FBIAS™ for the week ending 5/2/2014

The very big picture:

In the “decades” timeframe, we have been 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 little changed at 25.4, 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 63.1, up from the prior week’s 62.2, 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 28, up 1 from the prior week’s 27.  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 April for the prospects for the second 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 2nd quarter:  both US and International equities were in uptrends at the start of Q2, which signals a higher likelihood of an up quarter than a down quarter. 

In the markets:

The month of April was a mixed bag for markets worldwide.  In the US, only the LargeCap S&P 500 and Dow Industrial indices eked out gains for the month, while the SmallCap Russell 2000 fell almost -4%.  Canada and most International indices were winners for April, with Canada leading the way at +2.4% and an impressive year-to-date gain of +8.7% through April.  Although some segments of Emerging International have made big turnarounds recently (like Brazil), the MSCI Emerging Markets Index nonetheless finished April with a -1.1% year-to-date tally.

For the week, all major indices were positive, with International markets outpacing the US.  During the course of the week, the Dow established new all-time highs, and the S&P 500 kissed its all-time high for a moment, but the shakes over Ukraine pulled the rug from beneath the market on Friday and the week finished with a fizzle rather than a bang.  SmallCaps again underperformed LargeCaps as the rotation from small to large, and growth to value continued.  Canada’s TSX finished the week with a robust +1.6% gain.

Economic news in the US was bipolar: a lousy Q1 DGP (just +0.1%, well below the economy’s “stall speed”), and a very good April non-farm payrolls number.  The Fed, and most economists, seemed to give the GDP number the benefit of the doubt due to the unusually severe winter.  The non-farm payrolls number and attending unemployment rate were greeted warmly by the Administration, whose spokesmen mostly ignored the huge number of workers dropping out of the workforce (more than 800,000) which in turn facilitated the sizeable drop in the unemployment rate – and dropped the workforce participation rate to its lowest level in 36 years.  At least consumer spending for the first three months of the year was up smartly, even as business spending was down      -2.8%, the weakest performance since Q4 2009. Manufacturing figures from both the Chicago Purchasing Managers’ Index (“PMI”) (63.0) and the national Institute for Supply Management (“ISM”) reading (54.9) were above consensus, well above in the case of the Chicago PMI.

The US housing market continues to be tentative at best.  US home prices were nearly unchanged in February, after slumping -0.1% in each month since November, according to the Case-Shiller 20-city composite index released Tuesday. “The annual rates cooled the most we’ve seen in some time,” David Blitzer, chairman of the index committee at S&P Dow Jones Indices, said in a statement.  Including February, prices remained about 20% below a 2006 peak.  The Mortgage Bankers Association’s chief economist said housing is in a ”weaker spring market than we have seen in years.”

It is likely that not many teachers in Ontario, Canada, knew their pensions were partly invested in….lean hogs.  It was revealed last week that the Ontario Teachers Pension Plan Board was fined by the Chicago Mercantile Exchange for violating position size limits multiple times, and forced to disgorge some profits as well.

The unemployment rate for the Eurozone in March was unchanged at 11.8%, the same level as December and just a slight improvement over the past 12 months from the peak in March 2013 of 12.0%.  The unemployment rate was 5.1% in Germany, while unemployment is 10.4% in France (unchanged over the past year), 12.7% in Italy (up from 12.0% a year ago), 25.3% in Spain (down from 26.3%) and 26.7% in Greece.  Ireland’s jobless rate has fallen from 13.7% to 11.8% over the past year, but many attribute the decline to a renewed emigration by young Irish.  As for the youth unemployment picture, it remains incredibly sickly across southern Europe: Spain, 53.9%, Greece, 56.8%, and Italy, 42.7%.

In China, a crackdown by the government on internet porn requires Chinese online companies to review and censor all content before publishing it online.  This, of course, requires “porn investigators” to closely inspect all content – and a job posting for such a position generated 4,000 applicants within hours.  The video-sharing sites of web portals Sina and Sohu were forced to close after two of Sohu’s original video series were considered by the government to contain pornographic content, a closure which reduced China’s total internet traffic by an incredible 20% at one point.

(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, BBC)

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 11.5 from the prior week’s 12.0 while the average ranking of Offensive DIME sectors fell to 11.8 from the prior week’s 10.3.  The Offensive DIME sectors have given up the lead to the Defensive SHUT sectors.

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

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.