August 17, 2015

As I write this about an hour before the market open for the week, the Dow Jones Industrial Average stands at 17,477, about 460 points, or 2.6%, lower than when I wrote to you last month. The stock market, as defined by the #DJIA is now down 2% for the year, whereas the #S&P500 is essentially unchanged. The big picture is that growth (reflected more in the S&P) is outpacing value (more reflected in the Dow Jones). If we drill down even deeper, the gains in the "market averages" are being made by fewer and fewer names, meaning the market breadth isn't very good. But given that we're six years into a bull market, in the third year of the presidential cycle (a typically weak period), dealing with a sluggish economy, more debt problems with Europe and a slowing Chinese economy, things could be far worse. Indeed, some sectors, like energy and commodities, are in a bear market resembling the bottom of the financial crisis. So I don't think the "market" is in a bubble, and it isn't wildly expensive as some have said. I still think we'll finish the year with gains across the major averages, although those gains may be less than I originally expected. 

Now that the Q2 earnings season is over, the next big hurdle to overcome is the September meeting of the Fed, where it is widely believe that they will raise short term interest rates. I'm still not convinced. I don't think the domestic economy is that strong. Consumer confidence (as you'll see below) is flagging. China seems to be on the verge of imploding. I think the Fed will find a way to hold off a little while longer. But if they don't, I'm prepared for rates to rise. 

The chart of the #DJIA shows the decline, which began in mid-June, has continued to push the index lower. Having fallen well below interim support around 17,800, the question is will it test support at 17,100, or will it head higher. Remember, we still haven't had a real 5% drop, much less 10%, so there isn't all that much to be concerned about just yet. I'm still bullish on the market, and the recent upward movement in the Transports and Utilities helps that thesis. One point of technical concern is that the 200-day moving average just moved above the 50-day average, forming the "death cross", which is very bearish. If this continues, we may have something to worry about.

The Transportation Index continues to underperform the broader market but is showing some signs of life. The good news is that the index bounced off support around 8,000 and has moved higher. It would be very constructive if the index could surpass resistance around 8,700. I think the railroad sub-sector of this group is poised for a good recovery.  

Like the transportation average, the Dow Jones Utility Average has been a miserable performer this year but is showing signs of life now that rates have flattened a bit. Having pushed through 570, the index is poised to test resistance at 610. I've been unwavering in my support of the utility sector, and as a result, I've been wrong all year, but I'm looking less stupid these days. Last month I wrote that 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." So far, so good.

It's been a crazy year for bond investors who seek safety and security in US government bonds. First rates climbed from 1.65% to 2.5%, causing big losses because the price of a bond move in the inverse direction of the yield. That means that when the yield rose, the price fell. Now, with yields falling again, the price is rising as investors are moving out of "risky" stocks into "safer" bonds. This is not for the feint of heart. 

Last Month's Results

Since the broad market averages were down in June, after being up in May, it stands to reason that they were up again in July. Who wants to bet that they'll be down in August? A temporary resolution to the debt problems in Greece helps assuage some of the fears. And a similar temporary stop to the carnage in the Chinese stock market also put a bid under stocks. Whenever stocks rally, one would expect growth to outpace value, and last month as no exception. Notice how the S&P 500 is beating the Dow Jones Industrial Average, and how the Russell growth indices are crushing their value brethren. It's been a tough year for value investors, like me. 

* 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 8 was 274,000, an increase of 5,000 from the prior week, but a decrease of 22,000 from the prior month's figure. The four-week average of 266,250 was roughly 13,000 less than the tally from a month ago. About 2.273 million people continue to collect unemployment insurance, about 61,000 less than last month.
• The non-farm payroll employment report in July basically met modest expectations as the establishment survey reported that 215,000 jobs were added in the month, while revisions added 14,000 jobs to the May and June totals. The household survey reported that the unemployment rate stayed at 5.3% and the labor force participation rate remained at 62.6, the lowest figure in many years. 8.3 million workers were still being counted as unemployed. The comprehensive U-6 "underemployment" fell to 10.4%. 
• 2.2 million people remained unemployed longer than 27 weeks, up slightly from last month. The seasonally adjusted number of people who could only find part-time work fell to 6.3 million while the number of marginally attached workers held at 1.9 million. The number of people holding multiple jobs decreased to 7.0 million. Average hourly wages for blue collar workers increased to $21.01 while the average work week held at 33.7. This is not the picture of a robust economy.
• The Congressional Budget Office (CBO) estimated that on a net present value basis, the Treasury reported a budget deficit of $149 billion in July, leaving the ten-month deficit at $463 billion, about $2 billion larger than the shortfall recorded in the same period last year. If not for some shifts in timing, the deficit would have shrunk by $41 billion.
• The National Association of Homebuilders/Wells Fargo Confidence Index remained at 60 in July. "This month’s reading is in line with recent data showing stronger sales in both the new and existing home markets as well as continued job growth. However, builders still face a number of challenges, including shortages of lots and labor," said NAHB Chief Economist David Crowe.
• The Census Bureau reported that privately owned housing starts rose 9.82% in June, after falling 10.2% in May, to a seasonally adjusted annual rate of 1,174,000 units, which was 26.6% higher than a year ago. New building permits rose 7.4% from the prior month and were 30.0% higher than the year before. The general trend in starts and permits continues to be positive and points to future growth.
• The Census Bureau reported that on a seasonally adjusted annualized basis only 482,000 new homes were sold in June, down 6.8% from May (revised lower), marking declines in three of the past four months, but still up 18.1% from a year ago. The estimate of the number of homes for sale rose to 215,000, representing 5.4 months of inventory at the current rate of sales. The median sales price was $281,800, leaving it below the 12-month moving average price of $289,275.
• The National Association of Realtors reported that on a seasonally adjusted annualized basis, 5.49 million existing homes were sold in June, an increase of 170,000, or 3.2%, from May, and 9.6% higher than a year ago. The estimate of homes for sale is 2.30 million, which represents only 5.0 months of inventory at the current rate of sales. The average selling price rose to $236,400, the highest level since July 2007 and well above the rising 12-month average of $213,850. The existing housing market looks better than the new one, but both are ok, and based on permits, the new housing market should pick up by the fall. 
• According to the Institute for Supply Management (ISM), economic activity in the manufacturing sector dipped to 52.7 in July, which still marked overall growth for 24 straight months. The ISM index of non- manufacturing activity jumped to 60.3, the highest level since I started tracking this in 2008, which signaled growth in the service sector for 66 consecutive months. We continue to move towards a lower paying service economy.
• The Conference Board reported that its index of Leading Economic Indicators (LEI) increased 0.6% in June, following an 0.8% gain (revised up) in May. "The upward trend in the US LEI seems to be gaining more momentum with another large increase in June pointing to continued strength in the economic outlook for the remainder of the year" said Ataman Ozyildirim, Economist at The Conference Board.
• According to the "advance" estimate by the Bureau of Economic Analysis, GDP increased at an annual rate of 2.3% in Q2 2015, better than the decrease of 0.2% in Q1, and close to the 2.2% increase in Q4 2014. Still, it is well below the 5.0% and 4.6% growth rates in Q3 and Q2 2014, respectively. While I'm not sure this is the strong growth that people are hoping for, it's a start.
• According to the BLS, the seasonally adjusted Consumer Price Index for all Urban Consumers (CPI-U) increased 0.3% in June, but only 0.1% for the past 12 months. If you strip out food and energy, CPI rose only 0.2%. It is clear to me, if not to the Fed, that economic growth is tepid, at best.
• The Conference Board's Consumer Confidence Index fell in July to 90.9, the lowest level of the year. "Consumer confidence declined sharply in July, following a gain in June. Consumers continue to assess current conditions favorably, but their short-term expectations deteriorated this month. A less optimistic outlook for the labor market, and perhaps the uncertainty and volatility in financial markets prompted by the situation in Greece and China, appears to have shaken consumers’ confidence. Overall, the Index remains at levels associated with an expanding economy and a relatively confident consumer,” said Lynn Franco, Director of Economic Indicators at The Conference Board.

Trends To Watch

The price of the dollar index is becoming a bit range bound as it trades between resistance around 100 and support around 93.5. The current price has fallen just below interim support/resistance at 97.5. Should the dollar weaken a bit further it would be a real boon to the natural resource sector that has suffered greatly this year in the face of such a strong dollar. 

The price of West Texas Crude has simply been in free fall for almost two months since peaking at around $62 in mid-June. It plunged right through support around $53 and has hit major support around $42. This is very disturbing. If prices don't rebound soon, you will start reading about bankruptcies in the oil patch and huge layoffs across the sector. I have dramatically cut my exposure to this sector over the past year or so. 

The price of gold has been in a major decline, resulting in a huge bear market, since peaking in the summer of 2011. Since then the price has plunged over 40%, falling through every support line. Most recently is broke through $1,200, and then $1,140, before testing support at $1,100. Should this level not hold, we could see gold fall back below $1,000. As I've said all year: I'm completely out of this sector and I suggest you stay out as well.

As a percentage of the price, copper has fared even worse than gold, as the price has fallen by about 50% since peaking in early 2011. The price hasn't been this low since recovering from the carnage of the financial crisis in 2009, yet things today are FAR better than back then, so it's hard to understand why the price has dropped this far. As I said last month, this does not bode well for the health of the world economy. I hope the Fed is paying attention. 

After trading near the top of its trading range for most of the year, the Nasdaq Composite is now crawling along the bottom of the channel. The current price is slightly below the 50-day moving average, but still above the 200-day, and still within the channel. So for now, things are a little shaky, but ok. It would help if AAPL started moving higher again. 

Looking below at the chart of the financial sector, you can see the five "buy" calls I made over the past year, including the most recent one last month. While I would like to see the index move into the higher half of the trading range (around the purple dotted line), this is still a bullish chart. 

After eight years, the housing index finally managed to move above the old high established in early 2007. I've been calling for this to happen since early in the year. It just took a little longer than I expected,  

The index for developed international markets has fallen a bit since peaking in May but it remains safely above major support at 59 and the moving averages are getting close to forming a "golden cross" (whereby the 50-day average crosses above the 200-day), which would be very bullish. Barring more problems in Greece or other Euro-zone countries, this index should hold steady for a bit. 

Suffice it to say that I would stay out of the Chinese stock market. I don't trust their accounting and there is simply way to much overt government manipulation of their markets. This is for speculators only; investors beware. 

Two months I posited that "it looks to me like the NYSE Bullish sentiment index is setting up for the next buy call. . . The only question is when." Last month I answered by saying "I think the answer to that question was last week. I expect to see the index bounce off support at 53 and move higher." Well, that was wrong. The index fell even further as the market dropped. So now I'll again suggest it might be time to buy has sentiment has fallen well below 50%.

Even as the sentiment is falling, and the stock market along with it, the VIX remains surprisingly quiescent. After a quick spike to 20 in early July it quickly calmed down. Nothing here concerns me. 

It seems as though the stock market is teetering between fear of a global economic slowdown precipitated by China and optimism that corporate earnings are simply not that bad and a belief that the Federal Reserve will be able to chart a course through the current economic malaise. I am aligned more with the latter. I just think that the fundamental underpinnings of our economy and stock market are fairly stable and healthy. Yet certain sectors, like commodities and oil, are prices similarly to bottom of the financial crisis of 2008-2009. I just don't see the calamity waiting to happen. There is no massive bubble waiting to burst. As I said last month, I believe that were are simply experiencing a mini-correction that is part of the normal and healthy cycle of the stock market. They shouldn't be feared. Indeed, they create buying opportunities by moving money from the weak to the strong hands. 

Back in January I predicted that "the broad markets will again finish higher in 2015, although not without some greater pain, and with less of a gain. I think the best case scenario puts the Dow Jones Industrial Average up 8%, but could be as little as 5-6%." I think that we're likely on target for that modest gain, but it will require a nice 4th quarter rally. If we can escape the next month or two without any significant losses we should be ok. That being said, it wouldn't be the worst idea to raise some cash, as I've done, by selling some weaker holdings. 

Given the pessimistic outlook for the energy sector, and given the expectation that interest rates will begin to rise in the next few months, I have reduced my allocation to both oil stocks and certain REITs. I've also sold a few smaller positions and underperforming holdings. All told, I've eliminated seven positions so far this month. I used some of those proceeds to add to existing holdings while allowing the rest to bolster my cash position. I've added almost half a million dollars in cash since July. In the next month or so I may sell a few more positions in order to better align my portfolios with the current state of the economy and the world. It isn't easy to make big changes, especially when some of the positions have been held for 10 years or longer. But as times and conditions change, we must change along with them. 

News and Notes

I can't believe we're approaching the last few weeks of summer, with the beginning of school just around the corner.  Nola completed her summer internship last night and is looking forward to ten days of relaxation before she returns to college. Lily is continuing to work as a lifeguard and has begun work on college applications. Ezra finished over seven weeks at camp this morning and is on the bus home as we speak. I'll be heading to pick him up shortly after I push the "send" button. Overall, the children have had great summers. Unfortunately, school begins in less than three weeks. 

Kathiryn and I have also been keeping busy. Before this month ends, Kat will have performed four gigs with her two bands, we will have attended three concerts (Rob Thomas, Van Halen and the Zac Brown Band), had dinner with three sets of friends, attended a NY Mets baseball game (they won!) and spent five days visiting friends and family and Michigan. And September is shaping up to be equally busy. Whew! 

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

Best regards,

Greg Werlinich
President

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