FBIAS™ for the week ending 1/17/2014

The very big picture:

In the “decades” timeframe, we are in a Secular Bear Market which began in 2000 when the P/E ratio (using Shiller’s Cyclically-Adjusted P/E, or “CAPE”) peaked at about 44.  The job of Secular Bear markets is to burn off outrageously high P/E ratios over one or two decades, until finally the P/E ratio arrives back at a single-digit level, from which another Secular Bull Market can emerge.  See graph below for the 100-year view of this repeating process.

If history is a guide, we may not yet be done with this Secular Bear Market.  The Shiller P/E finished the week at 25.6, little changed from the prior week’s 25.5, and is now approximately at the level reached at the pre-crash high in October, 2007.  Even though P/E’s are substantially lower than their crazy peak in 2000, they are nonetheless at the high end of the normal historical range and leave little if any room for expansion.  This means that the stock market is unlikely to make gains greater than corporate profit growth percentage, if that.  (note: all P/E references are to the Shiller P/E values, sometimes called PE10 or CAPE, which are calculated so as to remove shorter-term fluctuations; see robertshiller.com for details).

In fact, since 1881, the average annual returns for all ten year periods that began with a CAPE at this level have been just 3%/yr (see graph below).

This further means that above-average returns will be much more likely to come from the active management of portfolios than from passive buy-and-hold.  Although a mania could come along and cause P/E’s to shoot upward from current levels (such as happened in the late 1920’s and the late 1990’s), in the absence of such a mania, buy-and-hold investors will likely have a long wait until the arrival of returns typical of a Secular Bull Market.

In the big picture:

The “big picture” is the months-to-years timeframe – the timeframe in which Cyclical Bulls and Bears operate.  The US Bull-Bear Indicator (see graph below) is at 76.1, down slightly from last week’s 76.3, and still solidly in cyclical Bull territory.  For more than a year, the US Bull-Bear Indicator has pushed further into Bull territory than other global asset classes, reflecting the higher strength of the US relative to the rest of the world.  The current Cyclical Bull has taken the US to new all-time highs, exceeding the highs of 2007, but most of the world’s major indices have barely matched 2011’s highs, let alone approach 2007’s levels.

In the intermediate picture:

The intermediate (weeks to months) indicator (see graph below) is in positive status and stayed at 35, unchanged from the prior week.   Separately, the quarter-by-quarter indicator – based on domestic and international stock trend status at the start of each quarter – gave a positive indication for the prospects for the first quarter of 2014.

Timeframe summary:

In the Secular (years to decades) timeframe (Figs. 1 & 2 above), the Secular Bear still is in force as the long-term valuation of the market is too high to sustain a new rip-roaring Secular Bull.  In the Cyclical (months to years) timeframe (Fig. 3 above), all major equity markets are in Cyclical Bull territory, with the US being far stronger than any other major market.  The Bond market is in Cyclical Bear territory as of June 7th.  In the Intermediate (weeks to months) timeframe (Fig. 4 above), US equity markets remain in positive status.  The quarter-by-quarter indicator gave a positive signal for the 1st quarter:  both US and International equities were in uptrends at the start of Q1, which signals a higher likelihood of an up quarter than a down quarter. 

In the markets:

US Markets were flat to mixed for the week, with the Dow Industrials up by a scant +0.1% and the S&P 500 down by -0.2%.  The Nasdaq 100 was the best US performer for the week, up +0.7%.  Canada’s TSX gained +1%, but most other non-US indices were down for the week.  Emerging Markets have continued their losses from 2013, losing another -1.3% for the week, with China and Brazil again leading the way down.

US economic news for the week can be summarized in four words: manufacturing good, retailing bad.  The Empire State index of New York state manufacturing surged to 12.5 in January, up sharply from 2.2 in December.  The first 2014 Federal Reserve “beige book” revealed economic activity expanded in 9 out of 12 Fed districts at the end of 2013, and national industrial production grew 0.3% month over month, the fastest pace in almost three years.  Retail sales for 2013 rose by 4.2% over 2012, but that seemingly good number was the smallest annual gain since the recession ended in 2009.  Many individual retailers have reported disappointing December numbers, with none generating such a strong reaction as Best Buy, which lost 30% of its stock price on Wednesday alone.

Canada’s Toronto Composite Index (TSX) reached a 2-1/2 year high this week, finally homing in on its 2011 highs.  The chief propulsion for the week’s gains was the gold miners group, coming off a -50% drubbing in 2013.  The TSX has gained in 8 of the last 9 sessions, and has outperformed the US so far this young year.  Meanwhile, the Loonie has earned the title of the world’s worst performing currency in the first two weeks of 2014, dropping         -3.1% to 91c/US dollar.

Economic confidence in the Eurozone climbed to 100.0 in December, rising for the eighth consecutive month to the highest level since July 2011.  Industrial production in Germany rose 1.9% in November after a 1.2% decrease in October, and weakling France’s industrial production jumped 1.3% in November, the best month since April.  Italy’s industrial production also rose in November and turned positive on a year-over-year basis for the first time in nearly three years.  Do you remember skyrocketing interest rates on Italian government 3-year bonds back in 2011?  Those who saw bargains in those depressed Italian bond prices have been richly rewarded, as interest rates for Italian 3-year government bonds have now fallen to their lowest level since the Euro was adopted 15 years ago.

Globally speaking, the latest Markit Global Sector Purchasing Managers Index (“PMI”) data indicated that the Technology industry expanded sharply at the end of 2013.  Among the eight broad global industry groups covered by PMI data, Technology was ranked second overall in the fourth quarter, behind only the Basic Materials sector.

(sources: Reuters, Barrons, Wall St Journal, Bloomberg.com, ft.com, guggenheimpartners.com, ritholtz.com, markit.com, financialpost.com, Eurostat, Statistics Canada, Yahoo! Finance, stocksandnews.com)

The ranking relationship (shown in Fig. 5) between the defensive SHUT sectors (“S”=Staples [a.k.a. consumer non-cyclical], “H”=Healthcare, “U”=Utilities and “T”=Telecom) and the offensive DIME sectors (“D”=Discretionary [a.k.a. Consumer Cyclical], “I”=Industrial, “M”=Materials, “E”=Energy), is one way to gauge institutional investor sentiment in the market.

The average ranking of Defensive SHUT sectors rose to 16.5 from the prior week’s 18.3, while the average ranking of Offensive DIME sectors fell sharply to 12 from the prior week’s 7.8.  With a big decline in the ranking of Consumer Discretionary and an equally big gain in Healthcare, the Offensive DIME sectors lost half of their lead over the Defensive SHUT sectors.

Note: these are “ranks”, not “scores”, so smaller numbers are higher and larger numbers are lower.

Summary:

The US led the recovery from 2011’s travails, and is the strongest among all global markets.  However, the over-arching Secular Bear Market may remain in place even as new highs are reached in the US.

Because we may still be in a Secular Bear, we have no expectations of runs of multiple double-digit consecutive years, and we expect poor market conditions to be a frequent occurrence.  Nonetheless, we remain completely open to any eventuality that the market brings, and our strategies, tactics and tools will help us to successfully navigate whatever happens.