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December 21, 2013

Don't Fear the Taper - Don't Fight 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

The Dow Jones Industrial Average currently stands at an all time record high of 16,221, up a 321 points, or 2.0%, from when I wrote to you last month. This leaves the venerable average up an astonishing 23.8% from the 2012 year-end closing price of 13,104. The S&P 500 and the Dow Jones Transportation Average are also at record levels while the Nasdaq has reached a height not seen since early 2000. All of this suggests, as I wrote last month, that the rally is broad and likely has further room to run. This rally certainly won't last forever, and we're destined for a correction, but I think that correction remains at least a few months away.

Last week, in his final press conference as Chairman of the Federal Reserve, Ben Bernanke announced that beginning in January, the Fed would begin to taper its $85 billion per month program of Quantitative Easing (QE). He said that that the Fed would reduce their bond purchases by $10 billion. If all goes well, they can reduce it by another $10 billion at their next meeting in the spring. The market applauded the announcement, sending the DJIA up almost 300 points in one day. The decision to begin tapering in January surprised many market observers, myself included. I believed that tapering wouldn't start before April. Be that as it may, it appears that the economy is strong enough to withstand the reduction in Fed support. 

Last month I wrote that I "believe that the market will close the year higher than current levels [and] maybe we'll surpass 16,000 along the way." Done and done. A little tapering notwithstanding, the Federal Reserve will remain accommodative through at least next year and well into 2015. They've also promised to keep rates artificially low even further than that. All of that means that the party should continue. 

Looking at the chart of the DJIA, there's simply nothing much to say except that there doesn't seem to be anything that can stop the rally right now. That being said, there's nothing to stop a breather from happening, which could take the index down as low as about 15,700 without disturbing the positive trend.

The Dow Jones Transportation Average also continues its upward trajectory with ever higher highs and higher lows. This is an almost perfectly bullish chart. And the fact that the Industrials and Transports have hit new highs concurrently is a Dow Theory bullish indicator. Last month I wrote that any weakness below the 6,900 level would be a buying opportunity. The last dip remained just above that level. Now, I'd say a dip below 7,100 would be a decent entry point. 

This month, because so many new records are being made, I thought I'd show you the chart of the S&P 500. Nice picture, huh? It's a beautifully tight upward channel, with the current price well above both moving averages and RSI and MACD at reasonable levels. There's nothing wrong with this picture.

The Dow Jones Utility Average really broke down during November and the first two weeks of December, dropping around 6.6% during that swoon. A rising interest rate environment, or even the expectation of rising rates, will negatively impact the utility sector, which has bond-like characteristics, because bonds don't like rising rates. That being said, it's not time to abandon utilities just yet as support hasn't been broken.

As you can see, the yield on the 10-year Treasury is again attempting to pierce a pretty solid resistance at 3.0% The strengthening economy, plus the announcement of the beginning of taper, have added fuel to the sell off in bonds, which has resulted in the rise in yields. I've written extensively that I expect rates to remain range-bound at least through the end of the year, and likely into the first quarter of 2014 before moving higher. Should the Fed accelerate their taper plans, rates could increase faster than that. But for now, the trend remains intact.

Last Month's Results

The market continued its amazing year-long rally in November with solid gains across the board. Gains for the year are now approaching 30%. Indeed, the tech-heavy Nasdaq is at 36% and small-cap laden Russell 2000 growth average has surpassed 40%! The bond market suffered a minor loss as rates begun to again creep higher as the economy is again showing strength. The big picture shows that stock investors are enjoying historic gains while bond investors are licking their wounds.

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 8 was 339,000, a decrease of 2,000 from the prior week's revised figure. The four-week average of 344,500 is about 6,000 lower than the tally from a month ago. According to the seasonal average, about 2.86 million people continue to collect unemployment insurance, which is roughly the same as the prior month.
  • The non-farm payroll employment report in November continued the strong progress begun in October. The establishment survey reported that a solid 203,000 jobs were added in the month, while an additional 8,000 jobs were added through revisions to the results for September and October. The household survey reported that the unemployment rate fell to 7.0% while the more comprehensive U-6 "underemployment" rate dropped to 12.7%, the lower level since mid-2008. 11.0 million workers were counted as unemployed (about 300k fewer than the prior month) and the labor force participation rate increased to 63.0%, which is promising.
  • 4.1 million people continued to be unemployed longer than 27 weeks, the seasonally adjusted number of people who could only find part-time work dropped to 7.7 million and the number of marginally attached workers fell to 2.1 million. The number of people holding multiple jobs remained at 7.0 million. The average hourly wages for blue collar workers inched higher to $20.31 while the average work week crept up to 33.7 hours. Overall, this is probably the most uniformly positive employment report we've seen since the financial crisis began in 2008.
  • The The Congressional Budget Office (CBO) estimated that on a net present value basis, the Treasury reported a federal budget deficit of $140 billion in November, which means that two months into fiscal 2014 the cumulative deficit is $232 billion, $61 billion less than the same period in the prior year, thanks to higher tax receipts and lower government expenditures.
  • The Census Bureau reported that the U.S. trade deficit of goods and services was $40.6 billion in October, a decrease of $2.4 billion from the prior month, and roughly in line with the results from the rest of the year. If congresss can figure out how to allow the country to export petroleum products, our deficit could really drop.
  • The National Association of Homebuilders/Wells Fargo Confidence Index remained unchanged in November from a downwardly revised level of 54 in October. Even after this small dip, confidence remains strong as for the sixth consecutive month more builders have viewed market conditions as good than poor.
  • The Census Bureau reported that privately owned housing starts surged 22.7% in November to a seasonally adjusted annual rate of 1,091,000 units, leaving them 29.6% higher than a year ago. New building permits fell 3.1% from the prior month but remained 7.9% higher than the year before. Overall, these are solid numbers.
  • The Census Bureau reported that on a seasonally adjusted annualized basis, 444,000 new homes were sold in October, a massive 25.4% increase above the paltry figure achieved in September, and 21.6% higher than a year ago. The estimate of the number of homes for sale inched up to 183,000, which represents 4.9 months of inventory at the current rate of sales. The median sales price has fallen for five of the last six months and is down to $245,800, which is below the 12-month moving average price of $258,983. These wildly divergent results are likely due to consumer sentiment surrounding the government shutdown. Now that that crisis is behind us, future results should be more normal.
  • The National Association of Realtors reported that on a seasonally adjusted annualized basis, 5.19 million existing homes were sold in October, a decrease of 3.2% from September but still 6.0% higher than a year ago. The estimate of homes for sale held steady at about 2.1 million, which represents 5.0 months of inventory at the current rate of sales. The median sales price remained around $199,500, which is below the rising 12-month average of $207,767. This was a disappointing report, as I predicted last month. And now we're heading into the seasonally slow period. 
  • According to the Institute for Supply Management (ISM), economic activity in the manufacturing sector expanded in November for the sixth straight month as the index increased to 57.3, easily the highest reading of the year. At the same time, the ISM index of non-manufacturing activity fell to 53.9, which still marked growth in the service sector for 46 consecutive months.
  • The The Conference Board reported that it's index of Leading Economic Indicators (LEI) increased 0.8% in November, following a slim 0.1% increase in October. “The LEI continues on a broad-based upward trend, suggesting gradually strengthening economic conditions through early 2014” said Ataman Ozyildirim, Economist at The Conference Board. Ataman went on to say that “Improving labor markets and new orders in manufacturing, combined with strong financial indicators, drove November’s gain. However, consumers’ outlook for the economy and the drop in housing permits continue to pose risks in 2014.
  • According to the Bureau of Economic Analysis, the "final" estimate of GDP growth for Q3 2013 was a surprisingly robust 4.1%, up from the advance estimate of 2.8% and second estimate of 3.6%. Much of this improvement is due to large inventory build ups, a benefit that's unlikely to be repeated in future quarters, and an increase in state and local government spending. Still, this is a solid improvement over 2.6% growth achieved in Q2, the meager 1.1% growth generated in Q1 and the anemic 0.4% growth in Q4 2012. It even managed to surpass the robust 3.1% growth from Q3 2012.
  • The Federal Reserve reported that in October the amount of total outstanding consumer credit grew at a 7.0% annualized rate, to around $3.08 trillion. This is, by far, the highest number I've noted since I first started reporting this statistic in 2007. It appears that the money may finally be trickling down to parts of the retail sector, which is showing some signs of life. 
  • The Conference Board's Consumer Confidence Index, which had declined sharply in October, declined again in November, and now stands at 70.4. Says Lynn Franco, Director of The Conference Board Consumer Research Center "Consumer confidence declined moderately in November after sharply declining in October. Sentiment regarding current conditions was mixed, with consumers saying the job market had strengthened, while economic conditions had slowed. However, these sentiments did not carry over into the short-term outlook. When looking ahead six months, consumers expressed greater concern about future job and earning prospects, but remain neutral about economic conditions. All in all, with such uncertainty prevailing, this could be a challenging holiday season for retailers."
  • According to the FDIC, no banks failed in November, leaving the total for the year at 23, versus 50 bank closures through the same period last year. My target of 25 bank closings for the year looks like it might be safe after all.

Trends To Watch

The dollar index appears, at least temporarily, to be stuck in the lower end of its trading range. The announcement of the taper, as well as an apparent budget deal, has boosted the greenback a bit, but not enough to pierce interim resistance around 81.50. A slightly stronger dollar would also indicate that the economy continues to gain strength. 

The price of gold recently fell below support at $1,200. To me, this is the final nail in the coffin of the 13 year bull market in gold. Clearly this will be the first year since 2000 that the price of gold will finish the year lower than it started. In fact, the price is now at its lowest point of the year and is again flirting with major support around $1,200. The next support level comes in around $1,100, last seen in early 2011. If it falls that far, the price could actually plunge below $1,000. My clients and I are completely out of this sector. 

The price of West Texas crude has ceased its slide and rallied to its interim support level around $99, which is higher than both moving averages. Last month I wrote that "many of the leading names in the energy sector, like Exxon, Chevron, ConocoPhilips, Schlumberger and others are all doing quite well. I can't explain the disconnect except to suggest that the bullish stock market is either ignoring the falling commodity price or it's discounting an expected price rise in the near future." The answer appears to have been the latter. 

The bull market in the financial sector continues unabated. Note how the price remains above both moving averages and stubbornly refuses to drop below the rising trendline (in blue). All I can do is reiterate what I've been saying all year: buy on weakness. 

After four months of gains, the housing sector may finally be tracing a positive trend. Indeed, the index current sits right on the interim resistance level, after failing multiple times to breach this level over the past six  months. Should the index advance a bit more it can take aim at the high of 210 set in May. Another positive factor is that the 50-day moving average has gained enough to reach parity with the 200-day average, meaning that we're about to experience a "golden cross", which would be very bullish. 

After four months of gains, the index for the developed international markets appears to be taking a breather right now. Even though the index has fallen slightly below the 50-day moving average, it remains above the 200-day. RSI and MACD have turned up, indicating that the index could be prepared to move higher again. 

The Shanghai Index simply cannot maintain any momentum. Every time it looks like the index will break out of the doldrums and head towards resistance at 2,450 it craters and falls back below interim support around 2,160, as it did again last week. So what does one make of this chart, and the direction of the Chinese stock market? Darned if I know. You'll notice that the moving averages did form a golden cross, but it may be very short lived. This is not a tradeable picture. 

The NYSE Bullish sentiment index remains in solidly bullish territory. It's been thirteen months and counting since the index last fell into the bearish range below 62, not including the one day during the budget crisis. I'm very comfortable with sentiment in the mid-70s. With RSI actually below 50 there doesn't appear to be much to worry about right now. In fact, there seems to be more room for this bull to run. 

Right now only about 60% of stocks traded on the New York Stock Exchange are currently trading above their 50-day moving average, which is a remarkably low number considering the market is trading at all time high levels. That implies that it is a somewhat narrow rally, which suggests that there is room for more stocks to join the party.   

In past years I would lament VIX levels this low as being an indication of big trouble ahead. At a risk of falling victim to "this time it's different" syndrome, the VIX has traded between 12 and 16 for the majority of this year, so the current price of around 13 doesn't bother me quite as much as it may have in the past. Indeed, as I wrote last month, maybe this level of complacency is the "new normal". 

What I'm Thinking and Doing

I am thinking that it's been a damn good year for the stock market, much better than anyone, including myself, could have reasonably expected. The market sidestepped every pothole, every foreign and domestic economic, political and military crisis, with nary a hiccup. Each small swoon was simply an opportunity to buy more; it was a "buy the dips" paradise. Given that the Fed will remain accommodative for at least another couple of years, and given that a budget deal seems to have been agreed upon, the economy should continue to strengthen and unemployment should continue to fall through next year. 

Last month I predicted that it will likely be next April, at the earliest, before the Fed would begin any meaningful taper program. Following that thesis I felt that the rally would continue through the end of the year and into the first quarter. I was wrong about the timing of the taper announcement, but correct about the rally. I think that given the current economic and political climate, the healthy corporate balance sheets and a generally good business climate, the stock market rally should continue for a while. 

Following that thinking, my clients and I will finish the year fully invested. That being said, our portfolios are more value oriented than growth, so we didn't participate fully with this year's extremely powerful rally and I"m ok with that. I don't mind missing out on some of the froth in order to be a little more conservatively positioned. Those same stocks that went up 100%, 200% or 300% (or more) this year will more than likely fall back to earth, and I'd rather not be holding them when they do. I prefer to own companies that dominate their sectors, pay above average dividends and can weather any economic crisis. Owning those stocks will tend to generate solid returns year in and year out. Our portfolios are built to last for years, if not decades. My clients and I will be able to sleep well at night; can you say the same?

News and Notes

This is my final newsletter of 2013. I hope by reading my musings and ramblings you have learned a bit about the economy and the stock market, and how they work together. Next month will be my annual Fearless Forecasts edition, where I lay out my predictions for the new year as well as review how last year's predications fared. In the meantime, please accept my wishes for a very happy and healthy holiday season and a prosperous New Year. 

As always, I thank you, my readers, and remind you that this newsletter is for you. I have been writing News and Views for ten years now. If you'd like to read any prior edition, simply go to my website and click on the link to my newsletter archives. I hope you have learned something about our economy and our stock market, and that you will continue to follow along with me in the future. If you have any thoughts or suggestions on how to make it better, please let me know. And if you'd like to speak with me about your investment needs, or if you know 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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