The very big picture:
In the “decades” timeframe, the question of whether we are in a continuing Secular Bear Market that began in 2000 or in a new Secular Bull Market has been the subject of hot debate among economists and market watchers since 2013, when the Dow and S&P 500 exceeded their 2000 and 2007 highs. The Bear proponents point out that the long-term PE ratio (called “CAPE”, for Cyclically-Adjusted Price to Earnings ratio), which has done a historically great job of marking tops and bottoms of Secular Bulls and Secular Bears, did not get down to the single-digit range that has marked the end of Bear Markets for a hundred years, but the Bull proponents say that significantly higher new highs are de-facto evidence of a Secular Bull, regardless of the CAPE. Further confusing the question, the CAPE now has risen to levels that have marked the end of Bull Markets except for times of full-blown market manias. See Fig. 1 for the 100-year view of Secular Bulls and Bears.
Even if we are in a new Secular Bull Market, market history says future returns are likely to be modest at best. The CAPE is at 27.3, down from the prior week’s 27.8, and approximately at the level reached at the pre-crash high in October, 2007. 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 Fig. 2).
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 the CAPE 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 more typical of a rip-snorting 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 Fig. 3) is at 57.2, down from the prior week’s 59.4, 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 markets have yet to top 2007’s levels – particularly in the Emerging Markets area.
In the intermediate picture:
The intermediate (weeks to months) indicator (see Fig. 4) is Positive and ended the week at 36, the top of its range and 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 January for the prospects for the first quarter of 2015.
In the Secular (years to decades) timeframe (Figs. 1 & 2), 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), all major equity markets are in Cyclical Bull territory. In the Intermediate (weeks to months) timeframe (Fig. 4), US equity markets are rated as Positive. The quarter-by-quarter indicator gave a positive signal for the 1st quarter: US equities were in an uptrend, while International equities were in a downtrend at the start of Q1 2015, 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 week ending March 6th was a rough one in the markets, with almost all of the major American indexes giving up at least -1%. The Dow Jones Industrial Average lost 278 points on Friday giving up -1.52% to close at 17856. The Nasdaq continued its retreat from the recently-regained 5000 level, giving up 36 points for the week to end at 4927, down -0.73%. The large cap S&P 500 benchmark index lost -1.58%, while the small cap Russell 2000 shed ‑1.29%. The Dow Jones Utility average continued its recent steep plummet, losing more than -4% for the week. Much of the market’s weakness is being attributed to Friday’s stronger than expected jobs report that is thought to give the Fed reason to begin raising interest rates sooner than expected (more on that below).
Canada’s TSX dropped -1.85%, Developed International retreated -1.98%, and Emerging Markets shed more than ‑3.6%. In commodities markets, West Texas Intermediate Crude Oil gained +0.53% for the week but was unable to hold above the $50 a barrel price. Gold lost almost all of its December and January bounce, giving up -3.75% for the week to close at $1168.20 an ounce. Silver likewise lost -3.92% and is also approaching its November lows.
In US economic news, the consumer picture brightened as personal incomes rose +0.3% in January thanks to a +0.6% jump in wages and salaries. Spending dipped -0.2%, but when adjusted for inflation it actually rose +0.3%. Core prices rose just +0.1% for the month, +1.3% higher year-over-year, quite a bit lower than the Fed’s +2% target.
Gallup’s consumer spending gauge rose to an average $82 per day in February, up $1. Markit’s Purchasing Managers Index (PMI) report for manufacturing was stronger than expected in February, rising to 55.1 from 53.9. The report showed production growth at a 4 month high, and new orders also saw improvement rising at the fastest pace in 4 months.
The Institute for Supply Management (ISM) nonmanufacturing index rose to 56.9 in February, beating expectations of a slowdown. The report’s employment component surged to 56.4, up 4.8 points, while the service sector reading was 57.1. That was the highest service sector reading since October and was led by strong levels of output and new business.
Friday’s Non-Farm Payrolls (NFP) report showed employers added 295,000 jobs in February, and the unemployment rate fell to 5.5%. However, the labor force participation rate slipped to a 37-year low as ever-increasing numbers of workers drop out (or retire).
There is no clear consensus of opinion among Fed members. Chicago Fed President Charles Evans said that the Federal Reserve should delay hiking interest rates until 2016 citing “few benefits, and significant risks” to moving before inflation picks up and unemployment falls closer to 5%. However, on Friday San Francisco Fed President John Williams stated that the central bank should start midyear “to have a serious discussion about starting to raise rates.” His concern is that waiting too late could force drastic hikes later. “I see a safer course in a gradual increase, and that calls for starting a bit earlier,” he added.
In Canada, annualized GDP growth was +2.4% in the 4th Quarter, down from +3.2% annualized growth in Q3. Consumption growth and exports both declined. Producer prices fell -0.4% in January, and were -2.2% below year-ago levels. Canada’s trade deficit surged to C$2.5 billion in January. Exports fell -2.8% driven by a -14.7% plunge in energy exports, while imports were flat.
In the Eurozone, the aggregate consumer price index was down -0.3% in the February flash reading, better than the -0.6% decline in January and beating expectations. February factory PMI was reported at 51.0, holding to the barely-expanding above-50 level. Ireland, the poster child for the austerity approach, saw its PMI touch a long-term high while France (most definitely not an austerity adherent) slid further into contraction. Germany was confirmed at 51.1, beating estimates with new orders also at a 7-month high. Eurozone unemployment dropped 1 tick to 11.2%, the lowest since April 2012. Eurozone producer prices fell -0.9% in January, worse than the -0.7% expected, -3.4% lower year-over-year and firmly in deflationary territory.
In the United Kingdom, the PMI for February was stronger than expected at 54.1. New businesses grew at the fastest pace since October, and the rates charged by subcontractors hit an all-time high.
In Asia, the Chinese government set a lower target of 7% for 2015 that it said would reflect “a new normal” of slowing growth. The government will also boost spending about 10% vs. 2014 and run a bigger budget deficit due to more stimulus spending.
At the beginning of this week’s report it was noted that the weakness on Friday is being attributed to the increased likelihood of a Fed rate hike sooner than expected. Is this concern really warranted? Brian Belski, chief investment strategist at BMO Capital Markets crunched the numbers on the market performance in the six months before and after the first rate hike in a Fed tightening cycle going back to 1980. He found that in the six months ahead of a rate rise, the S&P 500 rose +8.3% on average, while adding an additional +3.7% in the six months after the first move. Overall, the S&P 500 gained an average +12.6% in the 12 months surrounding the first move. It wasn’t all smooth sailing, however, as the 6-month “before” periods averaged a -10% pullback along the way.
(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, pensionpartners.com; Figs 3-5 source W E Sherman & Co, LLC)
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 14.5 from the prior week’s 15, while the average ranking of Offensive DIME sectors fell to 13.8 from the prior week’s 12.8. The Offensive DIME sectors have lost much of their recent lead, and now are very closely ranked to the Defensive SHUT sectors. 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 globally even as new highs are reached in the US.
Because the world 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.
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Take care, and have a great week,