FBIAS™ Fact-Based Investment Allocation Strategies for the week ending 8/28/2015
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 graph below 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 25.2, up slightly from the prior week’s 25.0, 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 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 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 graph below) is at 54.77, up sharply from the prior week’s 48.69, 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 graph below) turned Positive this week when the market sharply rebounded from a deep selloff, and ended the week at 3, down from the prior week’s 5, but up from the mid-week level of 2. 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 2015.
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. In the Intermediate (weeks to months) timeframe (Fig. 4 above), US equity markets are rated as Positive. The quarter-by-quarter indicator gave a positive signal for the 3rd quarter: US equities were in an uptrend at the start of Q3 2015, sufficient to signal a higher likelihood of an up quarter than a down quarter.
In the markets:
Major stock indices ended the week with modest gains, but not before enduring the highest level of volatility in many years. For the week, the Dow Jones Industrial Average closed up +1.1%, but not before traveling almost 1,300 points from peak to trough! The NASDAQ composite gained +2.6% to close at 4828, clawing its way back to positive territory year to date. The S&P 500 gained +0.91% and the SmallCap Russell 2000 gained +0.53%.
International markets followed the U.S. market’s lead in recovering from the steep losses that occurred early in the week. Canada’s TSX gained +2.9%, the United Kingdom’s FTSE was up +0.97%, and Germany’s DAX was up +1.72%. China, on the other hand, did not recover. Though China was able to halt an absolute market crash, the Shanghai stock exchange composite index still declined -7.85% for the week. Japan’s Nikkei index also declined, losing 1.54%.
In commodities, crude oil surged more than +12% on news that Saudi Arabia had invaded Yemen. Early-week strength in gold faded, and gold ended the week down -2.35% to $1132.60 an ounce. Silver also declined, dropping 4.83% to $14.58 an ounce. The industrial metal copper ended the week up 2.18%.
In US economic news, the economy expanded at a +3.7% annual rate in the second quarter, according to the Commerce Department. That smartly beat expectations for an upward revision to 3.2%. Nearly all the details were stronger and pointed to a healthy economy. Business investment led the upward revision with nonresidential investment now seen up +3.2% versus down -0.6%. Intellectual property spending grew the most since 2007. Both consumers and businesses spent more than initially forecast.
Home prices picked up as the S&P/Case-Shiller 20-city Home Price Index ticked down -0.1% in June, but rose +5% versus a year ago. The national average was up +4.5% versus a year ago in June. The hottest cities remain Denver, Dallas, and San Francisco. New home sales jumped to a 507,000 annual pace in July, a +5% gain versus June. Sales are up +26% versus a year ago, and it is the eighth straight month of double-digit yearly gains.
Business economists who are members of the National Association of Business Economists expect the Fed to hike rates before the end of 2015. A large majority, 77% of survey respondents, expect the Fed to hike rates, up from 71% in March. 66% feel that the Fed should take this step.
In a big upside surprise, the Conference Board’s consumer confidence index jumped more than +10 points to 101.5, blowing away expectations of a 94 reading. Consumers’ views of the labor market drove the increase. However, the University of Michigan’s sentiment index fell -1 point to 91.9, missing expectations for a gain. The current conditions gauge fell -2.1 points, but the overall U of M index remains up a strong +11.4% versus a year ago.
US durable goods orders jumped +2% in July, when analysts had been expecting a -0.4% decline. Orders remain nearly -20% lower versus last year, but analysts cite a large air show order as skewing last year’s data. Excluding transportation, July orders were up +0.6%, also beating expectations. Core capital goods, which gauge business investment, rose a strong +2.2% in July – the second straight monthly gain. This could indicate that the capital expenditure plunge triggered by the precipitous decline in oil prices may have leveled off.
Former Treasury Secretary Larry Summers said in a Washington Post opinion piece that it would be a serious error for the Fed to hike rates in September. Doing so would jeopardize price stability, financial stability, and even full employment, he wrote. His opinion is seemingly shared by New York Federal Reserve President William Dudley, a top Federal Reserve policymaker, who said that he’s less interested in a Fed “liftoff” next month, citing “international and financial market developments”. “From my perspective, at this moment, the decision to begin the normalization process at the September FOMC meeting seems less compelling to me that was a few weeks ago,” he said. However, other Fed officials are more hawkish. Kansas City Fed President Esther George said in a CNBC interview that recent market action “complicates the picture, but I think it’s too soon to say that fundamentally changes that picture. So in my own view the normalization process needs to begin and the economy is performing in a way that I think it’s prepared to take that.”
In the Eurozone, loans to business rose +0.9% for the year in July. Household borrowing was up a +1.9% yearly gain versus +1.7% in June. The data suggest that the European Central Bank’s efforts to boost the economy may be finally resulting in more demand. Consumer confidence also improved in the Eurozone as the EU commission sentiment tracker rose 2 ticks to 104.2. Consumer, retail, and construction sectors all rose. The German Economy Ministry soothed concerns that a slowdown in China will have significant negative impact in Germany, pointing out that German exports to China account for only 6.6% of total exports.
On Tuesday, China’s central bank cut interest rates and reserve requirements after several days of pronounced weakness in its stock market, which declined more than -7% on Tuesday and more than -8% on Monday. The People’s Bank of China cut interest rates by 25 basis points to 4.6%. It also reduced bank reserve requirements by a half percent, a step which should flood roughly $100 billion into the financial system. The government has stated its intentions of rebalancing the economy towards the service sector and consumption, and away from export-oriented manufacturing.
Finally, the volatility of this past week has many nervous investors searching for good news. Institutional research firm Ned Davis Research provided that dose of good news this week when it wrote about what it calls “the best indicator you’ve never heard of” – and it is bullish. This indicator is constructed from the stock market’s Price to Earnings (PE) ratio plus the unemployment rate plus the inflation rate. The latter two are sometimes combined into a number called the “Misery Index”. As the chart below shows, the stock market’s historical performance has been far better when this indicator is lower than when it is higher – and we are now in the second-lowest quartile, thanks mostly to a low unemployment rate and very low inflation, nicely offsetting a fairly high PE ratio. By this metric, anyway, the long-anticipated market correction that has finally occurred may be unlikely to become the beginning of a major bear market. See the chart below, from marketwatch.com.
(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, marketwatch.com, wantchinatimes.com, BBC, 361capital.com, pensionpartners.com, cnbc.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 fell to 5.5 from the prior week’s 4.5, while the average ranking of Offensive DIME sectors rose slightly to 17.8 from the prior week’s 18.0. The Defensive SHUT sectors maintained a large lead in rankings over the Offensive DIME 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.
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®