FBIAS™Fact-Based Investment Allocation Strategies for the week ending 9/25/2015
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 24.5, down from the prior week’s 24.9, 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 51.12, down from the prior week’s 52.74, and continues in Cyclical Bull territory. Several of the world’s major markets have entered Bear territory, most notably Germany, China and Brazil, while many of the world’s other markets – including some US indexes – are in “correction” territory (10% or more from their highs).
In the intermediate picture:
The intermediate (weeks to months) indicator (see graph below) turned Negative on September 25, after being Positive since August 26. The indicator ended the week at 13, down from the prior week’s 16. 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), a majority of major equity markets still remain in Cyclical Bull territory, although numerous others have moved to Bear status. In the Intermediate (weeks to months) timeframe (Fig. 4 above), US equity markets are newly 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:
Stocks ended the week lower despite what some saw as a pep talk by Federal Reserve Chair Janet Yellen, who said that global growth is strong enough to withstand turmoil in emerging markets and elsewhere. Most of the major stock indexes ended the week in the red. The Dow Jones Industrial Average gave up 69 points to close at 16314. The Nasdaq composite lost 140 points and ended the week at 4686. The LargeCap S&P 500 declined -1.36%, the MidCap S&P 400 index lost -1.75%, and the SmallCap Russell 2000 was the worst of the US indices at -3.49%.
International markets were also mostly down. Canada’s TSX declined -1.97%, Germany’s DAX was down for a second week, losing -2.3% (and now in Bear territory, more than 20% lower than its high). France’s CAC 40 similarly declined -1.22%. In Asia, Japan’s Nikkei also declined a second week down -1.05%, while China’s Shanghai composite declined only fractionally at -0.18%.
In commodities, a barrel of West Texas Intermediate crude oil gained +$0.02 to $45.34 a barrel. The price for an ounce of gold increased +$6.40 to $1,145.50, a gain of +0.56%. Silver declined -0.36% to $15.10 an ounce. Copper has now entirely reversed its huge surge two weeks ago, declining -4.14%.
In US economic news, the economy expanded +3.9% in the second quarter’s final estimate. That’s up +0.2% from the earlier estimate and a healthy rebound from the first quarter’s puny +0.6% gain. Exports, residential and non-residential fixed investment, and state and local government spending all increased.
On the jobs front, there were 267,000 initial claims for unemployment last week, an increase of 3,000 but still below estimates of 275,000. There were 2.142 million continuing claims, about the same as last week.
The US housing market showed signs of weakness as sales of existing homes declined -4.8% to an annual rate of 5.3 million in August, according to the National Association of Realtors. Forecasts had been for a rate of 5.5 million. Compared to last year, existing home sales are still up +6.2%. Prices were +4.7% higher versus a year ago. The Federal Home Finance Agency (FHFA)’s price index rose +0.6% in July as house price gains accelerated. FHFA’s index, which includes only mortgages guaranteed by Fannie Mae or Freddie Mac, stands just 1.1% below its 2007 peak. Contrary to existing-home sales, new-home sales ran at an annual rate of 552,000 in August, beating expectations of 515,000, and are +22% higher than year-ago levels.
Retail reporting service Redbook reported that same-store sales rose +0.9% versus a year ago last week. This was a sharp deceleration from the +1.7% annual gain the previous week. New orders for durable goods also disappointed as orders dropped -2% in August, matching forecasts. Ex-transportation, orders were flat, which missed estimates of a 0.3% gain—and down 3.9% versus this time a year ago. Manufacturing has suffered as energy producers hold back on capital expenditures. Core capital goods orders, considered a proxy for business investment plans, dipped -0.2%.
Bloomberg’s most recent weekly reading of consumer confidence increased +1.7 points to 41.9, the highest reading in a month. Consumers’ views of their personal finances rose to the highest level in 2 months. Likewise, the University of Michigan’s consumer confidence reading for September rose +1.5 point to 87.2, beating expectations but still the weakest reading since last October.
The US Purchasing Managers Index (PMI) for factory output remained unchanged at 53, the lowest reading since October 2013. Output rose at a slightly faster pace in September, but new business, and employment weakened. The employment component was the weakest in 15 months.
The Richmond Fed’s regional factory index hit a 32-month low and fell into contraction to -5 in September, down from zero. Expectations had been for a gain to three. The worst component was new orders, which plunged to 12, a bad sign for future activity. Manufacturing has struggled with a stronger dollar, which makes US exports less attractive. The Chicago Fed’s National Activity Index declined to -0.41 in August from 0.51. All 4 categories within the index declined.
In Canada, wholesale sales were flat in July, missing expectations of a +0.7% rise. Machinery, equipment, and supplies rose +1%, but sales of construction, forestry, mining and industrial machinery fell -3%. Canadian retail sales rose +0.5% in July, missing expectations of a +0.8% gain, but the third straight monthly rise nonetheless. Sales growth was driven by motor vehicle and parts, clothing and accessories.
In the Eurozone, the September composite PMI from Markit ticked down to 53.9 from 54.3, but that closed out the best quarter in four years. New orders were at a five month high and order backlogs improved, signaling probable higher future economic activity.
The Asian Development Bank (ADB) said that the Chinese economy will grow less than its government’s 7% target this year, and that the country’s slowdown could ripple throughout Asia. The ADB forecasts growth of 6.8%, down from 7.2%. China’s factory PMI from Caixin is now at a 6 ½ year low, declining -0.3 point to 47. Output, new orders, new export orders and employment gauges all declined at faster rates.
Finally, this week we take a closer look at the declining fortunes of “the world’s factory” — China. Unlike other Purchasing Managers Index (PMI) readings around the world, in China the PMI readings are from two sources: the official state-issued PMI, and the Caixin PMI. The difference between them is that the official state-issued version covers state-owned and very large enterprises, whereas the Caixin version is a gauge of nationwide manufacturing activity that focuses on smaller, medium-sized and privately-owned companies.
As seen on the chart below, both the state-issued and the Caixin PMI values show declines year-over-year, but the Caixin PMI has fallen hard and fast in the last few months. Both are now in the sub-50 area, signaling contraction. The Caixin version is now lower than the state version by a very significant 2+ points, indicating greater trouble in the small-medium-private sector…or perhaps indicating misrepresentation by the Chinese government in the state-issued version.
(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 9.3 from the prior week’s 8.8, while the average ranking of Offensive DIME sectors fell to 18.3 from the prior week’s 17. The Defensive SHUT sectors still have a 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 through new highs were reached in the US earlier this year. 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®