August 12, 2014

As I write this, the Dow Jones Industrial Average stands at 16,574, down 369 points, or 2.2%, from when I wrote to you last month. Even after the losses incurred over the past couple of weeks, this leaves the #DJIA only 494 points, or 2.9%, shy of the all time high achieved on July 3rd. The Dow Jones Transportation index and the S&P 500 also recorded new highs on the 3rd. Considering the unrest in the Ukraine, an outbreak of the Ebola virus in Africa, the fighting in Gaza, the bombing in Iraq, the default on Argentinian bonds, the struggling domestic housing market, to name just a few of the headlines shaping investor concerns, the stock market is doing remarkably well. So unless some other earth shaking event happens, I believe the market will shrug off all of these issues and start moving higher by the time our kids return to school in September.

Last month I wrote that "while I do believe that, on balance, the market will continue to move higher, that doesn't mean there won't be days or weeks when it loses ground. In fact, I expect a reversal to happen at some point this summer when bad news of some kind combines with low summer trading volume to provide a quick downward snap. And when that happens I'll be ready to buy because I'm convinced the market will finish the year higher." That is EXACTLY what happened over the past few weeks.

As we look at the chart of the #DJIA we can easily see the recent drop, but more importantly, that the decline did not violate the rising support line. Should that support fail to hold over the next few weeks, you can see the next lines of defense in beige and then lavender (which would represent a drop of "only" 7.7%. I said last month that "volatility has really smoothed out over the past four and a half months, which suggests that there will be a bigger move, up or down, coming up sometime soon. In order to create any concern at all, the price would have to fall below the 50-day moving average. After that, it would have to fall below support around 16,000 (orange line)." We got that move down, but neither the 200-day average, nor the support at 16,000 was violated, so the bull market continues. 

Similar to the picture above, the chart of the #DJTA shows the recent decline, which did not violate the rising support line. The current price aligns it with the 50-day moving average, which remains well above the 200-day average. RSI is recovering from being a bit oversold and MACD is turning up. This looks like a great place to buy. 

The #DJUA seems to have completed its month long correction and has begun to move higher. The current price is between the two moving averages and midway between the major trading range. Importantly, it bounced off interim support (lavender line) and has moved up. I'm going to repeat my December call not to abandon utilities just yet as they have more room to grow.  

The yield on the 10-year Treasury finally broke through support at 2.45% to fall as low as 2.3%. Clearly those, myself included, who called for an end to the bull market in bonds have been dead wrong, or at least highly premature. Bond investors continue to make money as yields continue to fall. That being said, there is no way I would buy bonds at these levels. Sooner or later, there will be blood in the streets. 

Last Month's Results

July was a poor month for investors across the board, but especially bad for small caps, which suffered particularly large losses. It's interesting to note the large divergence in performance between the S&P 500 and the Dow Jones Industrial Average. The latter is even being outperformed by the Barclays Aggregate and the Barclays High Yield. It would appear that the tech sector is powering added gains in the more growth oriented S&P index.

* 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 August 2 was 289,000, a decrease of 14,000 from the prior week's revised figure, and well below the figure from this time last month. The four-week average of 293,500 is about 18,000 lower than the tally from a month ago. About 2.52 million people continue to collect unemployment insurance, which is 52,000 people less than last month. The good news is that these numbers keep trending lower. 
• The non-farm payroll employment report in July basically met expectations as the establishment survey reported that 209,000 jobs were added in the month, while revisions added 15,000 in the prior two months. The household survey reported that the unemployment rate inched up to 6.2%. The more comprehensive U-6 "underemployment" rate also rose, coming in at 12.2%. 9.7 million workers were still counted as unemployed (two hundred thousand more than last month). The labor force participation rate increased for the first time in three months to 62.9%. The main takeaway from this is that more people are entering the labor force, which is good news.
• 3.2 million people were counted as being unemployed longer than 27 weeks, a slight increase. The seasonally adjusted number of people who could only find part-time work remained at 7.5 million and the number of marginally attached workers rose to 2.2 million. The number of people holding multiple jobs fell to 6.8 million. The average hourly wages for blue collar workers rose to $20.61 while the average work week held stubbornly at 33.7 hours for the fifth straight month. More people are looking for jobs, hours worked aren't moving and wage growth is below inflation. So on balance, this report is mildly good news. 
• The Congressional Budget Office (CBO) estimated that on a net present value basis, the Treasury reported a federal budget deficit of $96 billion in July, which means that for the first ten months of fiscal 2014 the cumulative deficit is $462 billion, about $146 billion less than the same period in the prior year, thanks to an 8% increase in revenues (mostly taxes). Spending is up 1% thanks to increases in social security and health care programs. The full year deficit is expected to be around $500 billion.
• The Census Bureau reported that the U.S. trade deficit of goods and services decreased again in June to $41.5 billion as the growth in exports continued to out pace imports. 
• The National Association of Homebuilders/Wells Fargo Confidence Index passed a critical milestone in July, rising 4 points to 53 in July. And reading over 50 indicates more builders view sales conditions as good than poor. “This is the first time that builder confidence has been above 50 since January and an important sign that it is strengthening as pent-up demand brings more buyers into the marketplace,” said NAHB Chairman Kevin Kelly, a home builder and developer from Wilmington, Del. 
• The Census Bureau reported that privately owned housing starts fell 9.3% in June, after falling 7.3% in May, to a seasonally adjusted annual rate of 893,000 units, the lowest level since September 2013, but still 7.5% higher than a year ago. New building permits fell 4.2% from the prior month but remained 2.7% higher than the year before. These figures do not inspire much confidence in a housing recovery.
• The Census Bureau reported that on a seasonally adjusted annualized basis, only 406,000 new homes were sold in June, down 8.1% from a much lower revised figure for May, and 11.5% lower than a year ago. The estimate of the number of homes for sale is 197,000, which represents a modest 5.8 months of inventory at the current rate of sales. The median sales price dipped to 273,500, which is just above the 12-month moving average price of $271,117. Again, more bad news.
• The National Association of Realtors reported that on a seasonally adjusted annualized basis, 5.04 million existing homes were sold in June, up 2.6% from May but down 2.3% from a year ago. The estimate of homes for sale inched up to 2.3 million, which represents only 5.5 months of inventory at the current rate of sales. The average selling price rose for the sixth straight month to $223,300, well above the rising 12-month average of $201,750. The results for existing home sales contradict new home sales and housing starts. I'm not sure what to make of that.
• According to the Institute for Supply Management (ISM), economic activity in the manufacturing sector jumped in July to 57.1, marking overall growth for fourteen straight months. The ISM index of non- manufacturing activity increased to 58.7, which marked growth in the service sector for 54 consecutive months. These results surprisingly strong and somewhat unexpected.
• The Conference Board reported that its index of Leading Economic Indicators (LEI) increased 0.3% in June, following a gain of 0.7% (revised) in May. "Broad-based increases in the LEI over the last six months signal an economy that is expanding in the near term and may even somewhat accelerate in the second half,” said Ataman Ozyildirim, Economist at The Conference Board. “Housing permits, the weakest indicator during this period, reflects some risk to this improving outlook. But favorable financial conditions, generally positive trends in the labor markets and the outlook for new orders in manufacturing have offset the housing market weakness over the past six months.”
• According to the Bureau of Economic Analysis, GDP increased at an annual rate of 4.0% in Q2 2014 according to the "advance" estimate. That is far better than the anemic decline of 2.1% in Q1. By comparison, GDP growth was 2.6% in Q4 2013, 4.1% in Q3 and 2.6% in Q2. I wouldn't be surprised if this number is revised a bit lower, but still, it's a solid result. 
• The Federal Reserve reported that in June the amount of total outstanding consumer credit grew at an annualized rate of 7.75%, up to $3.211 trillion. Month after month, the amount of outstanding consumer credit continues to grow and is now at the highest level since I started tracking this in 2004.
• The Conference Board's Consumer Confidence Index, which had increased in June, improved again in July, jumping from 86.4 (revised) to 90.9. Says Lynn Franco, Director of The Conference Board Consumer Research Center, "Consumer confidence increased for the third consecutive month and is now at its highest level since October 2007 (95.2). Strong job growth helped boost consumers’ assessment of current conditions, while brighter short-term outlooks for the economy and jobs, and to a lesser extent personal income, drove the gain in expectations."

Trends To Watch

For almost a year the dollar index has traded in a very tight range between 79 and 81.50. In that time the index has tried, and failed, numerous times to break through those support/resistance levels. Might it succeed this time? We can see the battle being waged at interim resistance for the past week or so. Given all the unrest in the world, it isn't surprising to see some strength in the greenback. We'll see if it lasts.

The price of gold seems to have calmed down a bit, settling into a new trading range between $1,350 and $1,275. I continue to believe gold is more of a trading play now, rather than a long-term buy. 

As I've mentioned before, the price of copper is often thought to be a key indicator of economic health because it is a key component of so many manufactured goods. If one believes that premise, then the resurgent price of copper over the past few months, even with the recent dip, suggests that the economy is on decent footing. 

This chart is a bit disturbing. Since last peaking just under $108 in June, the price of West Texas Crude has fallen by about $10 per barrel, or just over 9%. In doing so, it fell through interim resistance around $100 before bouncing off the next support level around $97.40. The current price is below both moving averages. So this is either a great buying opportunity or a sign of real danger in the oil sector. We'll know by next month.

The NASDAQ Composite continues to shine, barely reflecting the recent market dip. As I said last month, I think this sector has more room to grow so I'm looking to add to my holdings.

The financial sector has been a winner for more than a year, and it appears that if you don't own a position in this sector, you've now got a chance to get in. Each time the index has fallen to its rising support line it has moved higher. So it's time to buy.  

The index for the housing sector isn't looking too good right now. After stabilizing in the upper end of its trading range for the first seven months of the year, the index recently fell below interim support at 192. It is now fighting to regain its footing. If it fails, it has a long way to fall. 

As you can see below, the index for the developed international markets has fallen almost 10% in the past two months (thanks in large part to Mr. Putin). In doing so, it violated its support line and fell below both moving averages. This is not good. Eyeballing the chart, it appears that the next line of support comes in around 62. Stay tuned. 

Viola. After months of waiting, the move I was predicting finally came. The Shanghai Index has surged about 8.5% in the past month. To be honest, I'm not sure what precipitated the move, and that uncertainly caused me to miss the investment, but I feel a bit better for having seen that it was coming, even if I didn't profit from it. Perhaps you did? 

This is where I tell you that bad news is good news. The NYSE Bullish sentiment index has dropped about 17% in the past six weeks. In doing so, it has fallen just below support around 63. This has resulted in RSI being severely oversold, thereby setting the stage for the next rally. Remember, last month I said "RSI is very overbought, suggesting that a correction could be coming up." That proved to be correct. Now it's time to buy.

Our second contrarian indicator, the percentage of stocks on the New York Stock Exchange that are currently trading above their 50-day moving average, plunged about 68% in one month, before moving up a bit recently. That precipitous decline sent the index below interim and major support and caused RSI to fall to oversold levels. So, like the bullish sentiment indicator above, this suggests it's time to buy. 

Finally, even the VIX finally registered a bit of concern, as the index moved out of "super" complacency, through the "new normal" and briefly into the "old normal" area, before quickly falling back to new normal levels. Whew. Only options traders can appreciate that spike in volatility. Again, this looks like a good spot to be a buyer as volatility diminishes.  

Last month I wrote that while market results to that point were excellent, it "doesn't mean that the party will go on forever, which it clearly won't. As my Grandfather used to say, "times and conditions change" and you must be willing to change along with them." Well, the conditions certainly changed as the market dropped sharply. But it is (was?) a drop that was long overdue and not nearly as severe as many observers expected. If that's the entirety of the "correction" I will have missed a small buying opportunity because I was expecting a larger decline. But I'd rather missed the chance to buy something than be too hasty to sell. And I imagine there were more than a few people who bailed on the market at the first whiff of trouble. Those same people will likely miss out as the market rallies. If you aren't in the market right now, it might be time to put a toe back in the water. 

Nothing that has happened so far this year has dissuaded me from my belief that the market will finish the year up about 10%. I think that after another few weeks, or months, of choppiness, the market will settle down and return to its upward trajectory. While the economy has made some improvements, I don't think there's enough overall strength to convince the Fed to raise rates sooner than the second quarter of 2015. Their generally accommodative stance will continue to buoy the equity markets. 

I think the For the third straight month, I made very few changes to my portfolios. As I've said before, I'm following my own advice and simply sitting still until the market tells me to do otherwise. The recent decline brought a few stocks close to my buy prices but I haven't yet pulled the trigger. I'm content to wait as time is on my side. 

News and Notes

It's finally here! I leave early Thursday morning for the University of Maryland, where I'll spend four days competing in the Masters Long Course National Swim Championships. I've been tapering for about two weeks now, hoping to prepare myself to swim as fast as possible. We'll see what more than a year of hard work will bring in the pool later this week.

The other big news is that this is my final newsletter before I turn the Big 5-0 in three weeks. Party preparations have already begun. 

That's it for this month. Enjoy the next few weeks of vacation leading up to Labor Day. As always, I thank you for reading. If you'd like to speak with me about your investment needs, or if you know of someone that might benefit from my guidance, I'd be pleased to be of service. Simply give me a call or drop me an email.

Best regards,

Greg Werlinich
President

                               

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