July 11, 2016

After a first quarter that two very precipitous declines, the second quarter has been relatively sanguine, except for two days in June following the announcement of the Brexit vote. If you eliminate those two days, the Dow Jones Industrial Average traded in a fairly narrow range, roughly between 18,000 and 17,500, capped by the bright green line in the chart below. Amazingly, after a big rally on Friday, the #DJIA is just 166 points shy of the record close from May 19, 2015. The #S&P500 is an astonishing 0.92 points below its all time closing high from May 21, 2015. So the big picture seems pretty good, which is all the more remarkable given the backdrop of #Brexit, Donald Trump, terror around the world, horrific mass shootings in the US and an economy that is just stumbling along. Indeed, the market continues to "climb a wall of worry". 

In April I suggested that "I think the market is at an interesting inflection point; it could either move higher and attempt to surpass the November high or it could roll over and head back towards the lows. My best guess is that we'll see the averages move a little higher over the next month or two and finish the year high than it started." The averages have indeed moved a bit higher, have pierced the November (and April) resistance levels, and are taking aim at the all time highs. The only fly in the ointment is the woeful Transportation average, which we see in the next chart. 

I may have spoken too soon when I wrote in April that the strong rally from the January lows suggested much better things for the stock market and the economy. Since then, the #DJTA index has really struggled, as you can see. In fact, we can see a swoon (downward trending blue line) lasting almost a year and a half in this economically sensitive sector. After falling below interim support around 7,500 after the Brexit vote, the index has rebounded a bit, and now sits right at both moving averages, but still below the falling trendline. Remaining above 7,500 is important, as is managing to rise above that trendline. If that happens, there would be cause for optimism. If 7,500 is violated, it would be cause for concern. 

After the Dow Jones Utility Average spent most of 2015 churning in a tight trading range, the index has exploded higher this year, catapulting to record levels. This is very impressive action for this conservative, widows and orphans investment index. In a world of low- or no-yield bond returns, income from utilities looks very appealing. I wouldn't expect these results to continue; in fact, I wouldn't be surprised to see a pullback to test the 660 support level. Still, I wouldn't be a seller either. Just continue to hold and enjoy the income.  

I admit it. Month after month, year after year, I have been dead wrong about how low the yield on the 10-year treasury bond can go. Right now it sits at 1.36% which is the lowest it has been in its history. That's right; this is the lowest yield in recorded history in this country. And yet our government debt, currently paying next to nothing, looks fat compared to yields around the globe that are at zero, or are negative. Negative yields mean that bond investors are so concerned about what to do with their money that they're willing to lend their money, for 10 or 20 years, and PAY THE GOVERNMENT for the right to do it. They earn less than nothing! They're guaranteed to lose money. It seems incomprehensible to me but that's what's happening right now. And against that backdrop, it wouldn't surprise me to see our rates fall even further. Could 1% be in our future? I wouldn't be surprised. 

Last Month's Results

The first half of the year is in the books, and with all of the problems, the broad market averages managed to eke out modest gains. Not surprisingly, in the face of a muddling economy, negative interest rates, Brexit and Trump, bonds were the best performing asset class. Similarly, value stocks significantly outpaced their growth brethren. Technology and international stocks substantially underperformed the broad market and are in the red year-to-date. As crazy as this market has been, I expect more of the same in the second half. 

* Returns 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 2 was 254,000, 16,000 less than the prior week, and about 10,000 less than the prior month's figure. The four-week average of 264,750 was 10,000 lower than the tally from three months ago. The tally of jobless claims continues to hold relatively stable for the past year and a half. About 2.12 million people continue to collect unemployment insurance, about 700,000 less than last in early April. Overall, this is a fairly nice picture. 
• After a horrifically bad (and revised even lower) report in May, the non-farm payroll employment report in June blew away expectations as 287,000 jobs were gained in the month, with 6,000 net jobs lost in the prior two months. The household survey reported that the unemployment rate ticked back up to 4.9% after falling to 4.7% last month. The labor force participation is at 62.7, similar to where it's been for most of the year. Average hourly wages for blue collar workers inched up to a new high of $21.51 while the average work week again remained at 33.6 hours for the fifth straight month. 
• 7.8 million workers were being counted as unemployed, down a bit, and 2.0 million people remained unemployed longer than 27 weeks. The seasonally adjusted number of people who could only find part-time work fell to 5.8 million while the number of marginally attached workers held around 1.8 million. The number of people holding multiple jobs plunged to 7.06 million. All of this conspired to send the comprehensive U-6 "underemployment" rate down to 9.7%. The truth is that for all the hue and outcry about jobs in this country, we are about as close to "full employment" as we're going to get without creating massive wage inflation.
• The Congressional Budget Office (CBO) estimated that on a net present value basis, the Treasury reported a budget deficit of $53 billion in May, which leaves the eight month deficit at $408 billion, $41 billion more than the last fiscal year. 
• The Census Bureau reported that privately owned housing starts were essentially flat in May, down from the high in February, holding at an adjusted annual rate of 1,164,000 units, which was 9.5% higher than a year ago. New building permits were also essentially flat from the prior month and were down 10.1% from the year before.
• The Census Bureau reported that on a seasonally adjusted annualized basis 551,000 new homes were sold in May, down 6.0% from April, but up 8.7% from a year ago. The estimate of the number of homes for sale was 244,000, representing 5.3 months of inventory at the current rate of sales. The median sales price was $290,400, down almost $30,000 from last month, leaving it below the slowly rising 12-month moving average price of $301,575.
• The National Association of Realtors reported that just over 5.5 million existing homes were sold in May, which is the highest level of the year, up 1.8% from April, and 4.5% from a year ago. The estimate of the number of homes for sale was 2.15 million, representing a slim 4.7 months of inventory at the current rate of sales. The median price was $239,700 was also the highest level of the year, up 4.7% from last year, and about $15,000 above the rising 12-month moving average price of $224,917. The warmer weather does indeed seem to be helping home sales.
  
• According to the Institute for Supply Management (ISM), economic activity in the manufacturing sector expanded in June expanded for the fourth straight month, rising to 53.2. The ISM index of non-manufacturing activity was 56.5, which signaled growth in the service sector for 77 consecutive months. Both of these were the highest levels of the year.
• The Conference Board reported that its index of Leading Economic Indicators (LEI) decreased 0.2% in May, following a gain of 0.6% in April. "The US LEI declined in May, primarily due to a sharp increase in initial claims for unemployment insurance. The growth rate of the LEI has moderated over the past year," said Ataman Ozyildirim, Director of Business Cycles and Growth Research at The Conference Board. "While the LEI suggests the economy will continue growing at a moderate pace in the near term, volatility in financial markets and a moderating outlook in labor markets could pose downside risks to growth.
• According to the "third" estimate by the Bureau of Economic Analysis, GDP increased at an annual rate of only 1.1% in Q1 2016, up from the first and second estimates, but still lower than the 1.4% recorded in Q4 2015, the 2.0% recorded in Q3 and the 3.9% rate reported in Q2. The only good news is that even this meager number surpassed the decrease of 0.2% recorded in Q1 2015. This modest growth rate will do nothing to alter the current fiscal policy of the Fed. Don't expect to see an increase in their lending rate any time this year.
• According to the BLS, the seasonally adjusted Consumer Price Index for all Urban Consumers (CPI-U) declined by 0.2% in May after three months of gains. The food index was the laggard in the month. The index for all items less food and energy increased by 0.2% in the month. No inflation here.
• The Conference Board's Consumer Confidence Index increased to 98.0 in June from 92.4 in May. "Consumer confidence rebounded in June, after declining in May," said Lynn Franco, Director of Economic Indicators at The Conference Board. "Consumers were less negative about current business and labor market conditions, but only moderately more positive, suggesting no deterioration in economic conditions, but no strengthening either. Expectations regarding business and labor market conditions, as well as personal income prospects, improved moderately. Overall, consumers remain cautiously optimistic about economic growth in the short-term."

Trends To Watch

After falling for the first four months of the year, the dollar index has rebounded a bit recently, thanks primarily to the carnage in European currencies subsequent to the Brexit vote. Surprisingly, the stock market has managed to rally even as the greenback has strengthened. But I imagine there is a limit to how long the market can rise if the dollar continues to gain. As it stands, the index is bumping against resistance around 96.5. We'll see what the action is over the next few weeks and months. 

After being one of the worst performers in 2015 and early 2016, the price of West Texas Crude enjoyed a powerful four month rally, during which it almost doubled in price, and briefly topped major resistance at $50 per barrel in early June. But that resistance held, and since then the price has moved steadily lower, and now hovers around $45. Last issue I wrote that "my crystal ball is a little cloudy right now, but I think we'll break above $50 before we fall below $30 again." That turned out to be true, as that conviction allowed me to add to my energy positions a bit during the quarter. Looking out, I think support above $38 will hold firm, and we'll eventually crest $50 again. 

I have been dead wrong about the direction of the price of gold all year. And each time I say it is unlikely to go any higher, it confounds my prediction and moves to a new high. It did so again over the last couple of weeks as it blew past $1,300 and set its sights on $1,400, which is the next major resistance level. No doubt the recent strength is thanks entirely to the Brexit vote. Be that as it may, the gold bugs are dancing and again proclaiming that much bigger days are ahead. And while they may be right, I just don't feel it this time around, so for now, I'm gong to remain on the sidelines.

Tech stocks, as represented by the Nasdaq Composite, are at an interesting inflection point right now. The index remains down for the year after finishing the year near record highs. Right now the index is making a third attempt to break through interim resistance around 4,900 (dotted green line). If it can break through, it will have a chance to attack the high around 5,200. If not, it needs to remain above support around 4,600. The problem is that during difficult times, investors sell high multiple growth stocks with small dividend yields in favor of solid, blue chip stocks. So I'm not sure which way this is headed but I'm not selling any of my tech holdings.  

The financial sector has really struggled this year, thanks in large part to the unnaturally low interest rates, which keep a lid on their earnings. The good news is that the vast majority of domestic banks have fortress balance sheets and have passed all of the "stress tests". This means that they will weather just about any possible downturn in the economy. I wrote last time that "this would probably be a good time to be a buyer for patient, long-term investors." I put my money where my mouth was as I added to my positions in two banks, one insurance company and one asset manager. 

After a brutal two months, during which it fell into bear market territory as it plunged about 25%, the housing index has recovered almost all of the lost ground, has recently broken a key resistance level around $237 and is primed to make a move at the record high around $252. The record low interest rate levels don't hurt. The more quiescent the Fed, the better it is for the housing market. I expect to see a new high before winter.

Not surprisingly, given all the uncertainly surrounding Brexit, negative interest rates and low, or no, economic growth, the index for developed international markets is in poor shape. The good news is that support around 51 has held three times this year. The bad news is that the moving averages just formed a "death cross" as the 50-day moving average has fallen below the 200-day average. And the index is trading in the lower half of the trading range. I continue to believe, as I have for the past year or so, that investors should avoid the EAFE markets and put the bulk of their funds to work in the U.S. 

The NYSE Bullish sentiment index has traded in a fairly narrow range for the last four months. In my last newsletter I suggested that, at the time, sentiment is much more exuberant and RSI is too overbought, so I'd expect a period of consolidation to follow before the rally can resume." The index has indeed consolidated, along with the overall market. Given the low relative strength, we're set up for the next extended rally. 

After briefly popping into the "fear" zone during the Brexit scare, the price of the volatility index, or the VIX, has again fallen to the low end of the normal volatility range, where it has remained for most of this year. This doesn't suggest anything untoward in our immediate future. I have been a buyer during both of the spikes in volatility this year.