FBIAS™ Fact-Based Investment Allocation Strategies for the week ending 8/29/2014

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 is at 26.5, up slightly from the prior week’s 26.3, 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 64.9, up from the prior week’s 63.1, and still solidly in cyclical Bull territory.  The current Cyclical Bull has taken the US and some of Europe to new all-time highs, but many of the world’s major indices have yet to top 2007’s levels.  The most widely followed international indexes, the Morgan Stanley EAFE Developed International index and the Morgan Stanley Emerging Markets Index, are both still below their 2007 peaks.

In the intermediate picture:

The intermediate (weeks to months) indicator (see graph below) returned to Positive status during the week, and ended the week at 23, up two from the prior week’s 21.  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 July for the prospects for the third quarter of 2014.

Timeframe summary:

In the Secular (years to decades) timeframe (Figs. 1 & 2 above), the Secular Bear 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 returned to Positive status on August 25.  The quarter-by-quarter indicator gave a positive signal for the 3rd quarter:  both US and International equities were in uptrends at the start of Q3, which signals a higher likelihood of an up quarter than a down quarter. 

In the markets:

Global markets gained during the final week of August.  US indices gained +0.8% on average, with SmallCaps leading at +1.2% and the Dow Industrials bringing up the rear at +0.6%.  Canada’s TSX gained +0.6%, Developed International averaged +0.4% and Emerging International averaged +0.7%.  The best significant market was Brazil at +6.5% and the worst China at -1.0%.

The month of August started out very poorly, with markets retreating rapidly from yearly highs set in late July.  But the decline halted abruptly on August 5, and an equally rapid rise took many markets back to recent highs by the end of the month.  In fact, the month was the strongest August in the US since 2000.  US indices gained from +3.2% to +4.9% for the month, and the Nasdaq Composite closed the month above 4500, a level last seen in March of 2000.  Emerging International markets also had a good August, gaining +2.8% on average, while Developed International averaged only a +0.2% gain.  Canada’s TSX gained +1.9% for the month.

US economic news featured a huge jump in durable goods for July – up a whopping  +22.6%!  But the report should have been named the “Boeing Goods Report”, since a closer examination revealed that the entire jump was due to aircraft orders (Boeing signed a record 324 contracts during the period).  When Boeing’s aircraft orders are removed, the durable goods figure actually declined by -0.8%.  The second revision of second-quarter US GDP edged up to +4.2%, vs expectations of a decline from +4.0% to +3.8%.  Consumer spending fell slightly,      -0.1%, vs a forecast of a slight gain.  This was the first decline in six months.  The Chicago Purchasing Managers’ Index survey (“PMI”) bounced back to a very healthy 64.3 from the prior month’s 56.0, and the Richmond Fed’s survey of regional manufacturing activity was reported at 12, the highest level in more than 3 years.

Statistics Canada released Q2 Canadian GDP, surprising to the upside at +3.1% and exceeding expectations.  This was the highest GDP reading in almost 3 years.  The segment of Canada’s economy showing the biggest burst of activity was exports, surging +17.8% via gains in the automotive, agricultural and forestry sectors.

The economic news with the most ominous portent came from the Eurozone, where the first estimate of August inflation was reported at just +0.3% year-over-year.  This number is perilously close to deflation, and nowhere near the approximately +2% target of the European Central Bank (“ECB”).  Several countries actually did report falling prices year-over-year, the biggest of which was Spain, reporting a -0.5% fall in prices from a year ago.  ECB chief Mario Draghi has repeatedly talked about further monetary stimulus to ward off deflation, but so far no actions have been taken.  Meetings of economic officials on September 4th will be watched closely for signs of action to accompany all the talk.  The Eurozone (ex-UK) unemployment rate remained unchanged at 11.5% in July vs. June, but down slightly from the year-ago mark of 11.9%.  The jobless rate was a low 4.9% in Germany (the German government calculates it at 6.7%), but more than twice that most everywhere else: 10.3% in France, 12.6% in Italy, 24.5% in Spain, and 27.2% in Greece.  Youth unemployment rates were 53.8% in Spain, 53.1% in Greece, 42.9% in Italy and 35.5% in Portugal. 

One little-reported measurement of US economic activity is called the “Architectural Billings Index”, which measures design-stage activity for US commercial developments of all sorts (retail, office and industrial).  It is generally regarded as a 1 to 3 year preview of future construction activity.  It was reported this week that the index has regained levels last seen in 2007 (see chart below), representing a completed round-trip recovery in pre-construction planning and design.

(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, 361capital.com, S China Morning Post, calculatedriskblog.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 slipped to 14 from the prior week’s 13, while the average ranking of Offensive DIME sectors declined to 14.3 from the prior week’s 13.5.  Institutional investors remain cautious, and the Defensive SHUT group retains a slight lead over the Offensive DIME group ranking.

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

Summary:

The US has led the worldwide recovery, 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.

FBIAS™ Fact-Based Investment Allocation Strategies for the week ending 8/22/2014

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 belowfor 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 is at 26.3, up from the prior week’s 25.9, 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 61.5, and still solidly in cyclical Bull territory.  The current Cyclical Bull has taken the US and some of Europe to new all-time highs, but many of the world’s major indices have yet to top 2007’s levels.  The most widely followed international indexes, the Morgan Stanley EAFE Developed International index and the Morgan Stanley Emerging Markets Index, are both still below their 2007 peaks.

In the intermediate picture:

The intermediate (weeks to months) indicator (see graph below) is in Negative status, ending the week at 21, up 3 from the prior week’s 18.  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 July for the prospects for the third quarter of 2014.

Timeframe summary:

In the Secular (years to decades) timeframe (Figs. 1 & 2 above), the Secular Bear 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 changed to negative status on August 5.  The quarter-by-quarter indicator gave a positive signal for the 3rd quarter:  both US and International equities were in uptrends at the start of Q3, which signals a higher likelihood of an up quarter than a down quarter. 

In the markets:

Despite world turmoil seemingly in every corner of the globe, markets forged higher this past week.  The US led the charge, with average gains of +1.8% among the major indices.  The Dow and MidCaps gained more than +2%, while the S&P 500, SmallCaps and the Nasdaq gained +1.7%.  The SmallCap Russell 2000 index remains slightly negative for the year-to-date, while the Nasdaq 100 is up a substantial +12.8%.  Canada’s TSX forged ahead by +1.5%, and now is +16% year-to-date.  Both Developed and Emerging International indices gained a less-robust +0.5% for the week, with Brazil leading at +2% and China lagging at -0.4%.

The economic world waited impatiently for Janet Yellen’s major speech at the annual Jackson Hole, WY, conclave hosted by the Kansas City Fed.  There was nothing new in the speech, in which she reiterated the consensus view of Fed governors that although the Fed could lift interest rates sooner than currently anticipated, there is no rush to do anything.  Among various Fed officials who spoke, a variety of views emerged about the current state of the US labor market which was taken to mean that more “wait and see” is in order.  In particular, there seems to be disagreement about what “full employment” means in this new era. 

Good news for US homebuilding came from several fronts.  July housing starts were up +15.7% to their best level in 8 months.  July existing home sales also came in better than expected at +2.4%, the biggest increase in almost a year. Housing permits for new multi-unit construction climbed +8.1%, while permits for single-family homes climbed +0.9%, the highest level since December.  However, mortgage applications fell -0.4% from the prior week to a new 6-month low, despite extremely low mortgage rates.

The July US consumer price index was tame, up just +0.1%, and up a similar amount ex-food and energy.  For the trailing 12 months, the CPI is up +2.0% (+1.9% ex-food and energy).  This tame inflation reading is no doubt another reason why the Fed continues to feel there is little pressure to raise the funds rate in the near future.

In Canada, consumers bolstered the economy in June with retail sales rising for the sixth straight month, by a stronger-than-expected +1.1%.  A new retail sales record was set, according to Statistics Canada.  The median forecast in a Reuters survey of analysts had been for only a +0.3% rise, so it was a welcome “beat”.

In the Eurozone, the early “flash” report on manufacturing and services for August was released.  The composite reading came in at 52.8 vs. 53.8 in July, but the manufacturing portion was just 50.8 – too near the dividing line between growth and contraction for comfort.  Germany’s flash composite was 56.4 vs. 56.7 in July, with manufacturing ticking down to 52.0, but France’s manufacturing number, just 45.4, was little improved over the prior month’s 45.2 and remains in contraction territory.

The Chinese real estate slowdown continues.  Home prices fell in 64 of 70 surveyed cities in July compared to June, according to the China National Bureau of Statistics.

A survey of individual investors conducted in June and July by the Gallup organization, in conjunction with Wells Fargo, revealed that only 7% of investors are aware that the US market gained roughly 30% in 2013.  Fully 57% believe that the market gained 10% or less in 2013, including 9% who think the market actually declined!  Astonishingly, 2/3 of the very same respondents rated themselves as “Somewhat” to “Highly” knowledgeable about investing and markets.  The survey participants were all investors with at least $10,000 invested in stocks, bonds, mutual funds, or in a self-directed IRA or 401(k).  The survey summary can be found at http://www.gallup.com/poll/174746/investors-seem-unaware-bull-market-strong-gains.aspx.

(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, 361capital.com, S China Morning Post, gallup.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 slipped to 13 from the prior week’s 12.3, while the average ranking of Offensive DIME sectors rose slightly to 13.5 from the prior week’s 13.8.  Institutional investors remain cautious, and the Defensive SHUT group retains a slight lead over the Offensive DIME group ranking.

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

Summary:

The US has led the worldwide recovery, 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.

FBIAS™ Fact-Based Investment Allocation Strategies for the week ending 8/15/2014

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 is at 25.9, up from the prior week’s 25.5, 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 61.5, up from the prior week’s 61.2, and still solidly in cyclical Bull territory.  The current Cyclical Bull has taken the US and some of Europe to new all-time highs, but many of the world’s major indices have yet to top 2007’s levels.  The most widely followed international indexes, the Morgan Stanley EAFE Developed International index and the Morgan Stanley Emerging Markets Index, are both still below their 2007 peaks.

In the intermediate picture:

The intermediate (weeks to months) indicator (see graph below) is in Negative status, ending the week at 18, down 5 from the prior week’s 23.  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 July for the prospects for the third quarter of 2014.

Timeframe summary:

In the Secular (years to decades) timeframe (Figs. 1 & 2 above), the Secular Bear 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 changed to negative status on August 5.  The quarter-by-quarter indicator gave a positive signal for the 3rd quarter:  both US and International equities were in uptrends at the start of Q3, which signals a higher likelihood of an up quarter than a down quarter. 

In the markets:

Markets continued recovering this week, picking up where they left off the previous Friday when they shook off a scare from the Ukraine.  All major markets were higher for the week, with Emerging International Markets leading the way with an average gain of +1.8% and Developed International Markets at the end of the line with a still-respectable +1.3% average gain.  Germany was once again the laggard among major developed-market indices, gaining +0.5%.  US indices gained +1.4% on average, led by the Nasdaq 100 at +2.6%, while the Dow gained the least at +0.7%.  The S&P 500, now less than 2% beneath its all-time closing high, gained +1.2%, and Canada’s TSX gained +0.7%.

In the US, July retail sales were disappointing, unchanged, and up just +3.7% the past 12 months.  Stagnant consumer incomes are begetting stagnant retail sales.  Wal-Mart matched the overall retail report with flat U.S. same-store sales for its recent quarter, and lowered forward guidance again.  July industrial production rose +0.4%, which although small was slightly better than expected.  Small businesses continue to express optimism, as reflected in the National Federation of Independent Businesses optimism index rose to 95.7, up from 95.  In the housing sector, the Mortgage Bankers Association reported a -3.7% fall in mortgage applications from the prior week, continuing a very soft trend.  Home sales plunged in Southern California in the month of July, down -12.4% from a year earlier, according to research firm CoreLogic DataQuick.  Sales in this critical six-county region have declined since October as would-be buyers are discouraged by sky-high prices, with three of the most-expensive five US metro areas contained in Southern California, as shown in this list of median home prices:

San Jose $899,500
San Francisco $769,600
Anaheim-Santa Ana $691,900
Honolulu $678,500
San Diego $504,200

In Canada, the government number-crunchers at the (previously) highly-respected Statistics Canada made an embarrassing admission:  they had lost track of a large chunk of workers, and didn’t include almost 42,000 newly-created jobs in their July report released a week ago.  The discovery of these lost jobs changed the tone of the July jobs report dramatically, to say the least.  Nonetheless, the corrected figures were still negative, showing there were 18,000 full-time jobs lost in July – though a far cry from the 60,000 losses reported originally.   The addition of these lost jobs turned the report from calamitous to merely poor – still bad, but a lot better than first thought!

There were further signs this week of major weakness in the Eurozone. The flash GDP for the euro-18 was flat vs. the first quarter, when it had risen just +0.2%.  Annualized, the rate of growth in the Eurozone is just +0.7%, down from the prior quarter’s paltry +0.9% pace. Germany saw growth decline -0.2% in Q2 over Q1, and is now up just +1.3% on an annualized basis, while an index of investor confidence hit a 2-year low.  Germany represents over one quarter of all output in the Eurozone.  France reported its second consecutive quarter of flat economic activity (up +0.1% annualized), and its full-year growth projection was lowered to +0.5%.  Despite assurances to the contrary given to the European Commission in 2011, France now says it will exceed its deficit target of 4% of GDP.   Spain reported solid growth of +0.6% in the quarter and is now running at +1.2% for the 12 months, but inflation fell -0.4% in July, raising the specter of disinflation again.  The same for Portugal, where consumer prices fell -0.7% in July, year over year.  Greece reported its 24th straight quarter of GDP contraction for Q2, although it was the smallest contraction since Q3 of 2008.  Greek retail sales were down -8.5% in June, and industrial production was down -6.7% in July, but tourists have returned as tourism was up +16.5% year over year.  The UK continues to purr, reporting that the unemployment rate for the three months to June fell to 6.4% (the lowest since 2008), though average wages were down -0.2% year over year.  European bond rates continued to fall to record low levels.  The German 10-year bund closed the week at an amazingly low 0.95%. France’s 10-year set a record at 1.34%. The Netherlands’ was at 1.13%, Spain a record low 2.39%, and Italy a record low 2.58%.

It has been a tough year for stock pickers, even the world’s best.  Here is a table from Bespoke Investment Group detailing the performance of the top 15 holdings of Warren Buffet’s Berkshire Hathaway.  For both the year-to-date (through August 4) and the trailing year, his top-15 holdings have substantially underperformed the S&P 500.

(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, 361capital.com, S China Morning Post, bespokeinvest.com, CoreLogic)

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 12.3 from the prior week’s 13.0, while the average ranking of Offensive DIME sectors declined to 13.8, down from the prior week’s 13.5.  Institutional investors remain cautious, and the Defensive SHUT group added to its lead over the Offensive DIME group ranking.

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

Summary:

The US has led the worldwide recovery, 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.

FBIAS™ Fact-Based Investment Allocation Strategies for the week ending 8/8/2014

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 is at 25.5, unchanged from the prior week, 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 61.2, down from the prior week’s 63.6, and still solidly in cyclical Bull territory.  The current Cyclical Bull has taken the US and some of Europe to new all-time highs, but many of the world’s major indices have yet to top 2007’s levels.  The most widely followed international indexes, the Morgan Stanley EAFE Developed International index and the Morgan Stanley Emerging Markets Index, are both still below their 2007 peaks.

In the intermediate picture:

The intermediate (weeks to months) indicator (see graph below) changed to negative status during the week, ending the week at 23, down 8 from the prior week’s 31.  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 July for the prospects for the third quarter of 2014.

Timeframe summary:

In the Secular (years to decades) timeframe (Figs. 1 & 2 above), the Secular Bear 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 changed to negative status on August 5.  The quarter-by-quarter indicator gave a positive signal for the 3rd quarter:  both US and International equities were in uptrends at the start of Q3, which signals a higher likelihood of an up quarter than a down quarter. 

In the markets:

It was a down week for most markets around the world…until mid-day Friday in the US (after other markets had closed for the week).  A report ascribed to NATO said that Russia was pulling back from the Ukraine border, and that was all the US markets needed to rally sharply – pushing all US indices into the green for the week.  The Dow gained +0.4% for the week, and the hard-pressed Russell  2000 Small Cap index finished the week with a best-in-US gain of +1.5%.  The rest of the world was not so lucky.  Canada rallied, too, but finished at -0.1% for the week.  Europe came in at -1.5%, Developed Markets as a whole declined -1.3% and Emerging Markets pulled back -0.8%.  Germany is now down -10% from its recent highs.  Both China and Brazil, recent leaders in the Emerging Markets category, were negative for the week.  Japan was the worst among major worldwide markets at -2.1%.

US economic news was fairly light, and there are no new Fed pronouncements expected until their annual Jackson Hole conclave at the end of August.  Initial jobless claims came in at 289,000 vs 304,000 expected, and the 4-week moving average fell to the lowest levels since 2006.  The Institute for Supply Management (“ISM”) service index was reported at 58.7, up from 56 in July and better than the 56.5 expectations and the best since December 2005.  ISM service index readings at or above the upper 50’s are generally considered to be robust.  Factory orders were better than expected, having grown +1.1% month-over-month vs +0.6% expectations.  Yields on US Treasury notes continued to defy expectations, dropping back to end the week at just 2.42% for the 10-year note.  German bond yields (a tiny 1.05% for the 10-year Bund) hit new lows during the week, and are competitively holding down US rates as they are seen as being of equivalent safety.

Standard & Poor’s said on Friday it had revised its outlook on Canadian banks to “negative,” joining Moody’s which had issued a “negative” rating a month earlier.  Both ratings agencies said that Canadian banks were at a higher risk of failure given the Canadian government’s plans to implement a “bail-in” regime to handle future bank failures with minimal taxpayer funding.  It may be coincidental…but probably not: CEOs at four of the top five Canadian banks have all retired within the last year.  None were infirm or beyond retirement age.  It is widely viewed that they were simply getting out while the getting is good.

In Europe, European Central Bank (“ECB”) president Mario Draghi blamed euro-area governments for failing to boost reforms, especially in Italy, which fell back into recession in the second quarter.  Draghi also rebuffed France’s Francoise Hollande’s call for more ECB actions in France, with Draghi saying further ECB actions will do little to help France unless Hollande’s government tackles structural economic flaws.  Portugal’s Banco Espirito Santo collapsed, with the Portuguese government pledging a bailout that will result in the bank’s equity and bond holders being wiped out.  Germany reported an unexpectedly large plunge in factory orders for the month of June, down -3.2% from May, as sanctions on Russia were beginning to take effect.  German exports fell -4.1% in June over May, and exports to the euro area were down -10.4%.  There are whispers that the German economy may actually have contracted in the second quarter.  At the other end of the spectrum, The UK July Purchasing Managers Index (“PMI”) services index leapt to 59.1 from 57.5 in June.  Industrial production was up +0.3% in June from May, and new home prices in the UK rose to a record in July, up +9.9% year-over-year.

The Wall St. Journal reported that one reason for the dramatic and sudden underperformance of US Small Cap stocks this year (the worst underperformance in 16 years) may be the large dependence of Small Caps on the housing sector.  Small Caps get about 19% of their earnings from the housing market, while only 10% of Large Cap earnings are dependent on that sector, according to a Merrill Lynch analyst quoted by the Journal.  Housing stocks have taken a real beating recently, and most are substantially below their 200 day moving averages.  The US Department of Commerce recently released updated Home Ownership data, which may not give reason for optimism about the housing sector: the US home ownership rate is back to where it was 40 years ago, in the mid-1970’s, and has fallen steeply since peaking in 2005.  The many government programs to expand home ownership to a larger and larger percent of Americans have seemingly had no net effect beyond perhaps creating a bubble whose bursting hurt the very people the programs were intended to help.

(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, 361capital.com, S China Morning Post)

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 13.0 from the prior week’s 13.3, while the average ranking of Offensive DIME sectors declined to 13.5, down from the prior week’s 13.8.  Institutional investors remain cautious, and the Defensive SHUT group ranking continues to be a little higher than the Offensive DIME group ranking.

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

Summary:

The US has led the worldwide recovery, 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.

FBIAS™ for the week ending 8/1/2014

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 is at 25.5, down from the prior week’s 26.2, 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, down from the prior week’s 67.5, and still solidly in cyclical Bull territory.  The current Cyclical Bull has taken the US and some of Europe to new all-time highs, but many of the world’s major indices have yet to top 2007’s levels.  The most widely followed international indexes, the Morgan Stanley EAFE Developed International index and the Morgan Stanley Emerging Markets Index, are both still below their 2007 peaks.

In the intermediate picture:

The intermediate (weeks to months) indicator (see graph below) remains in positive status, ending the week at 31, down 3 from the prior week’s 34.  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 July for the prospects for the third quarter of 2014.

Timeframe summary:

In the Secular (years to decades) timeframe (Figs. 1 & 2 above), the Secular Bear 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 3rd quarter:  both US and International equities were in uptrends at the start of Q3, which signals a higher likelihood of an up quarter than a down quarter. 

In the markets:

July finished with a thud, as most markets gave up their July gains on the last day of the month.  In the US, the Dow suffered its worst point loss in 5 months on July 31st, at -317.1, and the S&P 500 recorded its worst week in 2 years.  The Nasdaq 100 was the lone profitable index in the US for July, managing to record a gain for the month of +1.1%, but the Russell 2000 small-cap index continued to underperform other US indices and lost a whopping   -6.1% for July.  Canada’s TSX index gained for July, returning +1.2% and widening its year-to-date lead over the US.  Developed International lost -2.6% for July, led on the downside by European countries.  Emerging International gained +1.4%, led on the upside by China and Brazil.

For the week, notwithstanding all the attention paid to the fireworks on Wall Street, other markets did significantly worse.  Germany lost -4.9%, and went negative for the year (as did the Dow Industrials).  European markets as a whole lost -3.2%, while US indices averaged a -2.6% loss  – and for the first time in a while, the small-cap Russell 2000 was not the worst US index, outperforming both the Dow and the S&P 500.  Canada’s TSX lost a relatively modest -0.8%.

Surprisingly, US economic news for the week was mostly good.  GDP grew on a +4.0% annualized basis in the second quarter, up from -2.9% in the first quarter and well above expectations of +3.1%.  Consumer sentiment came in at 81.8, up from 81.3 and better than the 81.5 expected.  The Institute for Supply Management (“ISM”) manufacturing index came in at 57.1, up from 55.3 and better than the 56 expected.   Jobless claims were reported at 302,000, and the 4-week moving average of jobless claims fell to the lowest level since 2006.  And the big report of the week, Non-Farm Payrolls, came in above 200,000 (at 209,000) for the sixth straight month – the longest such streak since 1997.  The Q2 Employment Cost Index (“ECI”) was up +0.7%, with wages and salaries advancing +0.6% – the fastest rate of increase since Q3 2008.  The ECI is up +2.0% year-over-year.  Many economists believe that wage growth will eventually take off and will force the Federal Reserve to begin raising interest rates sooner than is currently anticipated by markets.  US auto sales for July were extremely good, with the domestic Big 3, Toyota and Nissan all reporting sizable gains. General Motors Co. said sales were up 9% from a year ago, GM’s best July sales total since 2007, despite all its issues with recalls. Ford Motor’s sales were up 10%, its best July in eight years, while Chrysler Group reported U.S. sales soared 20% from the same month year-over-year, the best July for it since 2005.  There was significant slowing in the housing market, however.  Home prices rose at their slowest pace since February 2013.  Pending home sales fell -1.1% month over month, home prices fell by -0.3% month over month vs expectations for a +0.3% gain, and mortgage bankers reported refinancing applications fell -4% in the week.

The pace of growth in the Canadian manufacturing sector picked up to its best level in eight months in July as gauges of new orders and employment improved, according to data released Friday.  The RBC Canadian Manufacturing Purchasing Managers’ index (“PMI”), rose to a seasonally adjusted 54.3 last month from 53.5 in June.

Japan has been closely watched by economists for two years as Prime Minister Shinzo Abe attempts dramatic efforts to get the moribund, deflating Japanese economy going again.  After hopeful signs last year, and a quickening of manufacturing growth earlier this year, the latest readings are a distinct disappointment.  Retail sales fell -0.6% in June, year-over-year, with second-quarter sales down a surprisingly large -7% from the first quarter.  Industrial production fell -3.3% in June over May, far worse than expected, and June wage growth was up just +0.4% vs. year ago levels, also worse than expected.  Adjusted for inflation, wages were actually down -3.8%.  This is a terrible disappointment for the Abe government, which is pinning its hopes for defeating deflation on higher wages and expanding manufacturing output.

Before the upcoming release of its Q2 earnings, Dick’s Sporting Goods, the largest retailer in the United States of TaylorMade and Callaway products, on July 22nd fired all the PGA professionals it had employed in the golf sections of its more than 560 store.  Dick’s had professed to wanting one PGA professional at every store to better differentiate the experience from online retailers that try to undercut brick-and-mortar stores.  But the economy, the downturn in participation, the decline of Tiger Woods and too many products flooding the market have cut into Dick’s bottom line so much that the company seems to be giving up on winning the golf equipment business.  On average, the golf business accounts for about 15 percent of Dick’s overall revenues.   “Every macro-indicator that we’ve been looking at for the past 20 years – rounds played, number of minorities playing, women coming into the game – all of these things that we tracked say that there are fewer people playing,” said Mark King, the former president of TaylorMade who was recently named president of Adidas North America.  “Young people entering the game after high school, 18- to 30-year-olds are down 35 percent in the last 10 years.  So I don’t like where the game looks like it is going.”

(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, 361capital.com, S China Morning Post)

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 was unchanged from the prior week at 13.3, while the average ranking of Offensive DIME sectors was also unchanged from the prior week at to 13.8.  Institutional investors remain cautious, despite new all-time highs, and the Defensive SHUT group ranking continues to be a little higher than the Offensive DIME group ranking.

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

Summary:

The US has led the worldwide recovery, 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.