FBIAS™ Fact-Based Investment Allocation Strategies for the week ending 8/7/2015
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 26.4, down from the prior week’s 26.7, 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 51.38, down from the prior week’s 52.79, 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) is Negative and ended the week at 8, down a tick from the prior week’s 9. 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 Negative. 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:
It was a difficult week in the US equity markets as a solid jobs report made a September interest rate increase more likely. The Dow gave up -317 points ending the week at 17373. The LargeCap S&P 500 declined -1.25% ending the week at 2077. The tech heavy NASDAQ was able to maintain the 5000-level at 5043 despite losing 84 points. The MidCap S&P 400 index declined -0.98%. Small companies lost more than large ones, as the small cap Russell 2000 suffered a -2.57% decline, a bit more than twice the loss of the S&P 500. The only major index to have a positive week was the Dow Jones Utility Average which gained 1.11%.
In international markets, Developed International declined -0.26% and Emerging Markets dropped -2.21%. Canada’s TSX was unable to continue its rebound of last week, declining -1.15%. Unlike the US, European markets were predominantly positive. The United Kingdom’s FTSE gained +0.33%, Germany’s DAX increased +1.61%, and France’s CAC 40 added +1.42%. In Asia, China’s Shanghai Index rebounded +2.20%, and Japan’s Nikkei gained +0.68%.
After large recent declines, gold declined very slightly this week, only losing -$1.70 to $1093 an ounce. Silver was actually positive, gaining +$0.02 to $14.78 an ounce. Copper, however, continued its plunge, losing an additional 1.21%, marking its 11th weekly loss of the last 12 weeks. If copper is truly an indicator of future economic growth, this is definitely a cause for concern. A barrel of West Texas Intermediate crude oil plunged -6.46% to $43.75 a barrel. Oil has been negative 8 weeks in a row.
In US economic news, the Labor Department reported that the US economy added 215,000 jobs in July, the third straight monthly nonfarm payroll gain above 200,000. The jobless rate held at 5.3%, the lowest since 2008, but the rate would be far higher if the labor force participation rate wasn’t at a multi-decade low. Federal Reserve Governor Jerome Powell told CNBC that he is not all that impressed with the jobless rate, saying that there’s “more slack in the economy than the 5.3% (unemployment rate) would suggest.”
According to paycheck processor ADP, private payrolls increased by only 185,000 in July. Expectations were for a gain of 210,000. Almost all of the gains were in the service sector; construction added 15,000 jobs, the smallest gain in more than a year but the 4 year streak of hiring after the housing bust remains intact. Outplacement consultancy Challenger, Gray & Christmas reported that U.S. employers said they would cut 105,696 workers, the most in nearly 4 years. This is a 136% increase versus last month, and a 125% increase over July of last year. However, more than half of the cuts are attributed to the US Army, which is cutting 57,000 troop and civilian staff positions.
Real estate research firm CoreLogic reported that home prices rose +1.7% in June, a +6.5% year-over-year increase. Prices were at new all-time highs in 15 states and the District of Columbia. Sales excluding distressed properties increased +6.4% versus a year ago. Mortgage applications jumped +4.7% in the July 31 week, according to the Mortgage Bankers Association.
US Manufacturing declined as the Institute for Supply Management (ISM)’s index declined -0.8 point to 52.7, missing expectations. The details of the report were mixed. New orders gained a half point to 56.5, a good sign for the future, and production also increased to 56. However, the order backlog sank further into contraction territory (<50) to 42.5, and the employment component dropped 2.8 points. The “Prices Paid” measure also declined further into contraction territory, at 44. Of the 18 industries surveyed, just 11 reported any growth in July.
The services side of the economy is doing better, though. The US Non-manufacturing Purchasing Managers Index (PMI) jumped +4.3 points to 60.3 in July—a 10 year high. New orders were up +5.5 points to 63.8, and employment rose to 59.6, the highest since 2005.
Gallup’s US Economic Confidence Index dropped sharply from -8 to -12 as Americans turned sharply less confident in July. Only 39% of respondents said the economy was getting better, while 56% said it was getting worse.
In Canada, the trade balance declined to 0.48 billion Canadian dollars in June, from 3.37 billion CAD in May. Imports dipped -0.6%, but remained 4.4% higher than this time last year. Exports jumped +6.3%, but remain 1% lower for the year. Canada’s unemployment rate remained at 6.8% as the country added 6,600 jobs. Full-time positions fell 17,300 while part-time positions rose 23,900.
In the Eurozone, manufacturing remains solid according to the latest Purchasing Managers Index, which ticked down -0.1 point to 52.4 even though an all-time low reading of 30.2 was reported by Greece. All other countries recorded growth, except France. Producer Prices declined -0.1% in June, the first monthly decline in 6 months and the yearly rate dropped -0.2% to -2.2%. This deflation in producer prices is not what the European Central Bank is looking for, as its goal is for 2% inflation. In France, the factory sector slid into contraction again, as July’s PMI declined -1.1 point to 49.6 with broad weakness among the report’s subindices. Germany, though, reported slight manufacturing expansion at 51.8. Job creation was at a 3-month high and German factory orders rose +2% in June.
Finally, Apple is now in what Wall Streeters call “correction” territory. In Wall Street speak, this means it has declined at least 10% from its prior high of $134.5 (Apple closed the week at $115). The importance of Apple’s stock to the major market indexes is no secret. Apple makes up 4.4% of the Dow Jones Industrial Average, 14% of the Nasdaq 100 Index, and is worth more in market cap than the bottom 105 companies in the S&P 500 index combined! It is widely expected that further weakness in Apple’s stock would bring the broader market down with it.
Mark Hulbert published an article at marketwatch.com stating that “a bigger decline in Apple’s stock is just what we should expect, given extensive research into how bad news tends to get reflected.” What he was referring to is that analysts are quite slow to reflect a company’s declining stock price in their published price targets until well after a significant decline has taken place. When analyst price predictions are finally lowered, that has historically caused further declines. In the case of Apple, despite the almost 15% decline in price, analysts price targets have hardly budged, staying well north of $145. Hulbert concludes “It’s a good bet that Apple’s price will fall even further as analysts gradually incorporate the bad news into their analysis and lower their target 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, 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 rose to 8.3 from the prior week’s 10.8, while the average ranking of Offensive DIME sectors slipped to 18 from the prior week’s 17.8. The Defensive SHUT sectors again expanded their 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®