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August 14, 2017

Can Fear and Rhetoric Kill The Rally?

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

Current Market Analysis

After ascending to multiple record highs, the stock market took a little breather last week, precipitated mostly by the war of words (only words, for now) between Donald Trump and Kim Jong-un, both of whom appeared willing to bring their two nations to the brink of armageddon with fiery rhetoric and threats of annihilation. Fortunately for the rest of the world, that apocalyptic future is VERY unlikely, and therefore the broad selloff in equities was equally without merit. And based on the futures this morning, the market is set for a nice rebound today. Still, as forward-looking investors, we need to keep in mind that our president could, at any moment, do or say just about anything, and that his capriciousness could have a big impact on the market, positively or negatively. 

As we look at the chart of the #DJIA so far this year, even with the selling last week, we continue to see a very bullish primary trend. The current price is well above both the 50-day and 200-day moving averages, and interim support around 21,200. Q2 earnings, on balance, were better than expected, and early indications suggest that Q3 will be more of the same. This suggests that, barring any "Black Swan Events", the rally should continue. 

After a long and arduous climb to record heights in early July, the Dow Jones Transportation Average subsequently plunged over three weeks to test support at 9,100. After a brief rally, it fell a second time to again test the 9,100 level last week. This weakness in the face of general market strength is worrisome. I would feel much better if this index were to retrace its steps and rise back to the July highs.  

After digesting the Fed rate hike in June, and testing support around 695 in early July, the Dow Jones Utility Average surged over the next five weeks to return to match the record high set in early June. Low interest rates continue to benefit this rate-sensitive sector. Last month I noted that "the yield on the 10-year treasury has barely budged (see below), which suggests that the sector could regain some of those losses." That is exactly what has come to pass. 

Key Economic Statistics

  • According to the Department of Labor, the figure for seasonally-adjusted initial jobless claims for the week ended August 5 was 244,000, which is roughly in line with the same range of figures we've seen all year. The four-week average of 241,000 is down by about 17,000 from the beginning of the year.
  • The non-farm payroll employment report in July again exceeded expectations, as 209,000 jobs were gained in the month, and an additional 2,000 net jobs were added in the prior two months. The household survey reported that the unemployment rate inched back down to 4.3%, while the labor force participation rate inched up, for the third straight month, to 62.9 as more people entered the labor force. Average hourly wages for blue collar workers rose to a new high of $22.10 while the average work week held steady at 33.7 hours.
  • About 7.0 million workers were counted as unemployed, while 1.8 million people remained unemployed longer than 27 weeks. The seasonally adjusted number of people who could only find part-time work held at 5.3 million while the number of marginally attached workers crept stayed at 1.6 million. The number of people holding multiple jobs rose to 7.30 million. All of this resulted in the U-6 "underemployment" rate holding at 8.6. Once again, this was a very solid 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 $45 billion in July, about $68 billion less than the deficit from a year ago, although timing helped to reduce the deficit. This resulted in a deficit of $568 billion for the first ten months of fiscal 2017, $56 billion more than the shortfall recorded during the same period last year. 
  • The Census Bureau reported that privately owned housing starts increased 8.3% in June to 1,215,000, up from the lowest level of the year, and up 2.1% from a year ago. A lot more homes will have to be built, and sold, in order to benefit the new home sale market. 
  • The Census Bureau reported that on a seasonally adjusted annualized basis, 610,000 new homes were sold in June, up 0.8% from May, and 9.1% from a year ago. Note that the sales figures for the last three months were all revised lower. The estimate of the number of homes for sale was 272,000, representing 5.4 months of inventory at the current rate of sales. The median sales price dropped to $310,800, down from the revised lower number from the prior month, and about $2,000 less than the 12-month moving average price of $312,983.
  • The National Association of Realtors reported that 5.52 million existing homes were sold in June, down 1.8% from the prior month, and up 0.7% from a year ago. The estimate of the number of homes for sale was 1.96 million, representing only 4.3 months of inventory at the current rate of sales. The median price was $263,800, which is well above the rising 12-month moving average price of $239,475. The market for existing homes continues to be more robust than the one for new homes.
  • The Conference Board reported that its index of Leading Economic Indicators (LEI) increased 0.6% in June, following a gain of 0.2% (revised) in May and 0.2% in April. "The U.S. LEI rose sharply in June, pointing to continued growth in the U.S. economy and perhaps even a moderate improvement in GDP growth in the second half of the year," said Ataman Ozyildirim, Director of Business Cycles and Growth Research at The Conference Board. "The broad-based gain in the U.S. LEI was led by a large contribution from housing permits, which improved after several months of weakness."
  • According to the "advance" estimate by the Bureau of Economic Analysis, GDP increased at an annualized rate of 2.6% in Q2 2017, up substantially from the modest 1.4% growth in Q1. This is in the middle of the 2.1% rate of growth from Q4 2016 and the 3.5% from Q3, but compares well the 1.4% growth rate in Q2 2016. This figure should help to forestall any Fed rate increases before December. 
  • According to the BLS, the seasonally adjusted Consumer Price Index for all Urban Consumers (CPI-U) rose 0.1% in July, after being flat June. Over the last twelve months, the index rose 1.7%, still below the level sought by the Fed. Too many poor months like the last six and the Fed will have to postpone their next rate hike until sometime next year. 
  • The Conference Board's Consumer Confidence Index increased to 121.1 in July from 117.3 (revised) in June. "Consumer confidence increased in July following a marginal decline in June," said Lynn Franco, Director of Economic Indicators at The Conference Board. "Overall, consumers foresee the current economic expansion continuing well into the second half of this year."

Trends To Watch

This has really been one of the key stories of the year. The value of the dollar index has been in a steady decline for the past seven months, falling against almost all other currencies, as it descends to a 15-month low. This has had a very salubrious effect on the bottom lines of our large, multi-national companies and our tourism industry, as it has become less expensive for foreign visitors to spend their money here. 

While the yield on the 10-year Treasury bond has traded between 2.1% and 2.6% for the past nine months, you will notice that, in general, the primary tend is downward (see channel in blue). If this trend were to continue, the yield would likely break support at 2.1%. This would result in a very flat yield curve, which would suggest a forthcoming recession. So we will continue to keep a careful watch on this chart. 

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 consistent price (see purple channel). Unless you're trading oil futures, this is a pretty bearish picture, accurately representing the fundamentals of current supply and demand. As a result, I continue to be underweight relative to my historical exposure to this sector.

All of the saber-rattling last week about who would bomb whom, with all the the attendant repercussions, sent the price of gold higher, pushing it to a strong resistance level at $1,300. Should tensions subside, which I think they will, then one would expect the price of gold return to the mid-$1,200s. 

The Nasdaq Composite, led by the FAANG stocks (Facebook, Apple, Amazon, Netflix and Google), is taking a bit of a breather, as you can see below. The current price is just below the 50-day moving average, but still well above the 200-day. This doesn't concern me at all, as there have been a few similar declines along the way so far this year without damaging the general upward trend. I believe this will be more of the same. 

Trading in the financial sector continues to be range-bound, as you can see below, after failing twice to breach resistance around 25.20 or support around $22.65. Notwithstanding the recent decline, I still believe 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. I think the decline last week was nothing more than the baby being thrown out with the bathwater. And even though the price of the index fell below the 50-day moving average, I see no reason why the index can't continue to move higher.

I love this chart. The NYSE Bullish sentiment index is surprisingly downtrodden considering how well stocks have been performing this year. One would expect greater levels of bullishness since 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

The market dipped a bit last week as investors reacted negatively to the bellicose tone set by President Trump with regards to North Korea. All of a sudden, there is concern that Trump could instigate a nuclear war with Kim Jong Un. I'm sure saner heads will ultimately prevail upon both of these crazy leaders that compromises must be made by both sides in order to forestall a cataclysmic event. Still, it could be a rough few weeks, or months, before the rhetoric gets toned down. In the meantime, we could see greater volatility on a day-to-day basis than we've witnessed all year. 

The talking heads on CNBC, and other channels, keep trying to forecast the next move by Janet Yellin and the Federal Reserve. In my humble opinion, I think there is no chance that they will hike rates again at their September meeting, and there is probably only a 25-30% chance that their raise in December. Bottom line, there simply is no real indication that inflation has kicked in, nor is it likely that it will kick in over the next few months. And without inflation, there is little reason to increase rates. Indeed, should they raise rates too quickly, they risk squashing the tepid growth that we have. So my bet is they won't increase rates again until next year, at the earliest. 

After a very busy few months, during which I made several large, strategic trades in order to adjust my sector allocations, it's been much more quiet since I last wrote to you. My one purchase of any consequence was to add to an existing position in a key technology company with a large stake in the mobile telephony and automotive markets. Otherwise, just made a few small tweaks to specific portfolios. Overall, it's been a good year for WAM's clients and I'm hoping to keep it up through the end of the year.  

News and Notes

The gang is almost back together. Nola returned home last week after two very hard months doing carpentry for the Williamstown Theater Company in Massachusetts. After two quick days of rest, she headed into NYC where she was the scenic designer for a small, original production called "Resistance" on the Lower East Side. The show wrapped on Sunday, which means that Nola gets to rest for two weeks before moving to Washington DC, where she will begin a one year fellowship program with Arena Stage. Lily returned home last weekend after spending the summer learning a ton as an associate in the Public Policy & Media Relations department at the American Society for Cell Biology in DC. She will get to enjoy three weeks home before returning to GW for her sophomore year. Ezra got home yesterday after spending two weeks hiking in and around the French Alps. He'll then have just over three weeks to chill before starting his senior year of high school. It will be very nice to have all three home, at the same time, for a couple of weeks.

As for me, I'm still trying to rehab from shoulder surgery in June while also dealing with the repercussions of developing a somewhat rare neurological disorder called Parsonage Turner Syndrome. On top of that, my back went out again over the weekend. I'm clearly testing the theory that whatever doesn't kill you makes you stronger. This hasn't exactly been the carefree and fun summer I was hoping for.

Kathiryn recently wrapped up a very busy period at work and is looking forward to a little downtime before things ramp back up in September. Between now and Labor Day, she and I are looking forward to a few of her gigs, a Broadway show, a wedding and some time with friends. We may even sneak out and head to a beach one day. 

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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