FBIAS™ for the week ending 3/14/2014

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 25.5, down slightly from the prior week’s 26.0, and 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 69.1, down from last week’s 71.4, and still solidly in cyclical Bull territory.  For the last three years, 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 approached 2007’s levels.

In the intermediate picture:

The intermediate (weeks to months) indicator (see graph below) remains in positive status, ending the week at 27, down from the prior week’s 28.  Separately, the quarter-by-quarter indicator – based on domestic and international stock trend status at the start of each quarter – gave a positive indication on the first day of January 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 returned to Cyclical Bull territory as of February 28th.  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:

Major Markets worldwide retreated for the week.  China lead to the downside, falling -5.6% (not counting the Russian market, which has gyrated wildly during the Crimean crisis, and is down -26% for the year).  The US markets averaged a -2.0% decline, while the Canadian Toronto Composite fell just -0.5%.  Developed International averaged -3.8%, dragged down again by Germany (-4% for the week), while Emerging International averaged          -2.8% (now -8.1% YTD).

Precious metals in particular and commodities in general have been moving higher in recent weeks, and have been a prime driver of Canada’s continent-leading performance year-to-date.

It was a light economic news week in the US.  Initial jobless claims fell to 315,000, the 6th lowest figure in 7 years.  Retail sales (ex-autos and ex-gasoline) rose +0.3% vs +0.2% expected.  The Producers Price Index (“PPI”) fell -0.1% in February, the first decline in 3 months – inflation is well contained and fears of deflation have not been banished.  The White House released its estimate of 2014 GDP of 3.1% and 3.4% for 2015, but Morgan Stanley rebutted with a much lower forecast of just 2% for 2014.

Canadians must be viewing the Crimean secession referendum vote with mixed emotions and a bit of déjà vu: Quebec’s Premier Pauline Marois, who leads the separatist Parti Quebecois, has been a long-time promoter of separation from Canada.  But she said this week that the time is not now right, and would not commit to a date for a referendum vote, saying that she would instead wait for “opportune” conditions.

Eurozone industrial production for January fell -0.2% compared to December.  As has been the recent case, Germany was good (+0.4%), and France was bad (-0.3%).  The two hottest major European stock markets of 2013, the UK and Germany, have cooled considerably so far in 2014, down -3.3% and -5.2% respectively.

Panasonic has become the first (but certainly won’t be the last) multinational to find it necessary to induce its employees to accept assignments in China by giving bonuses to compensate for the exposure to dangerous levels of pollution that they must endure in China’s major cities.  The huge drop in Chinese exports reported last week appears to be, in part at least, due to overly-high export reports from the prior year that were “cooked” more than a little, leading to lower comparisons this year when the books were, well,  less cooked.

(sources: Reuters, Barron’s, 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 fell to 14.8 from the prior week’s 14.3, while the average ranking of Offensive DIME sectors fell to 12.8 from the prior week’s 12.0.  The Offensive DIME sectors have maintained their modest 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 continues to be 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.