FBIAS™ for the week ending 11/21/2014

The very big picture:

In the “decades” timeframe, we may still be in the 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.

Even if we are in a new Secular Bull Market, market history says future returns are likely to be modest at best.   The Shiller P/E is at 27.1, up from the prior week’s 26.7, 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 61.1, up from the prior week’s 58.8, 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 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 October for the prospects for the fourth quarter of 2014.

Timeframe summary:

In the Secular (years to decades) timeframe (Figs. 1 & 2 above), whether we are in a new Secular Bull or still in the Secular Bear, the long-term valuation of the market is simply too high to sustain rip-roaring multi-year returns.  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:

Markets were mostly positive around the world for the week.  Brazil paced the gainers with an eye-catching +11.9% gain, while China was among the few losers at -1.3%.  Also among the few losers were US SmallCaps, at     -0.1%, although all other US indices were positive, led by the S&P 500 at +1.3%.  European indices gained +3% to +4%, spurred by the European Central Bank (ECB) promises of an American-style QE to call their own.  Canada’s TSX was also nicely positive at +1.8%.

In US economic news, housing figures were good for the month of October with housing starts coming in at an annualized pace of 1.08 million, better than expected, led by single-family home starts rising +4.2%.  Existing home sales for October also came in above expectations at 5.26 million.  On the inflation front, October’s Producer Price Index (PPI) was up +0.2% (+0.4% for the “core” – ex-food and energy).  For the trailing 12 months the PPI is up +1.5%, and +1.8% on the core.  The Consumer Price Index (CPI) for October was unchanged, and up +0.2% ex-food and energy.  Year over year the two versions of the CPI were just +1.7% and +1.8% on core, so inflation remains unworrisome.  The Philly Fed Index of mid-Atlantic economic activity came in at 40.8, versus economists’ expectations of 20.7 – a big “beat” that is also the best reading since 1993.  As earnings season is ending, the percentage of companies in the S&P 500 beating their Q3 analysts’ expectations of their earnings is the highest since 2010.

Canada’s central bankers have expressed concerns over too-low inflation, but those fears were allayed at least for now by the October inflation report released by Statistics Canada on Friday.  Increasing costs of bacon, cigarettes and natural gas were among the many contributors that helped propel Canada’s annual inflation rate to the unexpected level of +2.4% last month, its highest level in almost two years.  A weaker Loonie helped boost prices for imports.  The +2.4% level is in the range desired by the central bank and, if it continues, will free the bank to remove disinflation from its concerns.

The ECB successfully jawboned Europe’s markets higher – much higher – on the week.  ECB President Mario Draghi used another variation of his “whatever it takes” mantra, this time saying “We will do what we must to raise inflation and inflation expectations as fast as possible, as our price-stability mandate requires.”  He went on to say that inflation expectations “have been declining to levels that I would deem excessively low.”  The ECB then announced it had purchased and will continue to purchase more asset-backed securities.  Euro-area stocks soared and bond yields fell on speculation the ECB is getting ever closer to a full-scale, U.S. style, quantitative easing program.

Japan shocked economists worldwide on Monday, when the government released an initial estimate on third-quarter growth at -1.6%, whereas an increase of +2.2% had been expected.  This follows a whopping -7.3% decline in Q2, and would put Japan back into official recession.  The final reading on Q3 isn’t until December 8, and it could be revised upwards a bit, but the number was all Prime Minister Shinzo Abe needed to delay until 2016 or even 2017 the final hike in the sales tax, from 8% to 10%, which had been slated for next October.  The sales tax hike has been a long-planned step to reduce Japan’s horrible deficit.  Japan desperately needs a return to growth and modest inflation to break the deflationary mindset that has beset Japan for the better part of 15 years.  The government also announced it is going to institute a $26 billion stimulus program focusing on childcare and other measures to help the middle class directly and boost consumer spending and business investment.

China added to the parade of government economic actions when, on Friday night China time, the People’s Bank of China cut its one-year lending rate to 5.6% from 6.0%, the first cut in the benchmark interest rate in more than two years.  Commodities in particular shot higher on Friday on the hope that the rate cut will provide fresh stimulus to China’s flagging economy.

Self-help guru Tony Robbins is out with a new book “MONEY Master the Game: 7 Simple Steps to Financial Freedom”.

Advisors are already fielding calls from clients wanting to know about his “All Weather Portfolio”, described in the book as the only investment portfolio anyone should need.  The 55% bond exposure called for in his portfolio is perfectly suited…to the last 30 years – the greatest bond bull market in history – yet seems extremely unlikely to fare as well in the future.  It appears to many observers – for example, see Barry Ritholtz’ column for Bloomberg here http://www.bloombergview.com/articles/2014-11-19/trade-against-a-selfhelp-genius – to be a prime example of “curve-fitting”, and Ritholtz also reminds readers that Mr. Robbins’ last foray into the world of investment advice was a disaster.  On August 6, 2010, when the S&P 500 was at 1121, Robbins released a flash warning to his millions of followers:  “Right now is a time you might want to take some stocks off the table in the stock market. Especially if they are in manufacturing or retail or banking or god forbid homebuilding and housing . . . I would feel bad if I didn’t warn you . . . One of the biggest bubbles in history is blowing up NOW.”  Instead, however, the S&P gained almost 90% to its present level (2063 as of Friday), presumably leaving behind Mr. Robbins and all who took his advice.

(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, St. Louis Fed, fivethirtyeight.com)

The ranking relationship (shown in Fig. 5 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 6.5 from the prior week’s 7.3, while the average ranking of Offensive DIME sectors rose to 16.5 from the prior week’s 17.8. Institutional investors remain cautious, and the Defensive SHUT group continues to rank substantially higher than the Offensive DIME group ranking.   This caution is reflected in the fact that institutional investors are underperforming market averages this year, having been cautious and defensively positioned with lots of cash while market averages have gone on to new highs – leaving them behind.

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 globally 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.