Werlinich Asset Management, LLC

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October 19, 2015

October Bounce Rewards Patient Investors

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 of the close of business Friday, the Dow Jones Industrial Average stood at 17,216, which is 617 points, or 3.7%, higher than when I wrote to you last month. The stock market, as defined by the #DJIA, is now down 3.4% for the year (after finishing last year at 17,823). The index has now regained more than half of the losses incurred in the summer correction. The current strength in the market suggests that the August 25 closing price of 15,666 may have been the bottom this year. I've been saying for months that I think the market will finish the year in the black, so we'll just need to improve by about 3.5% from here to make that happen. Since the Fed has made it pretty clear that it will not be adjusting their short-term lending rates in 2015, I think that rally will come to fruition. 

I'd like to take a moment to remind my readers of something I said last month about corrections because it's very instructive. "Corrections are a normal and healthy part of the stock market. They may not be much fun to go through, but go through them we must. The stock market, like the economy and most every other force in nature, goes up and down; through good times and bad. We've enjoyed six years of a bull market since the last bear market ended in early 2009. That's a long time to go without suffering through a decline of 10% of more; so we were overdue. If we've seen the worst of it we got off easy." Hopefully you took my advice and just sat tight with your investments. If you did, you've enjoyed some nice gains during this rally. And if you had the courage, like I did, to make some strategic investments, then you should feel pretty good right now.

The chart of the #DJIA is looking much better than a few weeks ago, not to mention two months ago. After setting the low at the end of August, the index tested that mark in late September, and support held before bouncing higher. The rise took it through a first resistance level (pink line) just below 16,500 before besting the next level around 17,100 (blue line). Should the rally continue the all time high would be in sight. 

The Transportation Index remains weak, but is showing some signs of life. After hitting bottom in August it has managed to rise past two lines of resistance, even as various components of the sector (like airlines, truckers and railroads) have taken turns getting crushed. I would like to see the #DJTA remain above support around 8,000 and then move through resistance around 8,700. I'd also like to see the moving average lines start to move up.

While the Dow Jones Utility Average has performed very poorly this year, it did not break through support during the correction, and has subsequently rallied very nicely this month. Notice the moving averages are moving higher and starting to converge. If this pattern continues, we could see a bullish #goldencross in the coming months. After falling about 18% over the first nine months, the #DJUA has rallied about 11% over the past six weeks. Last month I wrote that as "investors have fled the sector in advance of a rate hike that never materialized. As such, this sector represents an intriguing buying opportunity for long-term investors. . . If a rate hike is already "baked in", then we might actually see a rally before the end of the year." So far, that prediction has proven prescient as that rate hike is basically off the table at this point. 

Amazingly, after rising through most of the first half of the year, the yield on the 10-year treasury bond has fallen again for most of the second half, and is back to around 2.00%. During the recent panic investors fled stocks and flocked to bonds, twice knocking the yield down to 1.9%. I would expect yields to remain plus or minus 2% for the remainder of the year.

Last Month's Results

After a brutal August, September was merely bad, with modest losses across most of the major averages. Small-cap growth got killed in the month and got crushed in the quarter, and small-cap value didn't do much better. Large-cap growth stocks (Facebook, Amazon, Netflix and Google being some of the best examples) have been the best performers this year. But the only sector to be in the black is the one that I predicted would certainly lose money, and that's government bonds, which have eked out a 1.1% gain so far this 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 10 was 255,000, down slightly from the prior week, and about 20,000 lower than the prior month's figure. The four-week average of 265,000 was roughly 10,000 less than the tally from a month ago. This is also the lowest monthly average since December 15, 1973. About 2.16 million people continue to collect unemployment insurance, about 100,000 less than last month. This is also the lowest level for insured unemployment since November 4, 2000.
  • The non-farm payroll employment report in September was hugely disappointing as the establishment survey reported that only 142,000 jobs were added in the month, while revisions subtracted another 59,000 jobs from the July and August totals. The household survey reported that the unemployment rate remained at 5.1% while the labor force participation rate dropped to a new low of 62.4. Average hourly wages for blue collar workers remained at $21.08 while the average work week dipped to 33.6 hours.
  • Only 7.9 million workers were still being counted as unemployed. 2.1 million people remained unemployed longer than 27 weeks, down from last month. The seasonally adjusted number of people who could only find part-time work dropped to 6.0 million while the number of marginally attached workers inched higher to 1.9 million. The number of people holding multiple jobs rose to 7.4 million. All of this helped the comprehensive U-6 "underemployment" fall to a very low 10.0%. This is not the picture of a robust economy; it's barely muddling along. This data will likely mean the Fed will hold off on raising rates until late in Q1 of 2016, at the earliest.
  • The Congressional Budget Office (CBO) estimated that on a net present value basis, the Treasury reported a budget surplus of $95 billion in September, leaving the full-year deficit at $435 billion, about $48 billion less than the shortfall recorded in the same period last year, and the smallest deficit recorded since 2007. Relative to the size of the economy, that deficit - at an estimated 2.4% of GDP - was slightly below the average experienced over the past 50 years.
  • The National Association of Homebuilders/Wells Fargo Confidence Index rose one point to 62 in September. "NAHB is projecting about 1.1 million total housing starts this year," said NAHB Chief Economist David Crowe. "Today's report is consistent with our forecast, and barring any unexpected jolts, we expect housing to keep moving forward at a steady, modest rate through the end of the year."
  • The Census Bureau reported that privately owned housing starts were 3% lower in August after falling 4.1% in July, dropping to an adjusted annual rate of 1,126,000 units, which was still 16.6% higher than a year ago. New building permits rose 3.5% from the prior month and remained 12.5% higher than the year before. Even though the figures are a bit weaker now, the overall trend is positive.
  • The Census Bureau reported that on a seasonally adjusted annualized basis 552,000 new homes were sold in August, up 5.7% from July (revised higher) and 21.6% from a year ago. It also managed to surpass the previous yearly high set in February. The estimate of the number of homes for sale was 216,000, representing a very slim 4.7 months of inventory at the current rate of sales. The median sales price was $292,700, leaving it just above the 12-month moving average price of $290,300.
  • The National Association of Realtors reported that on a seasonally adjusted annualized basis, 5.31 million existing homes were sold in August, a decrease of 270,000, or 4.8%, from July, yet were still 6.2% higher than a year ago. The estimate of homes for sale is 2.29 million, which represents 5.2 months of inventory at the current rate of sales. The average selling price was $228,700, off the highest levels since July 2007 but well above the rising 12-month average of $228,700. Overall, the housing market appears to be fairly robust.
  • According to the Institute for Supply Management (ISM), economic activity in the manufacturing sector dipped (for the third straight month) to 50.2 in September, barely registering growth for the 26th straight month. The ISM index of non-manufacturing activity dipped (for the second month in a row) to 56.9, which still signaled growth in the service sector for 68 consecutive months. It's clear the reason wages aren't moving is all of the job gains are in the lower-paying service side of the economy. Could this portend "the end of jobs" in America, as higher wage jobs are outsourced to either robots or cheaper countries?
  • The Conference Board reported that its index of Leading Economic Indicators (LEI) increased 0.1% in August, following no change in July and a gain of 0.6% in June. "The U.S. LEI suggests economic growth will remain moderate into the New Year, with little reason to expect growth to pick up substantially," said Ataman Ozyildirim, Director of Business Cycles and Growth Research at The Conference Board.
  • According to the "third" estimate by the Bureau of Economic Analysis, GDP increased at an annual rate of 3.9% in Q2 2015, up from the second estimate of 3.7%. This was far better than the decrease of 0.2% in Q1, and the 2.2% increase in Q4 2014. Still, it remains 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, although it's one that's unlikely to continue at this level.
  • According to the BLS, the seasonally adjusted Consumer Price Index for all Urban Consumers (CPI-U) decreased 0.2% in September, and was essentially unchanged over the past 12 months. If you strip out food and energy, CPI rose 0.2% as energy prices fell in September while food gained sharply. It is clear to me, and it would seem to the Fed as well, that economic growth is stagnant right now.
  • The Conference Board's Consumer Confidence Index ticked up in September to 103, which is very near the highest level of the year, set in January. This continues the big rebound after the plunge in July. "Consumer confidence increased moderately in September, following Augustís sharp rebound," said Lynn Franco, Director of Economic Indicators at The Conference Board. "Consumersí more positive assessment of current conditions fueled this monthís increase. Consumersí expectations for the short-term outlook, however, remained relatively flat, although there was a modest improvement in income expectations. Thus, while consumers view current economic conditions more favorably, they do not foresee growth accelerating in the months ahead.

Trends To Watch

After peaking in March and April, the price of the dollar index has fallen to support around 93 five different times, most recently last week, before moving higher each time. Clearly the dollar has weakened as sentiment supporting a Fed rate hike waned. I wouldn't be surprised to see this support level violated before the end of the year. Also notice that the moving averages are about to form the bearish #deathcross, suggesting more price weakness ahead. 

I don't need to belabor the fact that this has been a tough year to be long oil or energy related stocks. Virtually everything that could negatively impact the price of oil has done just that. The good news is that since the correction low of around $37.75 the price of oil has recovered somewhat and is currently trading in the mid-$40s. The weaker dollar is certainly helping things. But it will be hard to make a bull case for the near-term price of oil until the global economy shows signs of sustained growth, and until either supply falls to meet demand or demand rises to meet supply. Until that happens, I expect the price of oil to remain between $40 and $60. 

The correction in the stock market, and the realization that the Fed will likely continue the easy money for at least a few more months, has helped bolster the price of gold. Indeed, the price of gold has risen about $120, or 11% in less than three months. This rally pushed the price past one resistance level around $1,150 and towards the next one at $1,225. I admit I'm surprised by how rapid, and how robust, this rally has been. Still, I really can't make the case for a lasting bull rally in the shiny metal. 

The fading dollar has provided no solace to the sickening downward spiral that is the price of copper. The fact that the price of copper, which is used in so many industrial applications, has fallen to a low not seen since the financial crisis ended. That is not indicative of economic health now, or in the near future. 

The price of the Nasdaq Composite twice bounced off support around 4,600 (notwithstanding the few days the index spent below that level during the panic) before moving higher and attempting to pierce resistance at 4,900. Last month the index formed a #deathcross, which is highly bearish. So it will be important for the future of this rally that the price moves higher, which I think it will. 

The market correction pounded the financial sector and it's just starting to recover. Last month I suggested that thanks to the violent sell off, it "seems like a great time to pick up some leading bank or insurance stocks so I'd be a buyer." I'm sticking with that prediction, even though the low interest rate policy by the Fed negatively impacts the earning potential of big banks. Long-term, I still like this sector. 

The chart of the housing index has quickly turned from bullish to bearish. After peaking in mid-August, the price has fallen by almost 9% to it's current level, after plunging 15% peak to trough. I've indicated two interim resistance/support levels in purple. The bottom one has been breached three times this year and is in danger of being pierced again right now. The short-term trend, as indicated by the green line, is downward and the moving averages are getting close to converging. Nothing about this picture is bullish to me. 

The index for developed international markets doesn't look good at all, although it is showing some signs of life. One month ago the price of the index bounced off support around 56.5 before moving higher. The question is whether it's a "dead cat bounce" or the beginning of a substantive rally. Clearly the fact that the Fed has backed off its intent to raise rates this year has helped bolster the fortunes of the emerging markets. Therefore I would expect this index to rally towards the end of the year. 

I'm struggling to come up with something new to say about the Shanghai Index. It's simply a mess and a market to be avoided, regardless of whether or not the index rallies in the short term. 

After crumbling to a new low in August, and testing that low in late September, the NYSE Bullish sentiment index is rallying furiously right now. Last month I wrote that "I'm not sure when sentiment will turn, and clearly I've been wrong with my recent "buy" signals, but things are setting up for a major rally sometime soon. And when it happens, it should be powerful." I think we're in the midst of that rally right now. 

The price of the volatility index, the VIX, has dropped right back into the normal trading range after the hysteria of the correction sent the index soaring to staggering levels in just a few days. This is perfect example of how quickly fear can spike, and how equally fast it can dissipate. I continue to urge all investors to resist the urge to panic when fear reigns; it's better to simply sit back allow the panic to fade, as it always does. 

What I'm Thinking and Doing

Last month I wrote about the reasons for the correction and how I felt it's a normal and healthy part of the natural cycles of the stock market. I also said that I believed that the fundamental underpinnings of our economy and stock market were healthy and that there was no massive bubble waiting to burst. I went on to say that when corrections are over, the stage would set for the next big rally. So far, that's exactly what has come to pass. More importantly, I don't think the rally is over. I expect further gains over the next two months will put the market in the black by year-end.

If I may, I'd like to take one brief moment to pat myself on the back, just a little. I have said, since back in January, that I didn't think the Fed would raise rates this year. I often felt like I was one of the very few people who felt that way. But it appears that my stance will be proven correct as it now appears that Fed won't change their interest rate policy until sometime in the first quarter of next year, at the earliest. But let me reiterate something else I said last month: whether or not the Fed raises their lending rate by 25 basis points is really irrelevant. Whether their lending rate is 0.25%, 0.50% or 0.75% really doesn't matter that much to the average American or the U.S. economy. In fact, higher rates would probably help large segments of the population that relay on the interest from their savings accounts. Most interest rates in the country are set by the market, not by the Fed. And those rates will likely stay reasonably low for months or years to come. The sooner we recognize that this particular policy decision by the Fed simply isn't that important the better off we'll all be. 

After being very busy in the market during August and September, I have done virtually nothing so far in the fourth quarter. Honestly, unless something very unusual were to happen between now and the end of the year, I don't expect to do much other than some minor tax-related trades. I've made all the changes to my portfolios that I wanted to make. Now I intend to sit tight and monitor the results of those moves. I'm ready to take all of my current holdings into 2016.  

News and Notes

The last vestiges of summer were blown away last night as a cold snap reduced the temperatures in my neighborhood to below 30 degrees. It was 29 when I went to practice this morning. To be honest, I'm not ready for cold weather yet. I only turned on the heat this morning when our bedroom was 59 when my alarm went off. The good news is that we have another week or two of beautiful foliage to look at here in the Northeast before we slide towards Halloween then November. 

Last week Lily and I completed our last college tours. Most of her applications are already in and she plans to have to final ones in before the end of the month. After everything is submitted, then it's a waiting game. But please don't ask her where she wants to go. She gets very touchy about the subject. 

After a crazy busy two months, things begin to ease up a bit this month. By the end of this month, Kat and I will have been to one beer festival, a Broadway show, two concerts (Joe Walsh and REO Speedwagon) and three charity galas. Plus, I took a flying lesson out of the White Plains airport. I flew a four seat plane down the Hudson River, around the Statue of Liberty, up the East River to Central Park, where we crossed back to the West Side and returned home. It was about 45 minutes of incredible views and tremendous excitement. I hope to do that again some day. And finally: LET's GO METS!! They are two games from the World Series. By the time I write to you next month they may have celebrated in the Canyon of Heroes on Wall Street. 

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

Best regards,

Greg Werlinich

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