Werlinich Asset Management, LLC

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October 14, 2014

Correction or Buying Opportunity?

Current Market Analysis
Last Month's Results
Statistics to Watch
Trends To Watch
What I'm Thinking and Doing
News and Notes

Current Market Analysis

As I write this after the close, the Dow Jones Industrial Average stands at 16,321, down 629 points, or 4.0%, from when I wrote to you last month. This big reversal leaves the #DJIA down almost 1,000 points, 5.5%, from the all time high achieved on July 16th. And that's the good news. The #S&P500 is down 6.4% and the #NASDAQ is off 8.4%. Even worse, the Dow Jones Transportation Average (#DJTA) is now officially in correction territory, as it's fallen 11% as is the Russell 200 index of small-cap growth stocks (#RUT) which has swooned 13.2% since its high in March. 

I'll share my thoughts on what's going on in greater detail later in this newsletter. For now, suffice it to say that after a long absence, fear has returned to the market. Investors are afraid that the party is over; that the world is heading back into recession and that stocks are doomed to fall. I suppose one could make that argument. On the other hand, I believe that this is simply a long overdue correction in a bull market that began five and a half years ago. That's a long time for the bull to keep running. He's taking a breather. Conditions in this country are far different than they were back in 2008, the last time we endured a sustained bear market. I was clearly wrong, at least in the short term, when I wrote last month that "looking ahead, I think we'll probably move a bit higher heading into the mid-term elections in November, after which the next big move will happen." But we still have three weeks until the election so we have some time for my prediction to come to pass. 

In the meantime, let's look at the charts, which no longer paint pretty pictures. As we look at the #DJIA we can see the damage done in the last month, a trend that recurs in almost every image to follow. The price of the index has now fallen below the rising support line (in blue) and below both moving averages. I've drawn two support levels in orange, the first of which is at around 16,333. After that comes 16,015. Let's hope we don't have to discuss where support comes in if that level is breached.  

The chart of the #DJTA is even worse as the current price has plunged well below the rising trendline and also below both moving averages. RSI has fallen to oversold levels and MACD looks terrible. The transportation average is selling off more than the industrials because it is seen as an indicator of an upcoming economic malaise. I simply don't agree. Time will tell.  

The #DJUA represents one of the few sectors still in a bullish mode. The current price is above both moving averages and solidly within the established trading range. Falling interest rates continue to prop up this sector and there doesn't appear to be anything on the immediate horizon that suggests a change in rate policy, so utilities should continue to benefit.  

This month I'm giving you a longer perspective on the 10-year treasury to help put the current yield in perspective. Looking at the last four years, you can see that yields fell from a high of about 3.75% to as low as about 1.4% in the summer of 2012, before rising again to 3% at the end of 2013. Over the subsequent ten months, yields have fallen again to a current low of 2.28%. It's possible that if the market continues to struggle, a "flight to safety" could send yields back to around 2%. I've certainly been dead wrong on this trade all year. 

Last Month's Results

After solid gains in August, stocks dropped a bit in September. Small-cap stocks suffered large enough losses to leave them down for the year. Large-cap growth, especially large tech stocks, continue to lead the way as evidenced by the large divergence between the S&P 500 (more growth) and the Dow Jones Industrial Average (more value). Bonds, especially high yield, had a poor month too, but still have accrued solid gains for the year. 

Name of Index





S&P 500




Large-cap stocks

Dow Jones Industrial Average




Large-cap stocks

NASDAQ Composite




Large-cap tech stocks

Russell 1000 Growth




Large-cap growth stocks

Russell 1000 Value




Large-cap value stocks

Russell 2000 Growth




Small-cap growth stocks

Russell 2000 Value




Small-cap value stocks





Europe, Australia, Far East

Barclays Aggregate




US government bonds

Barclays High Yield




High-yield corporate bonds

* 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 4 was 287,000, a decrease of 1,000 from the prior week's revised figure, and well below the figure from this time last month. The four-week average of 287,500 is about 5,000 lower than the tally from a month ago. About 2.31 million people continue to collect unemployment insurance, which is 200,000 people less than last month. This is the lowest level since May 2006. Progress continues to be made. 
  • The non-farm payroll employment report in September exceeded expectations as the establishment survey reported that a surprisingly robust 248,000 jobs were added in the month, while revisions added an additional 69,000 in the prior two months. The household survey reported that the unemployment rate dipped to 5.9%. The more comprehensive U-6 "underemployment" rate also fell, coming in at 11.8%. 9.3 million workers were still counted as unemployed (three hundred thousand less than last month). The labor force participation rate fell slightly to 62.7%, down from 63.2% just six months ago.
  • 3.0 million people were counted as being unemployed longer than 27 weeks, the same as last night. The seasonally adjusted number of people who could only find part-time work dropped to 7.1 million and the number of marginally attached workers rose to 2.3 million. The number of people holding multiple jobs rose to 6.95 million. The average hourly wages for blue collar workers held steady at $20.67 while the average work week held stubbornly at 33.7 hours for seven out of the last eight months. Overall, while the headline numbers paint a very positive picture, the lack of labor participation growth combined with no wage growth tells me that nothing here will force the Fed to change their interest policy any time soon.
  • The Congressional Budget Office (CBO) estimated that on a net present value basis, the Treasury reported a federal budget surplus of $106 billion in September, which means that for fiscal 2014 the cumulative deficit is $486 billion, about $20 billion smaller than expected, $195 billion less than fiscal 2013 and the smallest deficit recorded since 2008. Relative to the size of the economy, the deficit, at an estimated 2.8% of GDP, was slightly below the average experienced over the past 40 years. Revenues were up about 9% and spending was up 1%. 
  • The Census Bureau reported that the U.S. trade deficit of goods and services decreased slightly in August to $40.1 billion as the growth in exports continued to out pace imports.
  • The National Association of Homebuilders/Wells Fargo Confidence Index rose for the fourth straight month in September, reaching 59, the highest level since November of 2005. Any reading over 50 indicates more builders view sales conditions as good than poor. "Since early summer, builders in many markets across the nation have been reporting that buyer interest and traffic have picked up, which is a positive sign that the housing market is moving in the right direction," said NAHB Chairman Kevin Kelly, a home builder and developer from Wilmington, Del.
  • The Census Bureau reported that after surging 22.9% in July, privately owned housing starts fell 14.4% in August, to a seasonally adjusted annual rate of 956,000 units, but still 8.0% better than a year ago. New building permits dropped 5.6% from the prior month but remained 5.3% higher than the year before. There is too much month-to-month volatility here to draw any meaningful conclusions.
  • The Census Bureau reported that on a seasonally adjusted annualized basis, a robust 504,000 new homes were sold in August, up 18.0% from the July total, and a whopping 33.0% higher than a year ago. The estimate of the number of homes for sale is 203,000, which represents a slim 4.8 months of inventory at the current rate of sales. The median sales price was $275,600, down a bit from an upwardly revised figure in July, which is almost identical to the 12-month moving average price of $275,592. The average sales price has now fallen four months in a row.
  • The National Association of Realtors reported that on a seasonally adjusted annualized basis, 5.05 million existing homes were sold in August, down 1.8% from July and down 5.3% from a year ago. The estimate of homes for sale down up to 2.31 million, which represents 5.5 months of inventory at the current rate of sales. After rising for seven straight months, the average selling price dipped slightly to $219,800, which remained well above the rising 12-month average of $203,250. 
  • According to the Institute for Supply Management (ISM), economic activity in the manufacturing sector dimmed just a bit in September to 56.6, which still marked overall growth for sixteen straight months. The ISM index of non- manufacturing activity dipped to 58.6, which marked growth in the service sector for 56 consecutive months. While these numbers weren't great, they still demonstrate continued growth in the economy.
  • The Conference Board reported that its index of Leading Economic Indicators (LEI) increased 0.2% in August, following a gain of 1.1% (revised) in July. "The LEI continued to rise in August, although at a slower rate than in July." said Ataman Ozyildirim, Economist at The Conference Board. "The LEI's six-month growth trend has been held back slightly by lackluster contributions from housing permits and new orders for non defense capital orders. Despite concerns about investment picking up, the economy should continue expanding at a moderate pace for the remainder of the year."
  • According to the Bureau of Economic Analysis, GDP increased at an annual rate of 4.6% in Q2 2014 according to the "third" estimate, up from the second estimate of 4.2%. 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. This solid number simply brought the two month average back in line with recent results and future expectations. Looking ahead, GDP growth will likely return to the 2.5% range.
  • The Federal Reserve reported that in August the amount of total outstanding consumer credit grew at an annualized rate of "only" 5%, up to $3.247 trillion. The steady rise in the amount of outstanding consumer credit slowed a bit but remains at the highest level since I started tracking this in 2004.
  • The Conference Board's Consumer Confidence Index, which had increased in August, declined in September, falling from 93.4 (revised) to 86.0. Says Lynn Franco, Director of The Conference Board Consumer Research Center, "Consumer confidence retreated in September after four consecutive months of improvement. A less positive assessment of the current job market, most likely due to the recent softening in growth, was the sole reason for the decline in consumers' assessment of present-day conditions...All told, consumers expect economic growth to ease in the months ahead."

Trends To Watch

In order to put the dramatic increase in the dollar index in some perspective, I've had to show a five year horizon in chart this month. You can see that the current price of the index is close to a high last achieved in early 2010. This dollar strength, while more about Euro weakness is great for travelers and importing goods, but bad for our the exports of our multi-national corporations and terrible for commodities, which are priced in dollars. As long as the dollar continues to increase in value, the price of oil and metals will likely suffer.  

Twice this year the price of gold has fallen to major support and around $1,200 and twice it has rebounded. As the stock market is falling right now, investors are once again looking at gold as a potential safe haven, and therefore buying the shiny metal. Both RSI and MACD have turned up, so this trade could continue higher for the time being. 

Thanks in part to the strong dollar, the price of copper is falling. It has dropped below the interim support at $3.20 and is below both moving averages. It will be very important for support to hold at about $2.92. The price could also be weak if investors believe that the global economy, read China, will continue to slow down. 

The following chart has gone from bad to worse. The price of West Texas crude has plunged about 21% in the past four months since peaking just under $108 in June. In doing so, it crashed through interim resistance around $100 and major support around $92. Now it's headed for the next big support level at around $78. If it falls that far things would be very bad. This is either a great buying opportunity or an indication of very bad things to come. The optimist in me believes the former. 

After being a beacon of strength for most of the year, the NASDAQ Composite has rolled over dramatically in the last month. In doing so it has fallen through support at about 4,360 and below both moving averages. RSI and MACD are both approaching oversold levels. Important support comes in around 4,000 so keep you eyes on that level. 

It will be interesting to see if the financial sector can avoid the carnage enveloping much of the rest of the stock market. Right now, it remains safe as the current price remains within the trading range and above the 200-day moving average. The banks have strong balance sheets, solid earnings, and they're increasing their dividends to shareholders. I think this is a good buying opportunity.  

The index for the housing sector is again taking a beating as the price has fallen below interim support around 192 and is well below both moving averages. Also, a "death cross" appeared last month, whereby the 200-day average has moved above the 50-day average. That is very bearish. If this index falls much further, and approaches major support at 166, it might be time to get out of this sector for a while. 

The index for the developed international markets looks ugly. The situation in Europe looks terrible, without any near-term reason for optimism. The index has plunged 14% in four months, in doing so has fallen through interim support at 65 and well below both moving averages, which last month also formed the "death cross". The current price is just above major support at 60. I would be out of the sector right now. 

Amazingly, in the face of declines in most of the rest of the world's markets, the Shanghai Index continues to surge higher. The current price is just below the high last achieved in early 2013. Normally this optimism would bleed over to other markets. If these gains continue, I would expect other market to follow suit.  

Well, my prediction two months ago that it was "time to buy" (see below) was clearly premature and ill-timed. The NYSE Bullish sentiment index has plummeted to a severely oversold position. And while markets can remain oversold longer than one might hope, it does set things up for a rally. It is not time to be a seller; I'd be a buyer. 

As with the bullish sentiment indicator above, based on the incredibly low percentage of stocks on the New York Stock Exchange that are currently trading above their 50-day moving average, I would say we are setting up for a very strong buying opportunity.

Fear is back. Stock market volatility, as evidenced by the VIX, has returned with a vengeance. After almost a year of complacency, the VIX has jumped more than 100% over the past three months, much of that just in the past two weeks. Given how quickly the VIX has increased, I would not be surprised to see an equally fast decline sometime in the next few weeks as the market recovers a bit.   

What I'm Thinking and Doing

This afternoon a client sent me an email asking me if this is the correction that I have been saying would have to come sooner or later, or if he should be worried. I answered him by saying: "I do think this is a legitimate correction, and it's probably long overdue. That being said, it's never pleasant while it's going on. I don't think we're headed for a full-blown bear market. Corporate balance sheets are solid, as are earnings. Our national debt has dropped considerably. The Federal Reserve remains vigilant and will doing everything in its power to keep the economy moving forward. I think this is primarily a European problem, and while I don't mean to diminish that problem, it should not crater our stock market. This is way we are invested conservatively. We will suffer losses, but that losses should be less than the broader market indexes. And we'll continue to collect our dividends."

I think that sums up my feeling about the market pretty succinctly. Nobody likes it when the market declines, except maybe Warren Buffett. And that tells you something. Perhaps we should all think, and invest, a little more like the Oracle of Omaha. Be a buyer when others are selling and there is blood in the water. Wouldn't you like to buy a great stock after it's fallen 10-15% for no reason having to do with it's core business? I certainly would. 

Following that advice, last week I picked up a great American industrial company after it had fallen 15% in just a few weeks. While it may fall a bit lower if the overall market continues to drop, I'm confident that we'll earn solid profits over the next five years and beyond. And if the market remains weak, I'll look to add other stocks on my "wish list". There are plenty of stocks I'd love to buy if the price is right. 

News and Notes

The big news is that my fiance' and I have moved up our wedding date. We are now getting married in one month, on Friday, November 14. We are so excited! We're also quite busy trying to nail down all of the details. 

On Thursday night I'm attending two important fund-raising events for two local charities that I support: the Food Bank for Westchester (I'm on the Board of Directors) and Cluster, an organization based in Yonkers. Both are great organizations that do very important work in our community to help support those less fortunate. While I would have preferred that these two events not be on the same night, I will be at both of them, lending my support. I hope to see some of you there. 

That's it for this month. The weather report says we should enjoy a few (final?) days of Indian Summer the rest of the week as temperatures rise back above 70 degrees. So we should all get outside and enjoy it. 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

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