Werlinich Asset Management, LLC

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October 6, 2016

Better Than Expected

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

We have made it to early October. Fall foliage is about to begin, the presidential election is heading towards its explosive conclusion, Hurricane Matthew is battering the Northern Caribbean and threatening Florida, and the stock market is doing just fine, thank you. Since breaking above 18,000 in early July, the Dow Jones Industrial Average managed to establish a new all-time high of 18,636.05 on August 15 before settling into a fairly narrow trading range, roughly between 18,500 and 18,000. The S&P 500 hit it's high of 2,190.15 on the same August day. As of the close last night, the #DJIA sits only 355 points, or 1.9%, below it's record closing high. So looked at in context of everything that has happened this year, the stock market is in remarkably good shape. As long as stocks continue to "climb a wall of worry", which means rising in the face of investor trepidation, we should continue to enjoy modest gains. 

I have been steady in my belief that the stock market would see modest gains this year, and so far I've been correct. Looking ahead towards the rest of the year, I still believe we'll finish the year in the black. Only a Donald Trump victory in November or an unexpected rate hike by the Fed in December could derail that prediction. I don't think Trump will win so I discount that risk somewhat. Right now, I'd put the chance of a December rate hike at about 40%. If it is well telegraphed, and if the economy proves to be stronger in Q4 then it has been the rest of the year, the market should absorb that news fairly well. If, on the other hand, the economy continues to be stagnant, I think the Fed will push the rate hike into 2017, which will give the stock market further juice for a big December rally. 

font face="Arial" size="2">Looking at the chart of the #DJIA, we see a complete recovery from the jarring crash after the rate hike in January. Except for the post-Brexit scare in June, the market has been on a solid uptrend since mid-February. You can also see the trading pattern formed over the last three months between the solid red and dotted green lines. My guess is we'll remain in this channel until after the election. If Clinton wins, we could see a bounce to a new high. Should Trump prevail, we'll likely tumble below interim support at 18,000 and possible test major support around 15,750.


The chart of the Dow Jones Transportation Average, while not great, looks much better than it has for most of the year. The index is currently sitting just below an important resistance level around 8,250, a level not broken since Q4 of last year. Should the index break through it could take aim at levels not seen since late 2014. This move would prove especially helpful to the overall market as it would signal improved health for the overall economy.

As you can see below, the Dow Jones Utility Average had a great first half of the year, peaking twice in July at all-time highs. Since then, the overall trend has been lower, most notably during the past couple of weeks. It's hard to tell if this is just a cyclical move or something more ominous. Utilities still provide better-than-average income in a low interest rate world. But interest rates are moving higher (see below), which could imperil this sector, so stay tuned.  

After falling to 1.33% in July, which was the lowest rate in recorded history, the yield on the 10-year treasury bond has moved steadily higher and now sits at around 1.71%. I think rates are moving higher on the assumption of a December rate increase. But I also think higher rates will bring in more buyers looking for a better yield, which will push the rate back down. The rates on our government debt look juicy compared to yields around the globe that are at zero, or are negative. Negative yields mean that bond investors are so concerned about what to do with their money that they're willing to lend their money, for 10 or 20 years, and PAY THE GOVERNMENT for the right to do it. They earn less than nothing! They're guaranteed to lose money. It seems incomprehensible to me but that's what's happening right now. As a result, it's hard to imagine a scenario where our government yields can move too high as foreign buyers will likely provide a cap for any potential increases. 

Last Month's Results

Three  quarters of the year are in the books, and to the surprise of many market observers (but not me), equity markets are solidly in the black. "Sell in May and go away" didn't work this year. Sell in September because it is an historically bad month didn't really work either. In 2016, as it has been since 2009, it's really all about the easy money policies of the Federal Reserve. As long as the Fed keeps interest rates abnormally low, risky assets are likely to outperform. Just look at the massive gains in high yield bonds (or "junk bonds"). And while US government bonds continue to produce positive results, they were outpaced by all the broad domestic averages. It's interesting that value stocks continue to outperform their growth brethren, which demonstrates the interest in dividend stocks. Three months ago I said that "as crazy as this market has been, I expect more of the same in the second half." So far that has been the case. The two potential market disrupters are a Trump victory in November and a Fed rate hike in December, both of which would likely send the market tumbling much lower. 

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

* Returns 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 1 was 249,000, a small drop from the prior week, and about 10,000 less than the prior month's figure. The four-week average of 253,500 was 10,000 lower than the tally from three months ago. The number of jobless claims continues to hold relatively stable for the past year and a half. About 2.06 million people continue to collect unemployment insurance, which is the lowest level since July 2000.
  • The non-farm payroll employment report in August met lowered expectations, after exceptionally strong totals in June and July, as 151,000 jobs were gained in the month, with 1,000 net jobs added in the prior two months. The household survey reported that the unemployment rate held steady at 4.9%. The labor force participation is at 62.8, similar to where it's been for most of the year. Average hourly wages for blue collar workers rose to a new high of $21.64 while the average work week again remained at 33.6 hours for six of the last seven months.
  • 7.8 million workers were still counted as unemployed, and 2.0 million people remained unemployed longer than 27 weeks. The seasonally adjusted number of people who could only find part-time work rose to 6.0 million while the number of marginally attached workers slid to 1.7 million. The number of people holding multiple jobs rose to 7.23 million. All of this means the comprehensive U-6 "underemployment" rate stayed at 9.7%. Our economy remains close to "full employment".
  • The Congressional Budget Office (CBO) estimated that on a net present value basis, the Treasury reported a budget deficit of $108 billion in August, which leaves the eleven-month deficit at $622 billion, $92 billion more than the last fiscal year. While revenues are growing faster than the prior year, expenses are growing even faster.
  • The Census Bureau reported that privately owned housing starts fell 5.8% to 1,142,000 in August, after equaling the year high in July, and was 0.9% higher than a year ago. New building permits were also essentially flat from the prior month and were down 2.3% from the year before.
  • The Census Bureau reported that on a seasonally adjusted annualized basis 609,000 new homes were sold in August, down 7.6% from July, but up 20.6% from a year ago. The estimate of the number of homes for sale was 235,000, representing a very slim 4.6 months of inventory at the current rate of sales. The median sales price was $284,400, the lowest figure of the year, leaving it far below the 12-month moving average price of $304,267.
  • The National Association of Realtors reported that over 5.3 million existing homes were sold in August, down from the highest level of the year In June, and roughly flat from a year ago. The estimate of the number of homes for sale was 2.04 million, representing a tiny 4.6 months of inventory at the current rate of sales. The median price was $240,200, up 5.1% from last year, and about $13,000 above the rising 12-month moving average price. Overall, the housing picture looks solid if unspectacular.
  • According to the Institute for Supply Management (ISM), economic activity in the manufacturing sector expanded in September, after a brief decline in August, rising to 51.5. The ISM index of non-manufacturing activity was a robust 57.1, which signaled growth in the service sector for 80 consecutive months and marked the highest level of the year.
  • The Conference Board reported that its index of Leading Economic Indicators (LEI) decreased 0.2% in August, following a gain of 0.4% in July. "While the U.S. LEI declined in August, its trend still points to moderate economic growth in the months ahead," said Ataman Ozyildirim, Director of Business Cycles and Growth Research at The Conference Board. "Although strengths and weaknesses among the leading indicators are roughly balanced, positive contributions from the financial indicators were more than offset by weakening of non-financial indicators, such as leading indicators of labor markets, suggesting some risks to growth persist."
  • According to the "third" estimate by the Bureau of Economic Analysis, GDP increased at an annual rate of 1.4% in Q2 2016, up from the first and second estimates. This is better than the 0.8% recorded in Q1, even with the rate from Q4 2015 but below the 2.0% achieved in Q3. And for comparison, it paled in comparison to the robust 3.9% rate reported in Q2 from a year ago. This modest growth rate will allow the Fed to put off rate increases until December at the earliest, if not until sometime in 2017.
  • According to the BLS, the seasonally adjusted Consumer Price Index for all Urban Consumers (CPI-U) increased by 0.2% in August after being unchanged in July. Over the last 12 months, the all items index rose a meager 1.1%. The index for all items less food and energy increased by 0.3% in the month.
  • The Conference Board's Consumer Confidence Index increased to 104.1 in September from 101.8 in August. "Consumer confidence increased in September for a second consecutive month and is now at its highest level since the recession," said Lynn Franco, Director of Economic Indicators at The Conference Board. "Consumers’ assessment of present-day conditions improved, primarily the result of a more positive view of the labor market. Looking ahead, consumers are more upbeat about the short-term employment outlook, but somewhat neutral about business conditions and income prospects. Overall, consumers continue to rate current conditions favorably and foresee moderate economic expansion in the months ahead."

Trends To Watch

The dollar index has spent the better part of the last seven months trading in a tight range between 92.5 and 96.5, after falling from the January high around 100. That weakness in the dollar helped spur gains in commodity prices (as you'll see below) and in the stock market, as the price of US goods sold internationally became more competitive. It is therefore worrisome that the index is again bumping against resistance at 96.5. Should the dollar gain strength, that could mean future weakness for stocks. 

The price of West Texas Crude has enjoyed a stunning rally since mid-February, almost doubling in price from $26 per barrel to $50 today. This is the third time the price has attempted to pierce resistance at $50, so we'll see if it's successful this time. Still, this is a very positive development for a key sector in the stock market. I also believe that we'll be over $50 before the year ends.  

After being dead wrong about the price of gold all year, my concerns seem to finally be manifesting as the price swoons. After a few attempts over the past three years to break above resistance at $1,400, the rally seems again to have fatigued and is heading lower. It will be interesting to see if it falls below $1,200. If so, it may be a buying opportunity because longer term, I see the potential for a higher price of the shiny metal. 

Tech stocks, as represented by the Nasdaq Composite, are are on a roll right now. FANG stocks (Facebook, Amazon, Netflix and Google) have resumed their leadership role and are helping to power the tech-heavy index to record levels. Since breaking through interim resistance around 5,000 (dotted green line) in July, it's been full steam ahead. In July, I wrote that "I'm not sure which way this is headed but I'm not selling any of my tech holdings." Glad I held on; I hope you did as well. Looking ahead, I'm still holding firm.  

The financial sector has struggled this year, thanks in large part to the unnaturally low interest rates, which keep a lid on their earnings. Add to that the recent scandal at Wells Fargo and the stress on European banks, and you have a recipe for disaster. Still, the sector has held up remarkably well, as you can see below. The index remains close to its highest level and above both moving averages. My financial stocks are long-term holdings and I'm not selling anything.

After enjoying almost six month of gains, the housing index is struggling again. The price has fallen down to support around 238, which is between its moving averages. I think the recent weakness is a recent of real, and imagined, rate increases. I wouldn't expect this index to move too much lower as I don't think rates will go much higher.

The index for developed international markets has managed to recover from the Brexit nightmare, and return to pre-vote levels. Still, thanks to negative interest rates and low, or no, economic growth, it's hard to make a case for sustained gains in the immediate future. Therefore, I continue to believe that it would be more profitable for investors to put the majority of their funds to work in the U.S.

The NYSE Bullish sentiment index has traded in a fairly narrow range for the last seven months. It's interesting that the price is near the top of the trading range, yet RSI is almost in oversold territory. It's hard to know what to make of that divergence except to speculate that the market is likely to stay around current levels for a little while.

The price of the volatility index, or the VIX, has again fallen to the low end of the normal volatility range, where it has remained for most of this year. This suggests greater volatility ahead (which will likely occur as the election grows closer). Still, as I've said earlier, I don't expect any major declines before year-end unless Trump wins the election.

What I'm Thinking and Doing

I have felt since the beginning of the year that the market would be up around 5-6%, or as much as 8%. At this point, I still think that's where things will end up. The two big wild cards are the election and the Fed. I think Q3 earnings will basically meet lowered expectations. Higher crude prices, and a rising transportation average auger better things ahead. Inflation is quiescent, employment is solid, interest rates are stable and the economy seems to be puttering along at a 1.5% - 2.0% rate of growth. All of this suggests that the market should be ok, at least for now.

Through the end of September, this has been one of the least active years I've had in recent memory. Except for the two market plunges, during which I was a big buyer, I have done very little trading this year. Instead, I have been very happy to sit still with my existing portfolio of stocks and allow the gains to build and the dividends to accumulate. Sometimes doing nothing is the best move you can make, and for me, that has been the case this year. I anticipate that if things proceed as expected the rest of the year, the performance of our portfolios will be very satisfying.

News and Notes

It is all peace and harmony in the Werlinich household. Nola is moving through her senior year at Wesleyan, heading towards her degree in theater. Lily is settled in to her dorm, and college life, as a freshman in the honors program at George Washington University. She's even found time to pledge a sorority! Ezra has started eleventh grade with a bang and is very relaxed as the only child in the house. We'll see if his calm attitude, and new dedication to good grades, can continue with PSATs/SATs/ACTs on the horizon. 

Kathiryn and I have settled back into the school-time schedule. She is working particularly hard with increased responsibilities at work and I've been working overtime on behalf of the Food Bank for Westchester. We've gone to our last ballgame of the year (as the Mets broke our hearts last night) and our last concert of the year. We have one final Broadway show coming up later this month. Now we head into the season of charity benefit galas and holidays. Plus, we get to spend more time back in the Caribbean. 

That's it for now. I look forward to communicating with all of you via twitter, my blog and this newsletter throughout the rest of the year. I wish all of you a peaceful Autumn, and a sweet New Year (for my Jewish readers). Take advantage of the upcoming holiday season to find some way to give back to your community. Either give money to a favored local charity, volunteer for a cause, serve a meal at a shelter or soup kitchen, or maybe help build a house; just do something. I promise you will receive far more than you give as making such a gift repays itself many times over.

Best regards,

Greg Werlinich

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