FBIAS™ Fact Based Investment Allocation Strategies for the week ending 10/24/2014
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 25.7, up from the prior week’s 24.7, 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 52.6, up from the prior week’s 51.4, 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) is Positive and ended the week at 10, up sharply from the prior week’s 3. 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 October for the prospects for the fourth 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 October 17th. The quarter-by-quarter indicator gave a positive signal for the 4th quarter: US equities were in an uptrend, while International equities were in a downtrend at the start of Q4, and either one being in an uptrend is sufficient to signal a higher likelihood of an up quarter than a down quarter.
In the markets:
The US led a rally of most world markets from oversold levels, with the S&P 500 rocketing +4.1% higher for the biggest weekly gain in a year and a half, and the Nasdaq enjoyed its biggest weekly gain (+5.3%) since 2011. Non-US markets were much more subdued, however. Canada’s TSX climbed +2.2% for the week, Developed International +2.6%, but Emerging Markets rose just +0.7% (Brazil’s large -7.8% decline held it in check). The US SmallCap Russell 2000 index is still negative for the year to date, at -3.9%, as are both Developed International and Emerging International indices. Canada’s TSX earlier this year enjoyed a 7% lead over the US in year-to-date returns, but that has shrunk to only a 0.5% advantage as Canada’s correction was sharper and deeper than the US’s pullback.
US interest rates have fallen recently to a 1-1/2 year low, and mortgage refinance applications jumped +23.3% week-over-week in response. Existing home sales rose to 5.17 million annualized, the highest since September 2013, though new home sales were flat. Inflation data as represented by the Consumer Price Index (“CPI”) also was tame, with the CPI in September up just +0.1%, while the 12-month CPI was only +1.7%. Earnings from US companies were mixed during the week, with many old-line stalwarts disappointing. AT&T, Walmart, IBM, Coca-Cola, GE, among others did not meet expectations, but giant industrials Caterpillar and 3M reported upside surprises. A third of the 30 companies in the Dow Jones Industrial Average have posted shrinking or flat revenue over the past 12 months, according to data from S&P Capital IQ. Revenue growth for nearly half the Dow Industrials didn’t outpace the U.S. inflation rate of +1.7%. It might be logical to think that the large multinationals would be reeling from the effects of European stagnation, but data from the World Bank show that Europe represents just 15% of total US foreign trade.
Canadian retail sales dropped unexpectedly in August, the second consecutive month of falling retail sales, casting some uncertainty on prospects for broader economic growth. Retail sales dropped -0.3 percent in August, Statistics Canada said on Wednesday. Analysts had forecast that sales would be unchanged from July. It wasn’t all just lower gas prices, as sales were down in 7 of the 11 sub-sectors, representing 76 percent of retail trade.
Eurozone stagnation continues. The October manufacturing Purchasing Managers Index (“PMI”) was 50.7 vs 50.3 in September, barely in expansion territory. The service sector reading of 52.4 was unchanged over the prior month. The specifics for Germany and France were not enthusing. Germany’s manufacturing reading was 51.8 vs 49.9, services 54.8 vs 55.7, and a composite of the two 53.6 vs 54.1. For France, manufacturing was 47.3 in October vs 48.8 the prior month, services was 48.1 vs 48.4, and the composite of the two 48.0 vs. 48.4.
In China, GDP was reported at +7.3% in the third quarter, the weakest pace since Q1 2009, though it beat the estimate of 7.2%. Producer, or “factory-gate”, prices fell in September for an amazing 32nd straight month. In the critical housing sector, new-home prices fell in 69 of 70 Chinese cities monitored by the government in September from August, the most since January 2011. Nationwide, home sales fell -11% in the first nine months of the year. Prices in the previously-overheated Beijing and Shanghai markets fell -0.7% and -0.9% respectively. The city of Xiamen in Fujian province was the only one of the 70 cities surveyed to show an increase.
Casino revenue in the Chinese gambling mecca Macau, always a good economic barometer for China, fell -12% in September, the fourth straight month of decline, and the biggest drop since June 2009. A significant part of the decline is suspected to be the result of Chinese President Xi’s crackdown on corruption among government officials. Beijing reported spending by officials on trips (including to Macau), lavish receptions and official cars has dropped by almost $9 billion over the past year. The government also announced it had found and eliminated 150,000 ‘ghost jobs’, where people are paid without ever being required to show up.
As domestic West Texas Intermediate (“WTI”) crude oil hovers above $80/bbl, and foreign Brent Crude a bit higher, many energy-producing countries are facing the reality of large budgetary shortfalls vs their planned revenues that relied on much higher oil prices. Here is a chart from Deutsche Bank that shows how many previously comfortable sovereign budgets have been thrown into turmoil by the significant slide in world oil prices.
(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 (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 6.0 from the prior week’s 6.5, while the average ranking of Offensive DIME sectors rose to 19 from the prior week’s 20.3. Institutional investors remain cautious, and the Defensive SHUT group continues to rank substantially 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®