October 22, 2013

The Dow Jones Industrial Average currently stands at 15,392, or down a slim 59 points from when I wrote to you last month, which still leaves the average up a very healthy 17.5% from the 2012 year-end closing price of 13,104. It's especially rewarding to have the venerable average within shouting distance of its all time high right after the stupidity that was the government shutdown. The transportation average and the S&P 500 have both powered to all time highs, so the industrial average is lagging a bit, thanks in large part to a huge weakness in IBM shares.

Now that the government shutdown has ended and Congress has pushed the next round of budget battles into January, we can look back and see what affect it all had on the market. After hitting a high in mid-September, the DJIA dropped almost 1,000 points, or 6% on fears the Tea Party would actually for the government to default on its financial obligations. When Republicans leaders caved, I mean came to their senses, the market quickly rebounded, as you can see below.

So where do we go from here? I think the market will close the year higher than current levels. Maybe we'll surpass 16,000 along the way. The Federal Reserve will likely remain accommodative at least until the January meeting, when Janet Yellin takes over for a retiring Ben Bernanke as Chairman of the Fed. Given that, the financial headwinds should blow the market higher. The next step for the DJIA will be to rise above 15,710.

The Dow Jones Transportation Average continues its upward trajectory with ever higher highs and higher lows. This is almost a perfect bullish chart. The trend suggests that there will be some weakness soon, which would be the next buying opportunity.

The Dow Jones Utility Average is looking a little better. As the yield on Treasury bonds has fallen (see the next chart), the fortunes of utility stocks have improved. The first level of support (blue line) looks solid as the index heads back towards resistance (green line) around 510. MACD has turned up and RSI is moving higher. All of this suggests continues short-term strength. Remember, last month I wrote that "now that "taper" is off the table, utilities could benefit. Should these supports hold, and if interest rates stabilize, we could have a buying opportunity." That's exactly what happened.

As you can see, after yield on the 10-year Treasury bumped against major resistance at 3% early this month it has drifted steadily lower, heading towards support at 2.45%. I admit I'm surprised to see the yield fall this far, as it means investors are buying these bonds again. Why accept a 2.5% yield for 10 years when the stock market offers a MUCH better alternative? Last month I did say that "it's possible that rates could fall further now that the Fed has delayed the taper. Should that happen, bond investors should take advantage of the opportunity to lighten up because rates are certainly headed higher in the coming months." That advice still stands.

Last Month's Results

After the broad decline in August, otherwise known as a great buying opportunity, the market returned to its upward trajectory in September with solid gains across the board. With many of the major averages enjoying better than 20% returns, 2013 is shaping up to be one of the best years since 2009 and 2003. Not surprisingly, the bond market continues to struggle, although there appears to be a bit of a bond rally right now as investors digest the end of the shutdown and ponder the next budget battle. I still expect losses on bonds for the full year.

* 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 October 12 was 358,000, an increase of 15,000 from the prior week's revised figure. These numbers were adversely affected by the government shutdown. The four-week average of 336,500 is about 22,000 higher than the tally from a month ago. According to the seasonal average, about 2.86 million people continue to collect unemployment insurance, a big increase over the prior month. This will just be one of many statistics affected by the meat heads in Washington. 
• The non-farm payroll employment report in September was the third monthly disappointment in a row. The establishment survey reported that a meager 148,000 jobs were added in the month, while the figures for July were revised lower, and August was revised higher, adding a net of 9,000 jobs. The household survey reported that the unemployment rate fell to 7.2%. 11.3 million workers continued to be counted as unemployed and the labor force participation rate remained at 63.2%. When is job growth, if ever, going to materialize?
• The more comprehensive U-6 "underemployment" rate fell to 13.6%. 4.1 million people continued to be unemployed longer than 27 weeks (down from the prior month), the seasonally adjusted number of people who could only find part-time work held steady at 7.9 million and the number of marginally attached workers remained at 2.3 million. The silver lining in these numbers is that they didn't get worse. The number of people holding multiple jobs rose to 6.95 million. The average hourly wages for blue collar workers perked up to $20.24 while the average work week remained steady at 33.7 hours. Overall, the picture continues to be muddled at best and continues to bedevil the Federal Reserve.
• The Congressional Budget Office's (CBO) estimate for the federal budget deficit was not issued thanks to the shutdown. It will be reported in November.
• The Census Bureau's report on the U.S. trade deficit was not issued thanks to the shutdown.
• The National Association of Homebuilders/Wells Fargo Confidence Index fell two points in October to 55 from a downwardly revised figure of 57. Even after the drop, confidence remains strong. Rising interest rates and stupidity in Washington have caused consumers and builders to pause a bit. This too shall pass.
• The Census Bureau's report on housing starts was not issued thanks to the shutdown.
• The Census Bureau's report on new home sales was not issued thanks to the shutdown.
• The National Association of Realtors reported that on a seasonally adjusted annualized basis, 5.29 million existing homes were sold in September, a decrease of 1.9% from August but still 10.7% higher than a year ago. The estimate of homes for sale held steady at about 2.2 million, which represents 5.0 months of inventory at the current rate of sales. The median sales price fell to $199,200, which is below the rising 12-month average of $206,058. This was not a particularly good report. Rising interest rates and uncertainty caused by the government shutdown likely hurt the results, suggesting the October results could also be a little weak. 
• According to the Institute for Supply Management (ISM), economic activity in the manufacturing sector expanded in September for the fourth straight month as the index increased to 56.2, the highest reading of the year. On the other hand, the ISM index of non-manufacturing activity fell to 54.4, which still marked growth in the service sector for 45 consecutive months.
• The Conference Board's report on Leading Economic Indicators was not issued thanks to the shutdown.
• According to the Bureau of Economic Analysis, which released their September report days before the shutdown, the "third" and final estimate of GDP growth for Q2 2013 was 2.6%, which was slightly higher than the second estimate of 2.5%. That's a solid improvement over the meager 1.1% growth  generated in Q1 and the anemic 0.4% growth in Q4 2012, but below the robust 3.1% in Q3. For comparison, GDP growth was only 1.3% in Q2 2012. I'd expect the Q3 numbers to come in a bit lower thanks to . . . well, you know. 
• The Federal Reserve reported that in August the amount of total outstanding consumer credit grew at a 5.5% annualized rate, to around $3.04 trillion (revised). This is, by far, the highest number I've noted since I first started reporting this statistic in 2007. Since the retail sector is virtually stagnant, where is the money going? 
• The Conference Board's Consumer Confidence Index rose to 81.5 in August after a dip in July. Says Lynn Franco, Director of The Conference Board Consumer Research Center "Consumer Confidence increased slightly in August, a result of improving short-term expectations. Consumers were moderately more upbeat about business, job and earning prospects. In fact, income expectations, which had declined sharply earlier this year with the payroll tax hike, have rebounded to their highest level in two and a half years." A surging stock market in September will likely result in improved confidence next month.
• According to the FDIC, two banks failed in September, leaving the total for the year at 22, versus 43 through the same period last year. My target of 25 bank closings for the year looks like it might be a little too low, but we'll see.

Trends To Watch

The dollar index has fallen steeply over the past three and a half months. Indeed, after once again failing to pierce resistance at 85 in July, it has fallen perilously close to support at 79. Is it possible that the budget fight damaged the credibility of the greenback? Or is it simply the continuation of QE? It's hard to tell, but I think the dollar will likely rally towards the end of the year. 

Surprisingly, the price of gold is moving higher again, after the temporary resolution to the budget fight. The current price is almost midway between support and resistance and is getting close to the 50-day moving average. Part of the resurgence could be due to the weaker dollar. It's also possible traders are looking forward to the January budget and debt ceiling battle. We'll see if the gains can continue.

The price of West Texas crude, on the other hand, is dropping, and is on a collision course with the interim support level (green dotted line) around $99. The price is well below the falling 50-day moving average is perilously close to the 200-day average. RSI is heading lower and MACD is turning down as well. This is not a pretty picture. My warning last month that "seasonal factors, whereby prices ease heading into winter, could send prices lower in the next few months" seems to be coming true. 

The bull market in the financial sector continues unabated, regardless of how much money the government fines the big banks for misdeeds that easy-money government policy promulgated. Note how the price remains above both moving averages and stubbornly refuses to drop below the rising trendline (in blue). All I can do is reiterate what I keep saying: buy on weakness. 

The housing sector remains a puzzle. Rising interest rates earlier this year clearly hurt the sector, although rates are historically low and have fallen the last month or so. The index formed a "death cross" in August (where the 200-day moving average moves higher than the 50-day average), which is very bearish. Yet support around 165 continues to hold and the index has shown some life recently. So where is housing headed? As I wrote last month, "if rates stabilize and the Fed holds off on tapering, I think the sector moves higher." I still believe that to be true. 

Although it isn't a perfect picture, the fact is that the index for the developed international markets continues to make new highs. The current price is well above both moving averages. RSI is mildly overbought, which could lead to some profit taking. Still, this is a very bullish chart. 

It is no coincidence that metals and mining stocks in the U.S. have performed very well lately at the same time as a solid rally in the Chinese stock market. After bouncing off support a few times, the Shanghai index has gained about 21% over the past four months. Interim support (green dotted line) held during our budget crisis; can it continue to do so? The moving averages are close to forming a Golden Cross, which would be very bullish. I keep saying that a stronger China would be a boon for the world's economy. If this positive momentum continues, it will certainly fuel the year-end rally.

The NYSE Bullish sentiment index is in solidly bullish territory right now. It's been eleven months and counting since the index last fell below 60, not including the one day during the budget crisis when things looked a bit dicey.. I'm very comfortable with sentiment in the mid-70s. Should it approach 80, or should RSI move into overbought territory, watch for a correction. 

Right now about 82% of stocks traded on the New York Stock Exchange are currently trading above their 50-day moving average. This is clearly the higher end of the trading range, and it's the highest level since January. This is a minor warning sign. 

After a spike of increased volatility during the budget mess, the VIX, or the "fear index", has fallen right back into "complacent"  territory, where it has spent the better part of this year. The longer investors remain complacent, the more one worries about the risk of a future upheaval. But for now, things are ok. 

I was very confident that a deal to avert a financial crisis would get done, and I wrote to that affect in my last couple of blogs (click here to check them out), and right here last month when I said "I still believe that a deal will be struck before October 1 as all Congressmen are concerned first and foremost with their own re-election and to be blamed for shutting down the government won't help any of them at the ballot box." So what did we get after all the posturing and finger pointing? Absolutely nothing except the promise to do it all over again in January. Ain't this fun? Seriously though, the market was extremely happy the the crisis was pushed into 2014. Look for a nice year-end rally. 

The market also seemed pleased with the official announcement that Janet Yellin would succeed Ben Bernanke as Chairman of the Federal Reserve. Most observers believe Chairman Yellin will continue Bernanke's dovish monetary policies. This likely means that it will be January, at the VERY earliest, before the Fed thinks about tapering the QE program. And if there isn't significantly stronger job creation, and if the housing market doesn't pick back up again, the thought of tapering could be easily put off until Spring or Summer. I hope Ms. Yellin knows what she's gotten herself into.

So how does all of this inform my opinion of the market and what am I doing for my clients to capitalize on those beliefs? As I believe the market is headed higher through the remainder of the year, my clients and I are virtually fully invested. Indeed I have only 2% of my assets under management (AUM) in cash right now. By comparison, the lowest percentage of cash I've held in the past twelve years was 1.1% in April 2011. About 55% of my AUM is invested in 15 stocks. If you want to see the list, check out the Top Holdings tab on my website. Overall, I remain conservatively invested in companies that dominate their sectors, pay above average dividends and can weather any economic crisis. Our returns this year will be solid, but will lag the leading averages thanks to my precious metals positions, which have lagged terribly this year. I've subsequently pared those holdings, and a number of other small or under performing stocks, so that going forward they won't continue to drag down our returns. This also means I've done my year-end tax selling already, before everyone else drives the prices down. As things stand now, I'm very comfortable with our holdings. As I tell people, I could leave the country for five years and I would be very secure holding almost every single stock I now own. Can you say the same with your portfolio? 

News and Notes

Amazingly, it's time for my son, the youngest of my three children, to become a Bar Mitzvah. The celebration is this coming weekend. This will be the culmination of years of training on his part. I'm very proud of him, and excited to share his big day with him. 

On a personal note I'm exceedingly pleased and proud to have been nominated to join the Board of Directors of the Food Bank for Westchester. This is a wonderful organization that does incredible work for those less fortunate in Westchester County. I believe that providing food to those who might otherwise go hungry is one of the most basic ways in which we can help our less fortunate neighbors. My first day as an official Board member is tomorrow and I couldn't be more excited to get right to work so that I can make a difference in my community. If any of you would like some information on how you can help, please let me know.

I hope some of you have noticed the new photo at the beginning of this newsletter, as well as on my website, blog, twitter feed and LinkedIn page. I think the photographer did a great job. I can highly recommend him if any of you are interested in updating your professional look or have an event coming up.

We should only be a week or two away from the publication of my interview in the November edition of The Suit Magazine. As soon as the article appears on their website, I'll let my readers know. I hope you enjoy it.

As always, I thank you, my readers, and remind you that this newsletter is for you. I have been writing News and Views for ten years now. If you'd like to read any prior edition, simply go to my website and click on the link to my newsletter archives. I hope you have learned something about our economy and our stock market, and that you will continue to follow along with me in the future. If you have any thoughts or suggestions on how to make it better, please let me know. And if you'd like to speak with me about your investment needs, or if you know 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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