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.
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.
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.
If you have any questions about the FBIAS™ Fact-Based Investment Allocation Strategy portfolios, feel free to give your Anthony Capital, LLC advisor a call at 303-734-7178 or by scheduling a private virtual meeting/conference call. We work with clients from all over the country and would be happy to help.
You can also open up an online account by clicking HERE at our preferred custodian, Folio Institutional.
Dave Anthony, CFP®, RMA®