Werlinich Asset Management, LLC

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July 17, 2017

The Bull Keeps Running

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

Current Market Analysis

For the second month in a row, the market, as represented by the Dow Jones Industrial Average, attained a new record high as I write the newsletter. And once again, most sectors of the market are rallying. As I've said over and over this year, and for the past few years, investors should remain cautious, but fully invested. Rather than attempting to time the market, which invariably leads to buying high and selling low, the best way to build wealth is to own a diversified portfolio of high performing stocks. This is what I've tried to do for my clients over the past twenty years.

As we look at the chart of the #DJIA for the past eight months, we continue to see a very bullish primary trend. The rally that began over nine years ago, in March 2009, continues unabated today. The current price is well above both the 50-day and 200-day moving averages, and interim support around 20,400. Early indications point to Q2 earnings being better than expected, which suggests that the rally should continue. 

After months of disappointment, the Dow Jones Transportation Average finally joined the new record club. And did so at the same time as the Industrial Average, resulting in a bullish Dow Theory confirmation. Two months ago I suggested that the low price of the index presented a buying opportunity. Almost immediately thereafter it recovered and has moved higher ever since.  

Although the usually staid Dow Jones Utility Average has produced remarkably outsized gains so far this year, the index has retreated subsequent to the Fed rate hike in June. Still, the yield on the 10-year treasury has barely budged (see below), which suggests that the sector could regain some of those losses.  

Key Economic Statistics

  • According to the Department of Labor, the figure for seasonally-adjusted initial jobless claims for the week ended July 8 was 247,000, which is roughly in line with the same range of figures we've seen all year. The four-week average of 245,750 is also consistent with the numbers for most of the year.
  • The non-farm payroll employment report in June exceeded expectations, as 222,000 jobs were gained in the month, and an additional 47,000 net jobs were added in the prior two months. The household survey reported that the unemployment rate nudged up to 4.4%, while the labor force participation rate inched up to 62.8 as more people entered the labor force. Average hourly wages for blue collar workers rose to a new high of $22.03 while the average work week rose to 33.7 hours.
  • About 7.0 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 rose to 5.3 million while the number of marginally attached workers crept up to 1.6 million. The number of people holding multiple jobs dropped to 7.43 million. All of this resulted in the U-6 "underemployment" rate rising to 8.6. Overall, this was a very solid, if unspectacular, report, showing that the labor market continues to make slow and steady gains.
  • The Congressional Budget Office (CBO) estimated that on a net present value basis, the nation's budget deficit was $87 billion in June, about $93 billion less than the $6 billion surpluss from a year ago. This resulted in a deficit of $520 billion for the first nine months of fiscal 2017, $120 billion more than the shortfall recorded during the same period last year. The full-year deficit is now estimated to be around $693 billion. 
  • The Census Bureau reported that privately owned housing starts decreased 5.5% in May to 1,092,000, which is the lowest level of the year, and was down 2.4% from a year ago. This decline doesn't bode well for the future of new home sales this year. 
  • The Census Bureau reported that on a seasonally adjusted annualized basis, 610,000 new homes were sold in May, up 2.9% from April, and 8.9% from a year ago. The estimate of the number of homes for sale was 268,000, representing 5.3 months of inventory at the current rate of sales. The median sales price soared to 345,800, the highest figure in more than a decade, and $30,000 more than the 12-month moving average price of $315,600. My guess is that the high average price reflects low interest rates and not enough new homes for sale. 
  • The National Association of Realtors reported that 5.62 million existing homes were sold in May, up 1.1% from the prior month, and up 2.7% from a year ago. The estimate of the number of homes for sale was 1.96 million, representing only 4.2 months of inventory at the current rate of sales. The median price was $252,800, which is well above the rising 12-month moving average price of $238,150. The market for existing homes seems to be doing better than the one for new homes.
  • The Conference Board reported that its index of Leading Economic Indicators (LEI) increased 0.3% in May, following a gain of 0.2% (revised) in April and 0.4% in March. "The U.S. LEI continued on its upward trend in May, suggesting the economy is likely to remain on, or perhaps even moderately above, its long-term trend of about 2 percent growth for the remainder of the year," said Ataman Ozyildirim, Director of Business Cycles and Growth Research at The Conference Board. "The improvement was widespread among the majority of the leading indicators except for housing permits, which declined again. And, the average workweek in manufacturing has recently shown no sign of improvement."
  • According to the "third" estimate by the Bureau of Economic Analysis, GDP increased at a modest annualized rate of 1.4% in Q1 2017, up from the meager 0.7% advance and 1.2% second estimates. 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 on par with the 1.4% growth rate in Q2. The best I can say is it that compares favorably with the mediocre 0.8% growth rate from Q1 2016. 
  • According to the BLS, the seasonally adjusted Consumer Price Index for all Urban Consumers (CPI-U) was flat in June, after falling 0.1% in May. Over the last twelve months, the index rose 1.6%, continuing the downward trend since February, when it was 2.7%. Too many more months like this and the Fed will have to postpone their next rate hike until sometime next year. 
  • The Conference Board's Consumer Confidence Index increased to 118.9 in June from 117.6 (revised) in May. "Consumer confidence increased moderately in June following a small decline in May," said Lynn Franco, Director of Economic Indicators at The Conference Board. "Consumers’ assessment of current conditions improved to a nearly 16-year high. Expectations for the short-term have eased somewhat, but are still upbeat. Overall, consumers anticipate the economy will continue expanding in the months ahead, but they do not foresee the pace of growth accelerating."

Trends To Watch

The value of the dollar index has been in a steady decline for the past six months, falling to the same level as a year ago. I would have expected the dollar to be stronger in light of the rate increases. Instead, the index seems to be pricing in the instabilities of the Trump administration. For now, enjoy the benefits to corporate profits enjoyed by the lower dollar. 

The yield of the 10-year Treasury bond has traded between 2.1% and 2.6% for the past eight months. Every time I say that rates can't possibly go any lower, they manage to do just that. But I will again go out on a ledge and say that the Treasury yield will not fall below support at 2.0% and will likely remain in the trading range outlined below for the rest of the year.

For all of 2017, the price of a barrel of West Texas Crude has made lower highs and lower lows as it seeks to find a bottom. Interim support at $45 was violated last month, and again briefly last week. It wouldn't surprise me to see the price fall to the critical support level around $39. And that is why I've drastically reduced my exposure to the energy sector, holding only two core, long-term positions in a few accounts. 

The price of gold is also stuck in a trading range, between $1,125 and $1,300, as you can see below. Barring escalated tensions in the Middle East, North Korea, Russia or elsewhere, it's hard to make a case for a resurgence in the price of the yellow metal any time soon.

The Nasdaq Composite, led by the FAANG stocks (Facebook, Apple, Amazon, Netflix and Google), has continued to power to record highs, even accounting for two separate declines in the past two months. There seems to be no meaningful break in the momentum of this index so there's no reason to get off this train.

Trading in the financial sector has been range-bound for the past seven months, as you can see below, after failing twice to breach resistance around 25.20. Five times the index has fallen to, but not through, support around $22.80. As I said last month, my investment thesis 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. Lather, rinse, repeat.

The NYSE Bullish sentiment index remains remarkably sanguine considering how well the stock market is doing. One might expect greater levels of bullishness considering that the market continues to surge to new record levels. This lack of bullish sentiment is, as a contrary indicator, quite bullish.

What I'm Thinking and Doing

Last month, I said that while Presidents, Congressmen and Senators come and go, the economic cycle will outlast them all. Right now, we are in the midst of an historic period of relatively stable but modest economic growth, spurred by historically low interest rates, extremely low inflation and steady, predictable corporate profits. In addition to all of that, we have a very accommodative Federal Reserve. Given all of that, my basic investment thesis is as it has been since 2009: be fully invested in the stocks of quality companies, most of whom pay a steady dividend, while mixing in shares of some small, fast-growing tech stocks.

My long-time readers know that I ascribe to a sector rotation theory of investing. By that I mean that I tend to invest in the leading stocks of sectors that I believe have the best chance to outperform the overall market, and avoid the sectors that I believe will underperform. Over the last twenty years this strategy has led me in and out of the tech, gold, mining and biotech sectors. It has also spurred me to take an outsized position in energy before spending the last eighteen months to substantially reduce it. I've also reduced other long-held positions in telecom and real estate as times and conditions have changed. More recently, I've substantially increased my holdings in the technology sector, while adding to my already large position in defense. While my decisions over the years have not always been easy, indeed, they were sometimes very difficult, I always do what I think is in the best interests of my clients.

I have been very busy over the past two months, during which I have made a number of very strategic trades. I've substantially reduced my telecom stocks by liquidating one position and reducing two others. I also reduced my stake in the final two energy stocks I own. I used some of the proceeds of these sales to purchase a large position in one large tech stock as well as a smaller stake in a fast-growing micro-cap tech stock. I also bought an initial position in two large defense contractors. In addition, I've rotated out of an ETF of consumer discretionary stocks and into one focused on cyber security and another on mobile payments. Each of these trades were made with the intention of rotating out of poorly performing sectors and into fast growing ones. Looked at in its entirety, I'm very pleased with the composition of my portfolios. 

News and Notes

There's very little new to report this month with respect to my family. Nola is looking forward to coming home in less than three weeks after working insane hours for a theater company in Western Massachusetts. Lily has enjoyed a great internship in DC this summer but is also looking forward to coming home in two weeks. Ezra is in between his two amazing trips and enjoying some lazy time with friends. As for me, I'm almost six weeks removed from my shoulder surgery and trying to recover from a bout of Parsons Turner Syndrome. There's always something, right? Fortunately, Kathiryn is well and working hard for ADP. We have managed to have some fun, and we're looking forward to enjoying ourselves over the last six weeks of summer. 

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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