FBIAS™ for the week ending 5/23/2014

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 25.6 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 63.6, up from the prior week’s 62.0, and still solidly in cyclical Bull territory.  The current Cyclical Bull has taken the US to new all-time highs, but many of the world’s major indices have yet to top 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 one 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 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 may still be in force as the long-term valuation of the market is simply 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.  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:

Markets around the world were generally positive for the week ending May 23rd.  In the US, the Nasdaq set the pace with a +2.3% gain, followed by the Russell 2000 at +2.1%.  The Russell 2000 now remains the only US index with a negative year to date return, as the Dow broke into positive territory for the year. The S&P 500 gained +1.2%.  Canada’s TSX index gained +1.4%.  International markets lagged North American markets this week, with Developed International rising +0.3% and Emerging International gaining +0.5%.  Recently-hot Brazil went the other way this week, giving up -2.9%.

The major US economic news this week all started with the letters “R” and “e” – as in Real Estate and Retail.  Existing home sales for the month of April came in up +1.3% month over month, to an annualized figure of 4.65 million – the first such gain of the year (though down -6.8% when compared with April 2013).  New home sales for the month were a little better than expected.  The two taken together indicate some stabilizing after a rough winter.  Another positive is the average rate on a 30-year fixed mortgage is down to 4.14%, the lowest since last October.  All the big Retailers have now reported their first quarter sales, and they were mostly poor, with a few exceptions.  Some samples:

Macy’s…down 1.6%
Wal-Mart…down 2.4%
Kohl’s…down 0.8%
Target…down 0.3%
Nordstrom…up 3.3%
Home Depot…up 2.6%
Lowe’s…up 0.9%
Best Buy…down 1.3%

One of the aforementioned exceptions was Tiffany’s which, although it is nowhere near as large as those retailers listed above, nonetheless impressed with a +11% same-store gain.

Canada’s transportation of oil by rail has risen dramatically, by 50% in just the last year to 160,000 barrels per day.  Despite the horrific accident at Lac-Megantic, Quebec last year, more rail shipments seem destined.  And now TransCanada , which has waited more than 5 years for the Obama administration to move on the proposed KeystoneXL pipeline, has suggested using rail transport to move oil to a Nebraska terminal where it would feed an existing pipeline as a way to cope with the stall by the US.

One of the most common refrains from those watching the fixed-income markets for the past year has been “Rates have simply GOT to go up from here!”  However, rates have failed to cooperate, hovering recently in the 2.5% range for the benchmark 10-year note – far below the consensus view of where they “ought” to have gone.  But when seen from a global competition perspective, a different picture emerges.  There are so many countries with great credit ratings selling 10-year notes for even less than the US, there appears to be little competitive pressure for US rates to rise.  And even countries with much worse credit environments – like Italy and Spain – are able to sell their 10-year paper at rates only a little higher than the US, effectively limiting potential upward movement of US rates.  Here is a graphic illustrating the surprisingly large number of countries offering 10-year paper at even lower rates than the US:

(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, wallstreetrant.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 10.3 from the prior week’s 10.8 for the week, while the average ranking of Offensive DIME sectors slipped to 12.3 from the prior week’s 10.8.  The Defensive SHUT sectors have grabbed the lead over the Offensive DIME sectors by a margin of 2.

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 among the strongest of 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.