December 12, 2014

As I write this before the market opens for business, the Dow Jones Industrial Average stands at 17,596, down a slim 31 points from when I wrote to you Unfortunately, the market seems headed for a fall today if the futures are any indication. Still, there is really nothing to complain about this year, unless you had all of your money invested in the energy sector. Barring a catastrophe, most investors will earn solid gains for the full year, which ends in less than three weeks. 

In my Fearless Forecast edition, published in January, I predicted that the #DJIA would finish the year up 12% and the #S&P500 would close up 14%. While those predictions may end up being a shade optimistic, they will be pretty close to reality. I expect we will have a little year-end rally which should bring the major averages a bit higher, so we'll see how things end up. 

So how do things look now? Overall, not too bad! We can see that the price of the #DJIA continues to trade around the midpoint of the trading channel (green dotted line) and remains well above both moving averages. The current price is down about 2% from the record high set just last week on December 5. I wouldn't get worried as long as the price remains above the blue support line. 

The next chart shows that the #DJTA remains on track. Even though the price has dipped 3% below the record high set about three weeks ago, the index remains above both moving averages and higher than the first level of support (lavender line). If it falls below the line, but remains above the green line, then the sector would be a buy.  

The #DJUA quietly remains in bullish mode. You hear almost nobody talking about this sector in the media or on CNBC. It is really a stealth rally. The current price is above both moving averages and trading in the upper end of the trading range. 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. This year, amazingly, yields have fallen in almost a straight line, confounding my predictions, as well as those of most of the "experts". This is delivered solid gains to bond investors. Can this continue again in 2015? For that to happen yields would have to fall below 2%, which I just don't think will happen.   

Last Month's Results

Stocks continued to make gains in November, putting the losses from late September/early October farther behind. Growth sectors led the way, and large-cap significantly outpaced small-cap. In fact, small-cap value actually lost ground in the month. The Dow Jones Industrial Average, a proxy for large-cap value, continues to lag the more large-cap growth oriented S&P 500. Bonds continue to chug along; no big gains, but no big losses either, although high yield slipped in the month. The worst performer is the EAFE, which is down for the 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 29 was 297,000, a decrease of 17,000 from the prior week's revised figure, and similar to the figure from this time last month. The four-week average of 299,000 is about 15,000 higher than the tally from a month ago. About 2.36 million people continue to collect unemployment insurance, which is about 30,000 less than last month. Overall, progress continues to be made. 
• The non-farm payroll employment report in November blew away expectations as the establishment survey reported that 321,000 jobs were added in the month, while revisions added an additional 44,000 to the prior two months. The household survey reported that the unemployment rate remained at 5.8%. The more comprehensive U-6 "underemployment" rate fell to 11.4%. 9.1 million workers were still counted as unemployed (one hundred thousand more than last month). The labor force participation rate stayed at 62.8%. That key metric simply refuses to rise to a meaningful level.
• 2.8 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 6.9 million and the number of marginally attached workers dipped to 2.1 million. The number of people holding multiple jobs fell to 7.55 million. The average hourly wages for blue collar workers increased to $20.74 while the average work week held at 33.8. Except for the stagnant labor participation, this was a very positive report. 
• The Congressional Budget Office (CBO) estimated that on a net present value basis, the Treasury reported a federal budget deficit of $59 billion in November, leaving the two-month deficit at $181 billion, about $45 billion less than the shortfall recorded in the same period last year; but much of the difference can be attributed to a timing shift in the calendar. 
• The Census Bureau reported that the U.S. trade deficit of goods and services decreased slightly in October to $43.4 billion as exports marginally outpaced imports.
• After a one month decline in October, the National Association of Homebuilders/Wells Fargo Confidence Index regained four of the lost five points in November to 58. “Growing confidence among consumers is what's fueling this optimism among builders,” said NAHB Chairman Kevin Kelly, a home builder and developer from Wilmington, Del.
• The Census Bureau reported that privately owned housing starts fell 2.8% in October, to a seasonally adjusted annual rate of 1,009,000 units, which was 7.8% better than a year ago. New building permits rose 4.8% from the prior month and remained 1.2% higher than the year before. Overall, housing starts have been solid throughout the year, suggesting that the housing market is stable and improving.
• The Census Bureau reported that on a seasonally adjusted annualized basis, 458,000 new homes were sold in October, about the same as September and a meager 1.8% higher than a year ago. The estimate of the number of homes for sale is 212,000, which represents 5.6 months of inventory at the current rate of sales. The median sales price surged to $305,000, the highest monthly figure I've ever recorded in the past 10 years, and well above the 12-month moving average price of $279,583. 
• The National Association of Realtors reported that on a seasonally adjusted annualized basis, 5.26 million existing homes were sold in October, up 1.5% from September and up 2.5% from a year ago. The estimate of homes for sale held at 2.2 million, which represents only 5.1 months of inventory at the current rate of sales. The average selling price dropped for the fourth straight month, falling to $208,300, which remained just above the rising 12-month average of $204,917. 
• According to the Institute for Supply Management (ISM), economic activity in the manufacturing sector dipped at bit in November to 58.7, but still marked overall growth for eighteen straight months. The ISM index of non-manufacturing activity rose to 59.3, which signaled growth in the service sector for 58 consecutive months. These solid numbers demonstrate continued growth in the economy.
• The Conference Board reported that its index of Leading Economic Indicators (LEI) increased 0.9% in October, following a gain of 0.7% (revised) in September. "The LEI rose sharply in October, with all components gaining over the previous six months,” said Ataman Ozyildirim, Economist at The Conference Board. “Despite a negative contribution from stock prices in October, and minimal contributions from new orders for consumer goods and average workweek in manufacturing, the LEI suggests the U.S. expansion continues to be strong.”
• According to the Bureau of Economic Analysis, GDP increased at an annual rate of 3.9% in Q3 2014 according to the "second" estimate, slightly better than the advance estimate, but still 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. This is above average growth and unlikely to be continued in Q4. 
• The Federal Reserve reported that in October the amount of total outstanding consumer credit grew at an annualized rate of 5.0%, up to $3.279 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. But at least the consumer spending is a huge boon to the economy. 
• The Conference Board's Consumer Confidence Index, which rose in October, declined in November from 94.1 to 88.7. Says Lynn Franco, Director of The Conference Board Consumer Research Center, "Consumer confidence retreated in November, primarily due to reduced optimism in the short-term outlook. Consumers were somewhat less positive about current business conditions and the present state of the job market; moreover, their optimism in the short-term outlook in both areas has waned. However, income expectations were virtually unchanged and gas prices remain low, which should help boost holiday sales."

Trends To Watch

I think this is one of the two most important charts I'm showing this month. Notice that the value of the dollar index is at its highest level in many years, and this has a huge (negative) impact on commodity prices (oil, precious and base metals) as well as the balance sheets of companies that do a lot of business in foreign markets. If the dollar continues to strengthen, it will have negative impacts on large segments of the market.

Here is the other incredibly important chart. The price of West Texas Crude is in free fall and it's dragging the entire energy sector down with it. It's also adding quite a bit of fear and uncertainty to the stock market. The price fell through the first support (green line) and $80, and has today dropped through the second support (blue line) at $60. The final, rock-hard support is the financial crisis price level of $40. I don't think we'll get there. I think production levels will be cut, indebted companies will go out of business and M&A will provide support. I think we're going to have a major buying opportunity sometime very soon, and I will be participating; just not quite yet. 

Looking at a five year chart of the price of gold we see that after trading between $1,200 and $1,400 for the better part of two years, the current battle for the yellow metal is between support at $1,100 and resistance around $1,200. Should the price definitively move higher, $1,400 could be back in play. If not, we'll likely see a drop back to $1,100. 

The strong dollar is certainly no friend to the price of copper. It has fallen well below interim support at $3.20, is below both moving averages, and is perilously 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. Last month I said I would expect a rally sometime soon because the dollar will have to rest eventually. Well, that rest hasn't come yet.

The Nasdaq Composite is continuing its inexorable climb to reach the record closing price of 5,048.62 from March 10, 2000. As of this writing, the index is only 340 points, or about 7%, below the record . It has been a VERY LONG road to get to this point. I expect the tech-heavy index to finally reach that level sometime in the first half of next year.  

I've made two "buy" calls on the financial sector this year, both of which were fortunately well timed. Now we should sit tight and wait for the next pullback as the index is bumping against resistance at the high end of the trading range. I remain bullish on the long term prospects for this sector.   

For the second time this year the index for the housing sector hit resistance around 215. And for the second time that momentum quickly ebbed as the price turned and headed lower. The good news is that the moving averages just formed a "Golden Cross" whereby the 50-day moving average moves higher than the 200-day average. This is generally viewed as a very bullish price formation. So perhaps this dip will be temporary, setting the stage for a definitive move higher than 215. 

After a brutal 15% decline between June and October, the index for the developed international markets is now swinging between resistance at 65 and support at 60. This is not a pretty chart, and given to currency troubles plaguing much of the rest of the world, I don't things are going to get much better any time soon. I'd stay away from this sector.   

The Shanghai Index has gone parabolic. The price has jumped almost 50% in just over 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. And looking at the chart now, seeing both RSI and MACD both extremely overbought, I would sit and wait for the inevitable correction.  

The NYSE Bullish sentiment index continues to be a very good contrary indicator. Buying the declines, depending on your timing, has been a winning strategy all year. The one difference now is the current rally failed to reach the trading range before it turned over during market decline this week. My intuition says that we have further down to go before the next rally. 

After a furious, and profitable rally, momentum has ebbed a bit. The percentage of stocks on the New York Stock Exchange that are currently trading above their 50-day moving average has turned lower and is moving down towards interim support at 45. I wouldn't be surprised to see this level breached as the index trades lower with falling crude prices. But I believe we'll have one more rally before the year is over. 

Last but not least, we can see that a bit of fear and uncertainty has again return to the market. The VIX has moved up to 20, near the top of the "old normal" trading area. Should it break resistance at 22 we will have set the stage for our next buying opportunity. 

I think the turmoil in the energy sector is spilling over into the rest of the equity market. And if that's the case, I expect that the current market weakness will be relatively brief. The underpinnings of this market remain strong, the Federal Reserve remains accommodative and consumer sentiment remains upbeat. This all tells me that the current downturn will be short lived and that the rally is not over. 

Over the past two months I've culled some of my weaker positions in the energy and commodity sectors, while still retaining my core holdings. At the same time, I've purchased stocks that have limited international exposure and will benefit from a strong domestic economy. 

As I've already completed my year-end tax related selling, I'm just going to sit back and wait for the next buying opportunity, which will likely be from the oil patch. Some of those stocks are already in the bargain bin, just waiting for investors, like me, with foresight, patience and courage, to step in and start buying. 

News and Notes

After a beautiful wedding and wonderful honeymoon, it's back to work, swimming, family and my time with the Food Bank for Westchester. The holidays are fast approaching. Nola returns from school tomorrow, which means we'll be all together for a while. It'll be good to have her home again. Before we know it, it will be 2015.

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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