FBIAS™ Fact Based Investment Allocation Strategies for the week ending 9/26/2014

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 26.3, barely changed from the prior week’s 26.4, 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 62.0, down from the prior week’s 64.7, and continues 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) ended the week at 23, down 2 from the prior week’s 25.  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:

The week ending September 26 was a losing week for almost all markets around the world.  All major US indices gave ground, with the Small Cap Russell 2000 leading the way down with a -2.4% loss (2/3 of all Russell 2000 stocks are now below their 200-day moving average, the most in that unhappy condition in more than four years).  The Dow Industrials lost -1% and the S&P 500 gave up -1.4%.  Canada’s TSX retreated -1.6%, the fourth losing week in a row.  Internationally, Japan bucked the trend with a +0.9% gain, but the rest of Developed International was not that lucky, averaging a -1.8% loss.  Germany led the losers with a loss of -3.6%.  Developed International is now in negative territory for the year to date.  Emerging International sank -2.4%, with Brazil among the worst at  -2.6%.  Many commodities continued to fall.  Iron ore hit a 5-year low during the week, and coking coal, also used in the steel-making process, sits at a 6-year low.

US economic news continued to be solid if unspectacular.  Housing numbers for August showed existing home sales at 5.1 million, down -1.8% from July, but July’s pace was a 10-month high.  New-home sales for August far exceeded expectations, at an annualized figure of 504,000, a 6-year high going back to May 2008.  August durable goods plunged -18.2%, but when aircraft sales are removed, durable goods actually rose +0.7% in August.  The final reading on second-quarter GDP was revised upward to +4.6%, the best performance since Q4 2011 – a nice rebound after the awful first quarter’s reading of -2.1%.  Business investment increased at a +9.7% annualized rate in Q2, with corporate spending on equipment revised upward to +11.2%.

Canadians are among the top 10 wealthiest citizens in the world, but household debt levels are a concern, says Allianz’s fifth annual Global Wealth Report.  The report ranks Canada in 8th place based on per-capita financial assets, up one spot from last year.  However, the level of household debt is a large and growing worry, the report noted.  Canadians’ household debt hit a near record between April and June of this year, according to Statistics Canada. Household debt to disposable income rose to 163.6% in the second quarter, which was slightly below the record 164.1% reached in the third quarter of 2013.

Europe’s economy continues to struggle to rise above the flatline.  Markit’s flash composite Purchasing Managers Index (“PMI”) reading for the 18-nation Eurozone ticked down in September to 52.3 vs. 52.5 in August. The manufacturing PMI was 50.5 vs. 50.7.  Germany’s September flash manufacturing component of PMI was 50.3 vs. 51.4 the prior month, barely in growth mode and the weakest since June 2013, though the service reading rose to 55.4 from 54.9.  France’s composite was 49.1 vs. 49.5, with manufacturing edging up to 47.9 from 45.8, though still very much in contraction territory (50 is the dividing line between growth and contraction).

China’s manufacturing PMI was reported by HSBC at 50.5 for September, slightly better than August’s 50.2, so global markets reacted positively to this.  However, Finance Minister Lou Jiwei said the economy is stable and he doesn’t see the need for any major new stimulus initiatives, a negative surprise to many observers.

The US football season is now in full swing, including Sunday and Monday night games, and this week also marked the debut of the new seasons for the highest-rated prime-time network TV shows.  However, the viewership of the Sunday/Monday night football games vs those top prime-time network shows are going in opposite directions, as this chart from theatlantic.com dramatically shows:

(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, theatlantic.com)

The ranking relationship (see graph below) 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 9.5 from the prior week’s 10.8, while the average ranking of Offensive DIME sectors rose to 15.3 from the prior week’s 16.3.  Institutional investors remain cautious, and the Defensive SHUT group continues to rank 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™ Fact-Based Investment Allocation Strategies for the week ending 9/19/2014

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 26.4, barely changed 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 64.7, little changed from the prior week’s 64.6, and continues 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) ended the week at 25, unchanged from the prior week.  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:

LargeCap US equities gained for the week, and pretty much everything else around the world dropped.  On the plus side, the S&P 500 gained +1.3%, and the Dow Industrials rose +1.7%.  But US MidCap and SmallCap indices lost -0.2% and -1.2% respectively for the week.  Likewise, Canada’s TSX gave up -1.7%, Developed International pulled back a slight -0.1%, and Emerging International lost -0.8%.  It is a saying among Wall Streeters that when the market is running out of steam, “large caps are the last to go.”  If the market is indeed running out of steam, the market is following this script.

In US economic news, initial jobless claims fell to 280,000, the lowest number in 7 years.  The National Association of Home Builders (“NAHB”) reported its housing market index rose to 59 from 55 a month ago, and matched its highest reading since 2005.  The Empire State Manufacturing index grew to 27.5 in September, the highest level since October, 2009.  Producer Price Index and Consumer Price Index figures stayed steady, benefiting from falling energy prices which have declined significantly over the last month.  On the negative side, housing starts were below expectation, as was industrial production which was dragged down by motor vehicle production that dropped -7.6% from the prior month.  And although it was widely anticipated that the magic phrase “considerable time” (describing how long accommodative policy would remain in place) would be removed from the Fed statement issued this week, it remained in place rendering the Fed announcement mostly a non-event.

Canada’s annual inflation rate was reported at 2.1%, the fourth month in a row that it was above the Bank of Canada’s 2.0% target.  The Bank of Canada is now in a quandary: it is on record as intending to maintain low interest rates to boost a soft economy, yet also on record as being more than willing to raise rates to keep a lid on inflation.  The central bank said earlier in September that higher inflation recently seen has been attributable to “temporary effects.”

The Organization for Economic Development (“OECD”) issued revised (and mostly lower) estimates of Eurozone GDP for 2014. The Eurozone as a whole estimate was revised down to +0.8%.  Some individual country examples are:  U.K. (+3.1%); Germany (+1.5%); France (+0.4%); Italy (-0.4%).

In China, factory output rose just +6.9% in August from a year earlier after a +9.0% rise in July, further confirmation of a slowdown.  Foreign direct investment in China, which is the lifeblood of the manufacturing sector, fell -14% last month to a four-year low, and followed a -17% decline in July.  Chinese new-home prices fell a fourth straight month in August.  Of 70 major Chinese cities surveyed, prices fell in 68 of them last month, following a decline in 64 of 70 in the previous month.

All year, globally-allocated investors have hoped that non-US assets would outperform US assets for the first time in four years.  Indeed, Emerging Markets have done better than the S&P 500 in 2014 until just a couple of weeks ago.  Since then, however, Emerging Markets have underperformed the S&P by a large -5% and in the process gave up their lead.  This chart shows the rather sudden reversal in fortunes:

(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, scottgranis.blogspot.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 10.8 from the prior week’s 11.8, while the average ranking of Offensive DIME sectors rose to 16.3 from the prior week’s 18.3.  Institutional investors remain cautious, and the Defensive SHUT group continues to rank 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™ Fact Based Investment Allocation Strategies for the week ending 9/19/2014

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 26.4, barely changed 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 64.7, little changed from the prior week’s 64.6, and continues 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) ended the week at 25, unchanged from the prior week.  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:

LargeCap US equities gained for the week, and pretty much everything else around the world dropped.  On the plus side, the S&P 500 gained +1.3%, and the Dow Industrials rose +1.7%.  But US MidCap and SmallCap indices lost -0.2% and -1.2% respectively for the week.  Likewise, Canada’s TSX gave up -1.7%, Developed International pulled back a slight -0.1%, and Emerging International lost -0.8%.  It is a saying among Wall Streeters that when the market is running out of steam, “large caps are the last to go.”  If the market is indeed running out of steam, the market is following this script.

In US economic news, initial jobless claims fell to 280,000, the lowest number in 7 years.  The National Association of Home Builders (“NAHB”) reported its housing market index rose to 59 from 55 a month ago, and matched its highest reading since 2005.  The Empire State Manufacturing index grew to 27.5 in September, the highest level since October, 2009.  Producer Price Index and Consumer Price Index figures stayed steady, benefiting from falling energy prices which have declined significantly over the last month.  On the negative side, housing starts were below expectation, as was industrial production which was dragged down by motor vehicle production that dropped -7.6% from the prior month.  And although it was widely anticipated that the magic phrase “considerable time” (describing how long accommodative policy would remain in place) would be removed from the Fed statement issued this week, it remained in place rendering the Fed announcement mostly a non-event.

Canada’s annual inflation rate was reported at 2.1%, the fourth month in a row that it was above the Bank of Canada’s 2.0% target.  The Bank of Canada is now in a quandary: it is on record as intending to maintain low interest rates to boost a soft economy, yet also on record as being more than willing to raise rates to keep a lid on inflation.  The central bank said earlier in September that higher inflation recently seen has been attributable to “temporary effects.”

The Organization for Economic Development (“OECD”) issued revised (and mostly lower) estimates of Eurozone GDP for 2014. The Eurozone as a whole estimate was revised down to +0.8%.  Some individual country examples are:  U.K. (+3.1%); Germany (+1.5%); France (+0.4%); Italy (-0.4%).

In China, factory output rose just +6.9% in August from a year earlier after a +9.0% rise in July, further confirmation of a slowdown.  Foreign direct investment in China, which is the lifeblood of the manufacturing sector, fell -14% last month to a four-year low, and followed a -17% decline in July.  Chinese new-home prices fell a fourth straight month in August.  Of 70 major Chinese cities surveyed, prices fell in 68 of them last month, following a decline in 64 of 70 in the previous month.

All year, globally-allocated investors have hoped that non-US assets would outperform US assets for the first time in four years.  Indeed, Emerging Markets have done better than the S&P 500 in 2014 until just a couple of weeks ago.  Since then, however, Emerging Markets have underperformed the S&P by a large -5% and in the process gave up their lead.  This chart shows the rather sudden reversal in fortunes:

(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, scottgranis.blogspot.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 10.8 from the prior week’s 11.8, while the average ranking of Offensive DIME sectors rose to 16.3 from the prior week’s 18.3.  Institutional investors remain cautious, and the Defensive SHUT group continues to rank 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™ Fact-Based Investment Allocation Strategies for the week ending 9/12/2014

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 26.3, down from the prior week’s 26.6, 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 64.6, down from the prior week’s 66.7, and continues 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) ended the week at 25, up one from the prior week’s 24.  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:

All major markets gave up ground last week.  Emerging markets reversed their prior week role as leader, and became the laggard, by quite a margin.  US and Canadian markets escaped the worst of it, only falling -0.3% and     -1.1%, respectively.  Developed International markets retreated -1.5%, but the worst results came from Emerging Markets with an average loss of -4.5%.  Brazil, recently red-hot, gave up a whopping -10.1% while China fell -3.7%.

Emerging Markets had been outperforming the US in recent months, but gave up their year-to-date edge over the US and returned global ex-US investors to the all-too-familiar role of running behind the US, a role they have played for the last 4 years.

Two major fears gripped the markets.  The first fear, continued European stagnation at recessionary levels, received most of the coverage.  However, the major US story was largely absent from the headlines.  That story is the sudden, severe rise in US interest rates (more on that subject below).  Interest-rate sensitive sectors in the US took a pounding for the week: the Dow Jones US Real Estate index of REITS dropped by a huge -5.0%, and the Dow Jones Utilities Index fell -3.1%.

US economic news was generally positive.  Job openings were reported at the highest levels since 2001.  Retail sales gained +0.6% month-over-month, and July was revised upward to +0.3%. Consumer confidence rose to 84.6, up from 82.5 and above the 83.3 expected.  Consumer credit in July rose by the largest amount in 13 years, and the National Federation of Independent Business (“NFIB”) small business index rose to 96.1, half a point from the highest readings since 2007.  About the only sour note was that mortgage applications fell -2.6% from the prior week to the lowest level since February.

Despite some recent cooling, The Economist magazine just rated Canada’s housing market as among the most overvalued in the world and “bears an unhappy resemblance” to what the US housing picture looked like before the financial crisis.  When comparing the relationship between the costs of buying and renting, it cited Canada, Hong Kong and New Zealand as “the most glaring examples” of overheated markets.  The Economist magazine is not alone, as the Organization for Economic Cooperation and Development (“OECD”) has said Canada’s market is overvalued by as much as 30 per cent when measured by the price-to-income ratio and by 60 per cent based on the price-to-rent ratio.

In Europe, all eyes are on the Scottish vote on independence from Great Britain.  Several major financial institutions have stated their intention to move operations from Scotland should the vote be in favor of independence, including the Royal Bank of Scotland (would it then be the Royal Ex-Bank of Scotland?).  In France, which is firmly in recession and making little progress – or effort – to get out of it, President Francois Hollande suffers from an incredible approval rate of just 13%.  Even a quarter of his Socialist supporters, who swept him to power, want to see him resign, while 62% of the entire electorate likewise wants him to go.

More about US interest rates.  As shown on the chart below, rates have sharply risen on the widely-watched benchmark 10-year Treasury Note, moving up for 9 of the last 11 days.  The US dollar rose for the 9th consecutive week, its longest rally in 17 years, on continued weakness in the Euro and in recognition of the interest rate rise – and no doubt in anticipation of more to come.

It seems to have been concluded by many major investors that the US economy has finally reached the point of robustness that will force the Fed to commence their long-delayed but inevitable rate raising.  Many observers expect that the statement at the end of this coming week’s Fed meeting will strongly hint that the rate hikes will be sooner rather than later.

Two of the most important data points that the Fed is certain to consider are shown here – the Institute for Supply Management (“ISM”) separate readings for the Manufacturing and Services portions of the US economy.  Both have recently broken out to multi-year highs and are running on the “hot” side, leaving little room for the Fed to continue to use their frequently-employed word “slack” to describe the US economy.

(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, scottgranis.blogspot.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 slightly to 11.8 from the prior week’s 12, while the average ranking of Offensive DIME sectors declined to 18.3 from the prior week’s 16.8.  Institutional investors remain cautious, and the Defensive SHUT group again expanded 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 9/5/2014

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 26.6, up slightly from the prior week’s 26.5, 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 66.7, up from the prior week’s 64.9, 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) ended the week at 24, up one 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 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:

Except for Emerging International indices, markets were little changed for the week.  Nonetheless, most US indices managed to post a 5th straight weekly gain.  Both the Dow and the S&P 500 gained a modest +0.2%, while the Nasdaq was flat and the Russell 2000 SmallCap index declined by -0.4%.  Canada’s TSX also declined by -0.4%, dragged down by declining commodities prices.  The best performers were found in the Emerging Markets category, led by China with a large +5.1% gain for the week.  Another strong winner in the Emerging category, India posted a +3% gain.  Several popular India ETFs (e.g., EPI, INDY, INDA, SMIN) are up 30% – 50% for the year to date.  Developed International indices were up +0.4% on average, with Europe leading the way in that category with a +1.8% gain.

In the US, the August nonfarm payroll report was the biggest economic headline of the week, but was disappointing with just 142,000 jobs created.  This was the first figure below 200,000 after six consecutive months above that level, and was also well below expectations of 220,000-230,000. The unemployment rate ticked down from 6.2% to 6.1%, while average hourly earnings rose just +0.2%.  July construction spending was up a strong +1.8%, July factory orders rose +10.5% (looks like a big number, but 11% was actually expected!).  The Institute for Supply Management (“ISM”) readings for August manufacturing came in at 59.0, and the services segment was reported at 59.7.  Both were very solid and the services segment reading was the best since August, 2005.  Janet Yellen’s speech at the recent Jackson Hole conclave was dissected syllable by syllable by economists and Fed-watchers; one of the peculiar findings was that her (or the Fed’s) new favorite word is “slack” – an intentionally ambiguous word with no associated metrics.  Her speech used the word an incredible 25 times.  No slacker, she!

Statistics Canada, the branch of Canadian government in charge of reporting employment numbers, caused more raised eyebrows when its August employment report showed heavy losses in private sector employment, but a nearly-equal gain in self-employment for a net job loss of 11,000.  This followed the July report which required a correction after a rather large number of workers (some 42,000) were later discovered to have been overlooked by Statistics Canada.  Scotiabank economists Derek Holt and Dov Zigler pointed out that never before in the 38-year history of the employment report had a decrease in private sector employment of this magnitude occurred    (-112,000) nor had the nearly-equal increase in self-employment ever occurred.  They called it “very fishy” and urged their clients to regard the report with some suspicion.

In Europe, Germany’s Angela Merkel and the International Monetary Fund (“IMF”) chief Christine Lagarde continued their long-running feud over stimulative government spending (Lagarde’s preferred strategy) vs austerity and reform (Merkel’s preference).  Merkel pointed out again this week that countries which chose austerity and reform seem to be recovering better than those who have done little but pay lip service to reforms or reduced expenditures.  Ireland, for example, imposed severe austerity measures three years ago, but now Ireland has the Europe’s leading composite Purchasing Manager’s Index (“PMI”) for August at 61.8, the best level since August 2000, the manufacturing PMI is 57.3, the best since 1999, and its GDP is likely to grow +3% this year.  Even Spain, previously a basket case, is beginning to benefit from its own limited brand of austerity measures, reporting a composite PMI of 56.9 for August, the best in 89 months.  But those countries that have only given lip service to reform – in particular France and Italy – continue to be stuck in flat or declining economies.

The extent and duration of the “declining” mentioned above can be readily seen in this chart.  Total Euro Area industrial production has been down from its August 2011 peak for 3 years, and is up less than a third of the gain in US industrial production over the period December 2009-July 2014.

(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, Orcam Financial Group)

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 from the prior week’s 14, while the average ranking of Offensive DIME sectors declined to 16.8 from the prior week’s 14.3.  Institutional investors remain cautious, and the Defensive SHUT group expanded 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.