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December 12, 2016

A Very Unexpected Trump Rally

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 stock market has spoken. It likes what it sees, and hears, from President-Elect Trump. (I still get shivers writing that.) The market applauds his intentions to cut taxes, reduce regulations, pass a massive infrastructure spending plan, rebuild the military and overhaul ObamaCare. Time will tell if he can implement any of these proposals. And if he is successful, will they create short-term gains (above-trend growth) in return for long-term pain (increased deficits). So for now, as investors, we can enjoy the massive gains while we remain vigilant for the murmurs of future problems.

The #TrumpRally has been nothing short of remarkable. In the 23 trading days since November 7, the day before the election, the Dow Jones Industrial Average has gained a stunning 1,497.25 points, or 8.2%. That's a great year! At the same time, the S&P 500, Nasdaq Composite, Dow Jones Transportation Average and Russell 2000 indices have all hit record levels. One concern is that this rally has simply pulled next year's gains into this year, and that is something to contemplate. But for now, let's just enjoy the profits. 

In the short term, only the Fed stands in the way of the market finishing the year solidly in the black. The Fed has been telegraphing a 25 basis point increase for months, so if they go through with it, the market should absorb the news fairly well. At least that's the theory. We'll see what happens later this week. 

Looking at the chart of the #DJIA, we see the powerful surge from the #TrumpRally, leaving the index just below 20,000. If the Fed doesn't kill things, and if Trump doesn't put his foot in his mouth too many times (I know that's asking a lot), look for this important psychological barrier to be breached before the end of the year. 

After consolidating for eight months (between the dotted lines), the Dow Jones Transportation Average finally surpassed the old record high set almost two years ago. The fact that the #DJIA and #DJTA hit record highs on the same day triggered a #DowTheory bull market confirmation. It is worrisome that RSI is severely overbought, which suggests that the index may need to back off a little to reduce some of the froth. 

The Dow Jones Utility Average continues to be a little sickly. Rising interest rates (see below) are clearly hurting this sector, which has fallen about 11% since peaking in early July. It's important for the sector that support holds around 610. If rates stabilize, we could see a bump in the next few months. 

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 for the past four months, including a spike over the past few weeks. This has produced a lot of pain for bond investors (the price of a bond moves inverse to the direction of the yield). Last month I asked, "how high can they go? I don't think we'll see 3% any time soon, but time will tell." I still don't think we'll surpass 3% in the next few months, but it wouldn't surprise me if we see that level in the second half of next year. 

Last Month's Results

What a difference a month makes. After a rough three months of losses, the stock market roared its approval after the election. A broad spectrum of equities, led by small cap stocks, zoomed higher. At the same time, overseas stocks lost ground and bonds got pounded. Indeed, for the year, those are the two worst performing sectors listed below. The only thing that could trip up the market before the end of the year is the expected rate hike by the Fed this month. But since it is so widely anticipated, it should be "baked in" to market pricing right now, and therefore, shouldn't result in the same big sell-off we had last year. 

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 December 3 was 258,000, a drop from the prior week, and about the same as the prior month's figure. The four-week average of 252,500 a modest decline from the prior month. Importantly, the moving average is about 20,000 less than it was at the beginning of the year. The number of jobless claims continues to gradually decline as about 2.01 million people are collecting unemployment insurance, which is the lowest level since July 2000.
  • The non-farm payroll employment report in November roughly met expectations, as 178,000 jobs were gained in the month, while 2,000 net jobs were subtracted from the prior two months. The household survey reported that the unemployment rate fell to 4.6%. The labor force participation fell 62.7, as the number of unemployed fell because thousands have apparently given up finding a job. Average hourly wages for blue collar workers rose to a new high of $21.73 while the average work week remained at 33.6 hours for nine of the last ten months.
  • 7.4 million workers were counted as unemployed, and 1.9 million people remained unemployed longer than 27 weeks. The seasonally adjusted number of people who could only find part-time work dipped to 5.7 million while the number of marginally attached workers rose to 1.9 million. The number of people holding multiple jobs increased to 8.10 million. All of this means the comprehensive U-6 "underemployment" rate fell to 9.3%. Our economy remains close to "full employment", yet too many people still remain locked out of productive employment. 
  • The Congressional Budget Office (CBO) estimated that on a net present value basis, the Treasury reported a budget deficit of $135 billion in November, and $179 billion for the first two months of fiscal 2017, $20 billion less than the same period last year.
  • The Census Bureau reported that privately owned housing starts surged 25.5% to 1,323,000 in October, and was up 23.3% from a year ago. New building permits were essentially flat from the prior month and were up 4.6% from the year before.
  • The Census Bureau reported that on a seasonally adjusted annualized basis 563,000 new homes were sold in October, down 1.9% from September, but up 17.8% from a year ago. The estimate of the number of homes for sale was 246,000, representing a widened 5.2 months of inventory at the current rate of sales. The median sales price was $304,500, off the highest level of the year, and just below the 12-month moving average price of $306,825.
  • The National Association of Realtors reported that 5.6 million existing homes were sold in October, up 2.0% from the prior month, and 5.9% from a year ago. The estimate of the number of homes for sale was 2.02 million, representing a tiny 4.3 months of inventory at the current rate of sales. The median price was $232,200, up 6.0% from last year, and about $2,000 above the rising 12-month moving average price. Overall, the housing picture continues to look solid if unspectacular.
  • According to the Institute for Supply Management (ISM), economic activity in the manufacturing sector expanded again in November, rising from 51.9 to 53.2. The ISM index of non-manufacturing activity rose from 54.8 to 57.2, which signaled growth in the service sector for 82 consecutive months.
  • The Conference Board reported that its index of Leading Economic Indicators (LEI) increased 0.1% in October, following a gain of 0.2% in September. "The U.S. LEI increased in October for a second consecutive month. Although its six-month growth rate has moderated, the index still suggests that the economy will continue expanding into early 2017," said Ataman Ozyildirim, Director of Business Cycles and Growth Research at The Conference Board. "The interest rate spread and average weekly hours were the main drivers of October’s improvement, helping to offset some of the weaknesses in claims for unemployment insurance and new orders.
  • According to the "second" estimate by the Bureau of Economic Analysis, GDP increased at an annual rate of 3.2% in Q3 2016, up from 2.9% in the advance estimate. This compares very favorably with 1.4% in Q2, 0.8% in Q1 and 1.4% in Q4 2015. It easily surpassed the 2.0% achieved in Q3 2015. This report, will help give the Fed further cover to increase its lending rate by 0.25% in December.
  • According to the BLS, the seasonally adjusted Consumer Price Index for all Urban Consumers (CPI-U) increased by 0.4% in October, after an 0.3% increase in September. The index for all items less food and energy increased by 0.1% for the second straight month. Over the last 12 months, the all items index rose a modest 1.6%. Inflation remains below the 2.0% target set by the Fed.
  • The Conference Board's Consumer Confidence Index increased to 107.1 in November from 100.8 in October. "Consumer confidence improved in November after a moderate decline in October, and is once again at pre-recession levels," said Lynn Franco, Director of Economic Indicators at The Conference Board. "A more favorable assessment of current conditions coupled with a more optimistic short-term outlook helped boost confidence. And while the majority of consumers were surveyed before the presidential election, it appears from the small sample of post-election responses that consumers' optimism was not impacted by the outcome. With the holiday season upon us, a more confident consumer should be welcome news for retailers."

Trends To Watch

This month I'm showing a 13-year price history of the dollar index so that you can put what's happened over the last three (or six) years in the proper perspective. You can see that the dollar index plunged to a deep low leading up to the financial crisis in 2008. The next three years saw the index trade between support (72.5) and resistance (87.5). Then beginning in mid-2011, the index began a slow, four-year climb that culminated in late 2014 when it finally broke through that resistance. The index then spent most of the next two years trading between the new support (92.5) and resistance (100). The last time the dollar was this strong was early 2003. A strong dollar is good to a point, but it does have a deleterious effect on the earnings of large, multi-national corporations with lots of sales outside of the U.S. It also puts pressure on commodity prices.

The price of West Texas Crude is making another attempt to break through resistance around $52. Higher prices are driving big gains in the stock prices of companies throughout the energy sector.  

The price of gold continues to fall and is flirting with a key support level. Should the price fall below $1,175, the next support doesn't come in until $1,050. I would stay away from this sector right now. 

It has been a good year for the tech sector, as evidenced by the chart of the Nasdaq Composite. Except for a couple of brief swoons in the summer, this index has moved inexorably higher since February. Even the Trump's victory couldn't stop the party, although he is trying. His incessant anti-China rants could bring the tech rally to a quick and painful end. For now though, the sector seems to be in solid shape.  

The financial sector, which has surged to record levels, is a clear beneficiary of the Trump victory as the thinking goes that he will repeal Dodd-Frank, and perhaps other regulations, thereby releasing banks from some of their regulatory shackles. In addition, higher interest rates means higher lending margins, which will goose earnings. I've been a very long-term bull on a handful of leading financial companies, and that patience has been well rewarded. Just notice that RSI is at severely overbought levels, so wait for a pull-back before putting any new capital to work in this sector. 

The housing index is joining the party too, as it ascends towards record levels. Looking ahead, rising interest rates could be a bit of a drag on the sector. More immediately though, if people think rates are moving higher, there could be a short-term spike in transactions as a buyers try to close before rates move appreciably higher. So looking ahead, I would expect the index to remain in the trading range outlined between the dotted green and the solid red. 

I have been a bear all year on the developed international markets, and that pessimism has been proven correct as the index today is essentially where it was at the beginning of the year. And looking ahead, given all the pronouncements by Trump of treaties (like NAFTA, TPP and Iran) being ripped up, possible trade wars, and even the dissolution of the Euro Zone, I would continue to stay away from this sector. Even if none of the dire predictions come to pass, thanks to negative interest rates and low (or no) economic growth, it's hard to make a case for any real gains in these markets in the near future.

The NYSE Bullish sentiment index has remained in a narrow range for more than nine months, although the price has bounced off support at 52 and moved to resistance at 70. And RSI is overbought. Last month I told you that "the current rally probably has further to go." This month I'm suggesting caution as investors have gotten overly bullish. I wouldn't be surprised to see some profit-taking. 

After a brief election surge in volatility, the price of the VIX has collapsed back to the absurdly low levels last seen during the summer. Like the overly-bullish sentiment shown above, this much complacency makes me nervous. We're due to have something happen that will rattle the nerves of investors. 

What I'm Thinking and Doing

I'm making a real effort to keep this letter about the economy and the stock market, rather than rant about politics. Trump doesn't make it easy, but I'll save my ire for my blog, or twitter. For now, we'll stay on point. I am concerned about the #TrumpEffect on individual stocks, or entire sectors. For example, Trump went after Lockheed Martin over the weekend, driving that stock, and the entire defense sector, down in heavy trading today. He's had the same effect on some heavyweight tech companies, like Apple and Google. His frequent tweets and proclamations on Trump News . . . I mean Fox News, can make or break the market on a daily basis, and that isn't a good thing. I'm hoping, in vain, that's someone will shut off his twitter feed once he actually takes office. 

All of that being said, I haven't changed my primary opinion that I still want to be invested in US-based stocks. I can live with day-to-day volatility and small declines don't bother me. As long as my underlying thesis for why I bought a stock in the first place remains intact, I'm willing to continue holding it indefinitely.

I have finished the year-end review of all of my portfolios and all of my holdings. In the process I decided to liquidate my remaining mutual funds positions, a REIT, one ETF and two stocks. By doing so I raised more than $500,000 and closed out some under-performing positions. There are still one or two things that I'm keeping a close eye on, but unless they fall further, I'll likely hold onto them through year-end.

I've worked hard over the past five years to cull my smallest and weakest positions as part of a conscious decision to focus my holdings on my best ideas. Indeed, over the past five years I've reduced the total number of securities held from 156 to only 90 today. It's possible that number could fall even further next year. I think it's worth noting that of the top 50 securities held by WAM, I personally own 49 of them! So my interests are perfectly aligned with my clients as my skin is in the game right alongside theirs.

News and Notes

It's hard to believe that another year has come and gone and that this will be the last time I'll write to you in 2016. The girls both return home from school this week for their winter breaks. It will be great to have them home again. Ezra is prepping for the January SATs and also looking forward to vacation. Speaking of vacations . . . Kathiryn and I are looking forward to getting out of town for some R&R and warmer weather.

There really isn't anything else of consequence to report. I wish all of you a very Happy Holidays and a prosperous and healthy New Year. And don't forget to think about those less fortunate than you. Make a year-end donation (or two) to your favorite local charity. And make it a habit. A life in service to others is the best form of life worth living.

Best regards,

Greg Werlinich

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