Werlinich Asset Management, LLC

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November 16, 2015

Don't Fear The Fed

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 17,245, which is essentially the same as when I wrote to you last month. That belies the enormous moves, up and down, that have happened in the interim. Indeed, the #DJIA dropped by 665 points, or 3.7%, just last week thanks in part to questions about upcoming Fed moves and plunging oil prices. I wrote last month that I thought the Fed had made it pretty clear that it would not adjust their short-term lending rates in 2015, which would result in a year-end rally. Now, thanks to the better than expected employment report (see below) there is a greater belief that the Fed will indeed hike the lending rate in December, and that's partly what tanked the market this week. So I'll say again what I've said before: slightly higher rates are not a bad thing, and will not negatively impact our economy so there's no reason for the sell off. 

Looking at the chart of the #DJIA we see that the index staged a powerful rally in late October and early November before rolling over and plunging last week. As a result, the index is now testing support at around 17,100. If it holds, look for a final year-end rally.

The Transportation Index continues to show some signs of life as it struggles to move above support above 8,050, a level around which the index has traded for the past few months. Again, the question is whether or not that support level will hold. 

The Dow Jones Utility Average has been churning in a range between 610 and 530 for most of this year as the utility sector continues to battle the specter of looming interest rate increases, which are widely believed to hurt the earnings of regulated utilities. I just think the whole debate is much ado about nothing. A mild rate increase will do little to hurt this sector, and large parts are unregulated and can therefore adjust their prices to match any possible interest rate moves. The other factor is that higher interest rates will make bonds more appealing relative to utility stocks, but that argument too just doesn't hold water as bond yields won't approach dividend yields for many years to come. 

After dropping back to around 2.0%, the yield on the 10-year treasury bond has moved higher again thanks to the belief that the Fed will raise rates at their December meeting. Still, the yield remains between 2.0% and 2.5%, where it has stayed for most of the past six months.

Last Month's Results

After three down months in the last four, October exploded higher, bringing the year-to-date results into the black. There were strong gains across the board in every sector except bonds. Large-cap stocks did particularly well, led by the tech sector, which surged almost 10%. Growth stocks also remain the best performing stocks year-to-date. Value stocks, especially the small ones, are clearing lagging behind. With six weeks left in the year, it's going to be close as to whether the market ends the year in the black or the red. 

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 November 7 was 276,000, unchanged from the prior week, but about 21,000 higher than the prior month's figure. The four-week average of 267,750 was slightly higher than the tally from a month ago. About 2.17 million people continue to collect unemployment insurance, about 140,000 more than last month. 
  • After a hugely disappointing result in September, the non-farm payroll employment report in October was a massive surprise to the upside as 271,000 jobs were gained in the month, while revisions added back 12,000 jobs to the August and September totals. The household survey reported that the unemployment rate fell to 5.0% while the labor force participation rate remained at an historic low of 62.4. Average hourly wages for blue collar workers moved to a new high of $21.18 while the average work week inched up to 33.7 hours, which is still below the high for the year set in January.
  • 7.9 million workers were still being counted as unemployed and 2.1 million people remained unemployed longer than 27 weeks. The seasonally adjusted number of people who could only find part-time work dropped to 5.8 million while the number of marginally attached workers remained at 1.9 million. The number of people holding multiple jobs rose to a new annual high of 7.6 million. All of this helped the comprehensive U-6 "underemployment" rate fall to a very low 9.8%. This month was a big reversal from the desultory report last month. And it may be just good enough to give the Fed grounds to begin raising rates in December, although I still think they'll wait until next year.
  • The Congressional Budget Office (CBO) estimated that on a net present value basis, the Treasury reported a budget deficit of $137 billion in October, about $16 billion more than the shortfall recorded in the same period last year.
  • The National Association of Homebuilders/Wells Fargo Confidence Index rose three points to 64 in October, a level last achieved in late 2005. "With October's three-point up tick, builder confidence has been holding steady or increasing for five straight months. This upward momentum shows that our industry is strengthening at a gradual but consistent pace," said NAHB Chief Economist David Crowe. "With firm job creation, economic growth and the release of pent-up demand, we expect housing to keep moving forward as we start to close out 2015."
  • The Census Bureau reported that privately owned housing starts were 6.5% higher in September, after falling the prior two months, rising to an adjusted annual rate of 1,206,000 units, which was 17.5% higher than a year ago. New building permits fell 5.0% from the prior month but remained 4.7% higher than the year before. This is a mixed message, but still relatively positive.
  • The Census Bureau reported that on a seasonally adjusted annualized basis 468,000 new homes were sold in September, down a whopping 11.5% from August but up a slim 2.0% from a year ago. This is the lowest number of new homes sold this year. The estimate of the number of homes for sale was 215,000, representing a widened 5.8 months of inventory at the current rate of sales. The median sales price was $296,900, leaving it just above the 12-month moving average price of $294,592.
  • The National Association of Realtors reported that on a seasonally adjusted annualized basis, 5.55 million existing homes were sold in September, an increase of 250,000, or 4.7%, from August, and was 8.8% higher than a year ago. The estimate of homes for sale is 2.21 million, which represents 4.8 months of inventory at the current rate of sales. The average selling price was $221,900, off the high levels recorded in June and above the rising 12-month average of $216,600. 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 fourth straight month) to 50.1 in September, barely registering growth for the 27th straight month. The ISM index of non-manufacturing activity rose to 59.1, which signaled growth in the service sector for 69 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. As I've asked before, does 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) declined 0.2% in September, the first drop of the year. "Despite September's decline, the U.S. LEI still suggests economic expansion will continue, although at a moderate pace," said Ataman Ozyildirim, Director of Business Cycles and Growth Research at The Conference Board. "The recent weakness in stock markets, the manufacturing sector and housing permits was offset by gains in financial indicators, and to a lesser extent improvements in consumer expectations and initial claims for unemployment insurance. The U.S. economy is on track for moderate growth of about 2.5 percent in the coming quarters, despite the mixed global economic landscape."
  • According to the "advance" estimate by the Bureau of Economic Analysis, GDP increased at an annual rate of only 1.5% in Q3 2015, down sharply from the 3.9% rate reported in Q2. This was still better than the decrease of 0.2% in Q1, but below the 2.2% increase in Q4 2014. And it remains well below the 5.0% and 4.6% growth rates in Q3 and Q2 2014, respectively. Clearly this is not the strong growth that anyone is hoping for, and it may mean the Fed will hold rates at zero until next year.
  • 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 dropped in October to 97.6. "Consumer confidence declined in October, following September's modest gain," said Lynn Franco, Director of Economic Indicators at The Conference Board. "Consumers were less positive in their assessment of present-day conditions, in particular the job market, and were moderately less optimistic about the short-term outlook. Despite the decline, consumers still rate current conditions favorably, but they do not anticipate the economy strengthening much in the near-term."

Trends To Watch

After bouncing off support in mid-October, the price of the dollar index has zoomed higher, attempting to pierce resistance at 100. This has had a very negative impact on commodity prices, like oil (see below). Clearly the dollar has strengthened as sentiment supporting a Fed rate hike grew. How much stronger can it get? Recent history would suggest the index will dip again.

The chart of the price of West Texas Crude is just ugly as the price has fallen below interim support at $42.50 and looks to be headed toward major support at $37.50. A price below $40 per barrel could be devastating for the energy complex in this country, not to mention oil producing countries around the world.. As I said last month, it will be hard to make a bull case for a meaningful recovery in the 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. So far now, I'm not making any new investments in this sector. 

This isn't a pretty picture either, as the price of gold has collapsed in the past month and is in danger of falling below major support just above $1,075. Every time the price of gold has moved higher this year the rally has been quickly snuffed, sending the price lower. Last month, as the price was moving higher, I wrote that I couldn't make the case for a lasting bull rally in the shiny metal and that seems to be the case.

The surging dollar, and a faltering global economy, has simply crushed the price of copper, which has fallen to levels not seen since the depths of the financial crisis. I wonder if the Fed is looking at this chart. 

After failing to break to a new record high earlier this month, the price of the Nasdaq Composite is falling back towards support at 4,900. This is simply part of a bigger market swoon. I expect a quick recovery. 

The financial sector is one of the few areas of the market to benefit from the expectation of a Fed rate increase. Note how the XLF has jumped about 10% in the past two months, right after I wrote that the sector was a "buy". Let's see if the rally can move the index above resistance at 25.50. 

Except for a brief surge in August, the price of the housing index has remained in a fairly tight range (purple dotted lines) for most of the year, making it hard to profit from investments in the sector. Note a flat MACD and RSI, and moving averages that have converged perfectly. There's no volatility here right now. 

The index for developed international markets has remained in the bottom part of its trading range for the past four months. Given how little global economic growth is in evidence right now, it's hard to make a case that this index will move much higher any time soon. 

Is the breakout in the Shanghai Index real? Is this the beginning of a real rally, or simply another sucker's bet? Personally, I think their market is a mess and should be avoided, regardless of whether or not the index rallies in the short term. 

After forming a double bottom from late August to early October, the NYSE Bullish sentiment index surged higher over the past month. In my September letter 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." That was certainly the case. Now we'll have to wait and see if the rally has legs. 

The price of the volatility index, the VIX, is moving higher right now, heading up towards the higher end of the primary trading range. I don't think there's anything to worry about right now, nor is it the right time to start buying just yet.

What I'm Thinking and Doing

In my last two newsletters I suggested that the stage was set for the next big rally, and that I expected further gains in November and December, enabling the market to finish in the black by year-end. I was feeling pretty good about that prediction until last week, when the broad market headed lower. Still, I believe we've got another rally coming up which will indeed allow the market to finish the year higher than it started. 

Even though I've predicted many times that the Fed won't raise rates until next year, I kind of wish they'd do it already and get it over with. Rates have been kept at an artificially low level for far too long, punishing savers and people on fixed incomes. Enough is enough. The Fed should bump their lending rate up by 25 basis points, ending all the speculation. Then they should say that they expect to leave the rate alone until there is clear evidence of economic growth. That certainty would likely send the market higher and quiet all of the useless, and almost daily, speculation of when will the rate increase finally happen.

As of the close of business on Friday, I've completed about 95% of all anticipated trades for the year on behalf of my clients. Barring anything unforeseen events happening in the market over the next six weeks, I'll be pleased to begin 2016 with my portfolios as they are currently constituted. I'm very comfortable with my current holdings and I believe my clients are well positioned for whatever the market will throw at us in 2016.

News and Notes

This past weekend I was thrilled to celebrate one year of marriage to my amazing wife Kathiryn. We shared a great meal, highlighted by a spectacular bottle of wine. I'm so blessed to have met her four years and four months ago and I'm looking forward to at least another 49 more anniversary celebrations. I love you honey. 

In late October Kathiryn and I attended two great fundraising events in support of the Food Bank for Westchester and Cluster, Inc. Both charities support people in need in our local communities. I hope each and every one of you find a way to give back, whether it be with your money or your time. I believe that it's a moral imperative that those who have the most find a way to help out those who have the greatest need.

Finally, as the days grow shorter and colder I'm ready to head to warmer climes. It's time to sit in the sun, read some books and begin to recharge my batteries. Bon voyage. 

That's it for now. I look forward to writing to you for the final time this year next month.

Best regards,

Greg Werlinich

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