FBIAS™ Fact-Based Investment Allocation Strategies for the week ending 3/28/2014

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, barely changed from the prior week’s 25.7, 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 66.9, down from last week’s 68.8, 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, 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 25, down a tick from the prior week’s 26.  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:

Rotation in the markets continued unabated this week, with previous YTD losers gaining strongly in the market, and previous YTD winners being sold with vigor.  In the US, the Dow Industrials (the laggard index in the US year-to-date) gained a meager +0.1% for the week, but this modest gain was far better than the -3.5% loss suffered by the US market’s previous leader, Small Caps.  Of the main US indices, only the S&P 500 and Mid Cap 400 remain positive for the year-to-date, at +0.5% and +1.5% respectively.  Qualitatively, the rotation has been from growth to value, and this kind of rotation frequently marks the point in time when many investors have reached a conclusion that the economy has passed through the higher-growth stages and into the mid or late stages of the expansion cycle.  It does not mean that low- or no-growth is anticipated, just that the chase of high-multiple growth stocks is over and a time of more sedately paced growth has arrived in the US.   High-flying biotechs have been brought back to earth, as have a number of headline-grabbing techs, like Twitter (down about 40%), Facebook and even mighty Amazon.  And King Digital, the maker of the immensely popular smartphone game “Candy Crush”, was humiliated by its worst-first-day performance of any IPO in the last six months: -15%.

Canada’s TSX lost -0.5% for the week, while both Developed International and Emerging International gained smartly at +4.5% and +2.6% respectively.  Emerging Markets have caught investor attention for the last couple of weeks, and several members of this group (particularly India and Brazil) have rebounded sharply.  Brazil led all significant countries with an eye-popping one-week gain of +7.7%.  Even so, both Developed and Emerging are still negative year-to-date.

US economic news was mixed for the week.   January home prices rose +13.2% (annualized), the 11th straight month of year-over-year double-digit gains, but February pending home sales fell -0.8% month-over-month vs expectations of -0.2% – down for the 8th straight month.  Fewer homes are being sold – but they are being sold at higher prices.  Durable Goods rose +2.2% in February, better than the +0.8% expected gain.  Core Personal Consumption Expenditures (“PCE”) came in at +1.1% in January, well below the Fed targeted of +2%.  The US manufacturing Purchasing Managers Index (“PMI”) slowed to 55.5 from 57.1 and was below expectations of 56.5.  University of Michigan consumer confidence report fell to 80, below the expected 81.6, with particular weakness in the “future expectations” segment.

Canadian tech giant Blackberry slumped -6.5% on Friday to C$9.31, the worst decline in 5 months, falling as much as 15% intraday after an earlier rally sparked by sales and profit reports for the quarter fizzled.  BlackBerry posted sales of $976 million in the quarter, a -64% slump compared with year-ago figures.  The per-share loss of C$0.08 was much lower than expected, which gave rise to the initial rally.  Blackberry is shedding employees and assets as fast as CEO John Chen can manage.  A third of the remaining workforce is on the chopping block, and Blackberry hopes to sell off most of its real estate, as well.

Eurozone composite PMI came in at 53.2, the ninth-straight month of economic expansion.  Consumer confidence throughout the Eurozone is on the rise, surging in March to the best level since 2007, and the best one-month gain in five years.  Even Italian consumer confidence joined in, rising to 101.7 in March, a 3-year high.

Chinese HSBC manufacturing PMI unexpectedly fell to 48.1, an eight-month low.  This had the counterintuitive effect of rallying Chinese stocks, as speculation abounded about possible government stimulus measures.  At the same time, however, it was reported last week that the Chinese government has directed commercial banks to curb lending to those industries deemed to have “excess capacity”.  The industries targeted are said to include steel, cement, chrome, flat glass, electrolytic aluminum and shipbuilding.  A capacity utilization rate of 70%-75% is thought to be the level at which “excess capacity” is deemed to exist, and numerous industry subgroups are already operating in that range.

(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, wantchinatimes.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 11.8 from the prior week’s 11.0, while the average ranking of Offensive DIME sectors fell to 15.3 from the prior week’s 14.8.  The Defensive SHUT sectors have maintained their recent lead over the Offensive DIME 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.