November 14, 2014

As I write this midway through the trading day, the Dow Jones Industrial Average stands at 17,627, up 1,306 points, or 8.0%, from when I wrote to you in the middle of the panic last month. This huge reversal leaves the #DJIA, and most of the other major averages, at or near their historic high levels. Not bad for a few weeks of work!

Last month I wrote that "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." Fortunately for me and my clients, because I was a buyer during the panic, I was correct in my belief that the downturn was nothing more than an overdue natural correction. Looking back, it was an easy decision to be a buyer, but in the moment, it took some resolve. 

So how do things look now, after the snap back in prices? I'd say they look pretty damn good! We can see that the price of the #DJIA has return to the midpoint of the trading channel, is at all-time record levels and is well above both moving averages. Last month the price fell below one support (green line) but bounced right off the other one (orange line). Fortunately, we didn't have to see what would happen if that support was broken. Even though RSI is a little stretched right now, there are no big danger signs. 

The chart of the #DJTA is also right back on track. This index only fell to it's first big support before bouncing higher. The price is now back to the upper end of the trading range and well above both moving averages. Like the industrials, RSI is a bit stretched, but everything looks pretty good. 

The #DJUA remains stubbornly in bullish mode. The current price is above both moving averages and trading in the upper end of the trading range. During the panic it barely budged, never falling below the rising trend line. Low interest rates continue to prop up this sector, and as there doesn't appear to be anything on the immediate horizon that suggests a change in rate policy, utilities should continue to benefit.  

Looking at the 10-year Treasury over 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 low of about 2.20%. I'm a little surprised that yields haven't increased more during the recent surge in equities, but I suppose I should give up waiting for higher yields. The Fed has won this battle.  

Last Month's Results

After falling sharply in late September and early October, stocks roared back in the second half of the month. Small caps, which have lagged all year, roared back to life. Still, for the year, large-cap stocks, powered by growth and technology, have led the way. The Dow Jones Industrial Average, a proxy for value, continues to fall behind the more growth oriented S&P 500. And bonds just continue to chug along; no big gains, but no big losses either. I would never have believed you could make 5% in government bonds this 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 November 8 was 290,000, a decrease of 12,000 from the prior week's revised figure, and similar to the figure from this time last month. The four-week average of 285,000 is about 2,500 lower than the tally from a month ago. About 2.39 million people continue to collect unemployment insurance, which is about 80,000 more than last month. Overall, progress is being made. 
• The non-farm payroll employment report in October was slightly below expectations as the establishment survey reported that 214,000 jobs were added in the month, while revisions added an additional 31,000 to the prior two months. The household survey reported that the unemployment rate dipped to 5.8%. The more comprehensive U-6 "underemployment" rate also fell to 11.5%. 9.0 million workers were still counted as unemployed (three hundred thousand less than last month). The labor force participation rate rose slightly to 62.8%. That key metric refuses to rise to a meaningful level.
• 2.9 million people were counted as being unemployed longer than 27 weeks, slightly better than last month. The seasonally adjusted number of people who could only find part-time work dropped to 7.0 million and the number of marginally attached workers dipped to 2.2 million. The number of people holding multiple jobs rose to 7.77 million. The average hourly wages for blue collar workers held inched higher to $20.70 while the average work week ticked up to 33.8. Overall, while the headline numbers paint a very positive picture, the lack of labor participation growth combined with stagnant wages means that the Fed is unlikely 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 deficit of $132 billion in October, about $41 billion more than the shortfall recorded in the same month last year; but the entire amount can be attributed to a timing shift in the calendar. I would expect the annual deficit to fall again in fiscal 2015.
• The Census Bureau reported that the U.S. trade deficit of goods and services increased in September to $43 billion as exports fell and imports grew.
• After four consecutive monthly gains drove sentiment to the highest level in years, the National Association of Homebuilders/Wells Fargo Confidence Index fell five points in October to 54. Any reading over 50 indicates more builders view sales conditions as good than poor. “We are seeing a return to the mid-50s index level trend established earlier in the summer, which is in line with the gradual pace of the housing recovery,” said NAHB Chairman Kevin Kelly, a home builder and developer from Wilmington, Del.
• The Census Bureau reported that privately owned housing starts rose 6.3% in September, to a seasonally adjusted annual rate of 1,017,000 units, which was 17.8% better than a year ago. New building permits rose 1.5% from the prior month and remained 2.5% higher than the year before. There continues to be too much month-to-month volatility here to draw any meaningful conclusions, but the general trend of new construction remains relatively solid.
• The Census Bureau reported that on a seasonally adjusted annualized basis, 467,000 new homes were sold in September, about the same as August and a solid 17.0% higher than a year ago. The estimate of the number of homes for sale is 207,000, which represents 5.3 months of inventory at the current rate of sales. The median sales price swooned to $259,000, well below the 12-month moving average price of $276,292. 
• The National Association of Realtors reported that on a seasonally adjusted annualized basis, 5.17 million existing homes were sold in September, up 2.4% from August but down 1.7% from a year ago. The estimate of homes for sale held at 2.3 million, which represents 5.3 months of inventory at the current rate of sales. The average selling price fell for the second straight month, falling to $209,700, which remained just above the rising 12-month average of $204,067. 
• According to the Institute for Supply Management (ISM), economic activity in the manufacturing sector dimmed moved higher in October to 59.0, which marked overall growth for seventeen straight months. The ISM index of non-manufacturing activity dipped to 57.1, which marked growth in the service sector for 57 consecutive months. These solid numbers demonstrate continued growth in the economy.
• The Conference Board reported that its index of Leading Economic Indicators (LEI) increased 0.8% in September, following no gain (revised) in August. "The LEI picked up in September, after no change in August, and the strengths among its components have been very widespread over the past six months,” said Ataman Ozyildirim, Economist at The Conference Board. “The outlook for improving employment and further income growth are expected to support the moderate expansion in the U.S economy for the remainder of the year.”
• According to the Bureau of Economic Analysis, GDP increased at an annual rate of 3.5% in Q3 2014 according to the "advance" estimate, down from 4.6% in Q2. That remains far better than the anemic decline of 2.1% in Q1 and 2.6% in Q4 2013. By comparison, GDP growth was 4.1% in Q3 2013. There is nothing wrong with this number. 
• The Federal Reserve reported that in September the amount of total outstanding consumer credit grew at an annualized rate of 6.5%, up to $3.267 trillion. The steady rise in the amount of outstanding consumer credit has resulted in the highest levels since I started tracking this in 2004; nobody is saving any money because interest rates on savings is basically zero.
• The Conference Board's Consumer Confidence Index, which declined in September, rose in October from 89.0 to 94.5. Says Lynn Franco, Director of The Conference Board Consumer Research Center, "“Consumer confidence, which had declined in September, rebounded in October. A more favorable assessment of the current job market and business conditions contributed to the improvement in consumers’ view of the present situation. Looking ahead, consumers have regained confidence in the short-term outlook for the economy and labor market, and are more optimistic about their future earnings potential. With the holiday season around the corner, this boost in confidence should be a welcome sign for retailers."

Trends To Watch

In order to put the action of the dollar index in some perspective, I'm showing you a five year chart. You can see that the current price has equaled the high last achieved in early 2010. This dollar strength, while great for travelers and shoppers, is bad for our our exports 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.

Like oil, it takes a five year chart to put the decline in the price of gold into perspective. Twice this year the price of gold had rebounded higher after falling to major support at around $1,200. The third time was the charm as support failed and the price fell to levels not seen since early 2010. The next line of defense comes in at around $1,100. After that, look out below! 

The strong dollar is certainly no friend to the price of copper. It is well below interim support at $3.20, is below both moving averages and is falling dangerously close to major support at $2.92. As the global economy appears, at least for now, to be ok, this really is all about the dollar. So I would expect a rally sometime soon because the dollar will have to rest eventually. 

The following chart continues to go from bad to worse. The price of West Texas crude has plunged about 30% in less than five months months since peaking just under $108 in early July. In doing so, it crashed through support around $92. The big question is will support hold at around $77.50? The current price is $75.20 so things look grim. I still think this will be looked at as a great buying opportunity.  

The one major average that has not yet achieved a record closing high is the Nasdaq Composite. But as you can see below, it is awfully close. As of this writing, the index is only 358 points, or about 7.5%, below the record closing price of 5,048.62 from March 10, 2000. It has been a VERY LONG road to get to this point. Let's see if the index can push higher and make history.  

Last month I told you it was again time to buy the financial sector. If you did you've made a quick 12.5%. The ETF shown below has quickly recovered and is again trading near the top of the trading channel. I'm very bullish on this sector.   

The index for the housing sector has been very volatile this year. Twice is has fallen below interim support around 192, but both times it quickly recovered. I'd watch for the next inevitable downturn before buying. 

After a brutal 15% decline between June and October, the index for the developed international markets has recovered a bit recently. Support at 60 held, which is very important. I'd like to see the "death cross" reversed before I get too excited. I'm still very wary of the international sector right now.  

The Shanghai Index continues to surge higher. The price has jumped 25% in just five or six months, and amazingly, nobody is talking about it. I wish I could say I bought a Chinese ETF and booked some big gains, but no, I didn't believe in the rally. Clearly Alibaba has a lot to do with this, so maybe the gains will hold. 

Once again, the NYSE Bullish sentiment index has proved to be a great contrary indicator. Buying the decline, depending on your timing, would have been the smart thing to do. And based on the fact that the index hasn't yet returned to the trading range, I'd say there's more gains to come.

Last month I said "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." Did you buy? I did.

Fear is so last month. After spiking 250% higher, and providing a great buying opportunity, the VIX has fallen right back to where it started two months ago as stock market volatility evaporated. Last month I wrote that "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." Bingo.

On October 15, which coincidentally, was the day before the bottom was made, I wrote a blog entitled "Don't Succumb To Blind Fear". In case you didn't read it, I'd like to share it with you because it will give you a lot of insight into the way I think about the market and how investors should treat the ups and downs.

"The past week has been a very turbulent, and nerve-wracking, time for investors. Stock markets around the world have been rocked by massive losses. In just the seven trading sessions, the Dow Jones Industrial Average (#DJIA) has fallen about 850 points, or 5%. By comparison, the S&P 500 has fallen 5.2%, the UK FTSE a slightly better 4.8% while the German DAX has dropped a whopping 6.9%. These are significant losses in only seven trading days.

Today was a microcosm of the past few weeks as the major averages were whipsawed all day long. At one point, the #DJIA was down 2.8%, before finishing down 1%. Similarly, the Dow Jones Transportation Average (#DJTA) was also down 2.8% before actually ending the day 18 points higher. The S&P 500 dropped 3% before winding up down only 0.9%. Investors who panicked today and sold at the bottom will likely regret that when the market inevitably recovers and they find themselves sitting in cash on the sidelines, missing the large gains.

So what are the reasons for the big declines and the crazy volatility? They include (just to name a few): a growing economic malaise in Europe, concerns about a continued economic slowdown in China, fears on an expanding Ebola outbreak, continued trouble in the Middle East thanks to ISIS and other terrorists, plunging oil prices thanks to the dollar surging in value against most other currencies and horrible policy decisions within OPEC. You could probably add concerns over social unrest in Hong Kong. Don't forget natural disasters like cyclones, hurricanes and typhoons that are growing in frequency and magnitude. And that doesn't even count worries about economic slowdown in this country, anticipation about future rate increases by the Federal Reserve and uncertainty about the upcoming mid-term elections. Phew, did I miss anything?

Given all the ills that I enumerated above, we should all dump everything, build a bomb shelter and stick all of our money under our mattress, right? WRONG!! Succumbing to fear, acquiescing to panic and abandoning your financial plan is exactly the opposite of what you should be doing.

First of all, in my opinion, you shouldn't be investing any money that needs to be spent in the next two years. So if we take that as a given, and if we assume (yes, I know what happens when we assume, but that's the only way I can continue this narrative) that the money you have invested is for some future purpose (of at least five years), than weekly volatility is really irrelevant. In fact, it is normal and present opportunities.

Let's put things in perspective. On October 9, 2007, almost exactly seven years ago, the #DJIA was 14,164.53. From there it proceeded to go down for the next year and a half, finally hitting bottom on March 9, 2009 at 6,547.05, for a loss of 53.8%. From that low, the market hurtled forward for the next five and a half years, erasing all of those losses before peaking on September 19 at 17,279.74, a gain of 163.9%! Today the #DJIA closed at 16,141.74, which means we've fallen 6.6% from the high. Is that really so bad? In the grand scheme of things is that likely to derail your future plans?

The truth about the stock market is that it goes up and it goes down. And after a prolonged period of going up, with only a few very short down periods, we were due for a correction of sorts. Now, I don't know either the depth or duration of this correction, but I'm confident it won't be nearly as bad as 2008/2009. Global economic conditions are MUCH better today, even with all of our problems, than they were back then. So relax, have a nice glass of wine (or whatever your drinking pleasure is), take stock of your portfolio and look at your "wish list" of stocks that you'd like to buy. Perhaps now is the tie to use some discretionary cash to pick up one or two of them on the cheap. Then sit back, wait for the rebound and congratulate yourself for remaining calm and sticking with your plan.

Full disclosure: I purchased one new position last week, and another one this afternoon, totaling about $600,000. So I'm putting my money where my mouth is. I'm very confident those will be very opportunistic and profitable purchases, creating solid profits for me and my clients for years to come."

Over the past two weeks, as the market soared higher, I began the process of tax loss selling and small-position pruning. I do this every year around this time. Whenever you have to sell and take a loss, or just admit that you were wrong about something, it's tough to pull the trigger and get out. But that's part of being an investor. And as difficult as it can be, I actually find the process cleansing as I get rid of the underperforming holdings to make way for better ideas. By the end of the month I hope to completed all of these trades. Then I'll sit back and watch the market in December, ready to buy something if the price is right, or content to just sit and wait for 2015. 

News and Notes

The REALLY BIG NEWS is that tomorrow I'm getting married to the woman of my dreams, the about to be former Kathiryn Sikkema. I spent the first half my life looking for this spectacular woman; I can't wait to share the second half with her. The intimate event will be held in our home, witnessed by a few family members and close friends. We couldn't be happier. And now that I've finished this newsletter, the celebration can begin!

That's it for this month. 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
President

                               

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