about the current state of business and employment conditions. In addition, they are now more optimistic about the near-term future, although sentiment regarding income prospects is little changed. Overall, consumers are in considerably better spirits and their renewed optimism could lead to a greater willingness to spend in the near-term.

Trends To Watch

The price of the dollar index is becoming a bit range bound as it trades between resistance around 97.5 and support around 93.5. Should the dollar soften just a bit it would be a boon to the earnings of multi-national companies and to companies in the energy and commodity sectors. 

West Texas Crude found a hard ceiling on prices around $62.50 where it traded for two months before falling steeply this month. Indeed, it fell right through support around $53, going as low as $50. It's now trading right around resistance at $53. I think much of the weakness is due to the perception (true or false I do not know) of real trouble in China, which would therefore curb demand, and a possible deal with Iran that could increase supply. While I still believe prices will be higher by the end of the year, I'm less sanguine about the near-term future. 

The price of gold remains bound in a range between $1,140 and $1,215, where it has traded for most of the past nine months. I think it's instructive that during the recent panic about Greece and China, during which time the stock market fell 4%, the price of gold could not break above $1,200. And now it appears ready to again test major support at $1,140. I'll reiterate what I've been saying all year: I'm completely out of this sector and I suggest you stay out as well.

Ugly is the word that first comes to mind when looking at this chart. For the second time this year, the price of copper is testing major support at around $2.50. This does not bode well for the health of the world economy. I hope the Fed is paying attention to this chart. 

Unlike the previous chart, the one below, describing the fabulous gains in the technology sector, is just beautiful. The Nasdaq Composite continues to grind higher, even accounting for the drop earlier this month. I see no reason to curb my enthusiasm for big tech just yet.

Looking below at the chart of the financial sector, you can see the four "buy" calls I made over the past ten months. Given the accord just reached in Greece over the weekend, I'm comfortable placing my latest "buy" call today at 24.64. Over the next 6 to 12 months, I think we could see big gains for the financial sector. 

I've tightened the time perspective this month to give you a better perspective on the action in the housing index. Here you can see that the index is trying for the fourth time to piece resistance at 238, a level that dates back to before the financial crisis. First I thought it would happen before Memorial Day, then by Independence Day. But this index is stubborn. I still expect the breakthrough to occur, I'm just going to stop speculating on when. 

Last month I wrote that "the biggest surprise to me in the first half of the year has been the strong performance of the developed international market [but that] 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." Unfortunately, that is exactly what happened as selling knocked the index through the support. The good news is that the deal on Greek debt will likely mean support at 59 will hold and the index could move higher.

All year I've been noting, with incredulity, the parabolic rise of the Shanghai Composite Index. I also warned you that I didn't trust the Chinese markets and that I wouldn't put any of my own money to work there. Shortly after I wrote that last month, in a very sudden, and very painful correction, the index completely fell apart. The index dropped about 35% in just over a month! Ouch! The Chinese government is doing everything in its power to stanch the bleeding, and it seems to be helping, at least for now. Buyer beware.

Last month I said that "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." I think the answer to that question was "last week". I expect to see the index bounce off support at 53 and move higher. 

Not surprisingly, the VIX spiked from being super complacent at 12 to bumping into fear at 20 over the past two weeks. This coincided with the overall market decline and fears around Greece and China. Now that things are, if not resolved, at least less urgent, I would expect the VIX to return to between 12 and 16.


What I'm Thinking and Doing

Last month I said that "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." Over the past two weeks we experienced a 4% decline in the #DJIA on fears of a Greek debt default, and possible removal from the European Union, as well as concerns over the implosion in the Chinese stock market. Equity markets are the world quickly plunged, only to just as quickly recover after the Chinese market stabilized, thanks to massive government intervention, and a debt deal was reached in Greece. So was that they dip I expected, or could there be further losses in the future? I believe that was simply one of two or three mini-corrections that we're likely to experience between now and the end of the year. And remember, these declines are healthy and to be expected as part of the natural course of the market. They shouldn't be feared. Indeed, they create buying opportunities. 

I've said all along that I expect the broad market averages to be up 6% - 10% for the full year. In order to achieve those gains I believe we'll enjoy a nice year-end rally. In order to reap those gains you must be in the market, not sitting on the sidelines in cash, waiting for the bear market so many prognosticators have called for. I believe that the Fed will refrain from increasing rates until next year, or at the December meeting at the earliest. Until interest rates on the 10-year Treasury exceed 3.5% for any meaningful period of time, the best game in town will continue to be the stock market.

I'm beginning to pay more attention to the bloated, and bloviating, chorus of Republican contenders for the Presidential nomination. I think we're up to around 16 people today, but the list grows almost daily. I have to say, this is going to be great theater for the next six months or so as the pretenders are whittled down to the contenders. Hopefully the Koch brothers will waste a few billion backing the wrong horse.

Why aren't more people up in arms about the fact that at least 22 million people, and certainly our national security, will be affected by the hack of the Office of Personnel Management? That is absolutely frightening. This should be front page news today, and every day, until the government can prove that they have put in place the necessary safeguards to prevent this from happening again. And there should be a detailed investigation as to who perpetrated this hack, and who allowed it to happen. And finally, there have to be repercussions if and when the hackers are found. We cannot allow this breach to go unpunished. 

After two busy months, during which I deployed over $2.25 million in two large acquisitions and a number of smaller ones, things have been quiet in the past month. I'm happy to sell a few smaller, lagging positions and allow dividends to replenish my cash supplies. With the exception of a few of my most interest rate sensitive holdings, and my legacy energy and commodity stocks, I'm very pleased with the performance of the bulk of my positions and equally excited about their prospects for growth in the coming years. 

News and Notes

Life in the Werlinich Family continues to be fairly quiet these days so there is little new to report. Nola continues to work very hard interning with a summer theater company in New Canaan, CT. Lily returned at 2:00am this morning from two weeks in Fiji. She's still asleep, recovering from almost 24 hours of traveling across 16 time zones, so I haven't had the chance to speak with her yet. And Ezra has finished his first two weeks of camp and is having a great time. 

Kathiryn and I will be celebrating our 4th anniversary of meeting each other by attending the King and I tomorrow night at Lincoln Center. Then we have a baseball game and a few concerts to look forward, as well as a long weekend out of town coming up in two weeks.

Happy birthday Dad!!

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

Best regards,



Greg Werlinich
President


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