FBIAS™ Fact-Based Investment Allocation Strategies for the week ending 9/11/2015

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 24.8, up from the prior week’s 24.4, 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 53.18, up from the prior week’s 50.92, and continues in Cyclical Bull territory.  Several of the world’s major markets have entered Bear territory, most notably 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) has been Positive since August 26, after having been Negative since May 6.  The indicator ended the week at 11, up from the prior week’s 7.  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.

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.  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:

US stock indexes rose in a holiday-shortened week as market participants await the Federal Reserve’s decision on interest rates in the coming week.  For the week just ended, the Dow Jones Industrial Average gained 330 points to end the week at 16,433, a rise of +2.05%.  The tech-heavy Nasdaq rose almost +3% to end the week at 4,822.  The Nasdaq is now the only major index in the green for the year.  The LargeCap S&P 500 gained +2.07%,  the MidCap S&P 400 tacked on +2.03%, and the SmallCap Russell 2000 added +1.9%.

In international markets, Canada’s TSX ended slightly down by -0.12%, the United Kingdom’s FTSE gained +1.24%, France’s CAC40 added +0.57%, and Germany’s DAX gained +0.85%.  In Asia, China’s Shanghai Stock Exchange composite ended a 3 week downtrend by gaining +1.27%.  Japan’s Nikkei rebounded from last week’s plunge by gaining +2.65%.

In commodities, crude oil resumed its decline by giving up -2.16%, ending the week at $44.78 a barrel.  Gold experienced its 3rd week of declines, down -1.28% to $1107.90 an ounce.  Silver tacked on +$0.03 an ounce to $14.59, and Copper surged +6.06% after being down the prior week.

In US economic news, the Job Openings and Labor Turnover Survey (JOLTS) revealed there were 5.75 million job openings in July, the highest in the history of the Labor Department’s survey and up more than a million versus a year ago.  Seemingly at odds with the JOLTS number, actual hires declined to 5 million from 5.2 million.  This discrepancy illustrates what economists call a skills mismatch.  Employers aren’t finding the workers they want even as lots of Americans remained unemployed.  The “Quits” number, which signals job holders’ confidence in the job market, declined slightly to 2.69 million from 2.73 million.

The Mortgage Bankers Association’s weekly index dropped -6.2% last week as refinancings dropped -10%.  Purchases were down -1%, but up +41% compared with this time last year.  Fannie Mae introduced the Home Purchase Sentiment Index that combines the results from consumer surveys into a new index.  The new sentiment index declined to 80.8 in August due to consumer concerns of expectations of rising interest rates and the direction of the economy.  CoreLogic reported that foreclosures were down -24.4% vs. a year ago in July.

Consumer confidence sank as the University of Michigan’s reading for September fell 6.7 points to 85.7.  That was the largest monthly decline in nearly 3 years.  Most of the drop came from a -8.4% decrease in the expectations component.  The current conditions gauge fell -4.6 points to 100.3.  Producer prices were flat in August, beating consensus of -0.2% and were down -0.8% versus a year ago.  Ex food and energy, prices rose 0.3% in August, beating expectations.  That measure is up 0.9% versus a year earlier, but well below the Fed’s 2% inflation target. 

Import prices were down -1.8% in August, more than the -1.6% expected and remain -11.4% below year ago levels.  Export prices dipped -1.4%, lower than the -0.4% expected, and down -7% for the year.  Prices of imports and exports returned to levels not seen since 2009.  The Fed’s target for inflation is 2%, but as the price of oil continues to test lows that target is going to be hard to reach.

Redbook reported that same-store sales rose +1.3% versus a year ago last week—in line with expectations.  Small business sentiment showed improvement as the National Federation of Independent Business’s optimism index rose almost half a point to 95.9 in August, barely missing expectations of 96.  More owners stated they plan to hire, however plans to expand capital stock remain unchanged.  The sales outlook improved, but overall views of the economy pulled back.

In Canada, housing starts rose +12.2% in August to an annualized rate of 217,000, beating expectations of 194,000.  It was the highest reading since August 2012.  Multi-family units gained almost +20% while single-family homes were up just +1.4%.  The household debt-to-income ratio rose to an all-time high of 164.6% in the second quarter, with mortgages accounting for the biggest portion of household debt.  The Canadian housing market has been robust amid concerns that two rate cuts by the central bank will prompt consumers to borrow even more.

In the United Kingdom, a country sometimes called “a nation of shopkeepers”, those same shopkeepers have been having a tough time maintaining their pricing: the British Retail Consortium reported that retail shop prices fell 1.4% in August, the 28th straight month of declines.

In the Eurozone, the economy grew +0.4% in Q2, up from the initial +0.3% reading.  For the year, growth was revised up to +1.5% from +1.0%; expectations were for a +1.2% gain.  Much of the gain was due to a strong rise in exports, attributed to the weaker euro.  In export powerhouse Germany, exports jumped +2.5% in July, to a +6.2% annual increase and a new record high.  Imports rose +2.3%, increasing the trade balance to 22.8 billion euros from 22.1 billion.  Weakness persists in France, as French industrial production dropped -0.8% in July.  Expectations had been for a flat reading, but most subcomponents declined, including manufacturing, which was down -1%.  Output was also -0.8% lower for the year to date.

In Asia, China’s trade balance rose to $60.24 billion in August from $43.03 billion.  Exports declined -5.5% versus a year ago.  Imports declined more than twice the decline in exports, plunging by -13.8%, and twice the -6.5% decline forecast, widely interpreted as a sign of weak domestic demand.

Finally, if you have thought to yourself recently that there seems to be a rise in the number of days when all stocks are going up or all stocks are going down, with large moves in either direction…you are right.  Between August 20 and September 4 (12 trading sessions), there were 8 days when at least 80% of all stocks went in the same direction, whether up or down.  This is very unusual, having only happened two other times since 1990, according to research group Bespoke.

Some analysts believe that the rise in popularity of “Index” ETFs and Mutual Funds are at least part of the cause, since (to use an oversimplified example) when there is buying in an S&P 500 Index ETF, well, 500 stocks have to be simultaneously bought, and when there is selling in that same S&P 500 Index ETF, 500 stocks have to be simultaneously sold.

One might think that this simultaneous buying or selling of huge swaths of the market in these “one-way days” would increase correlation among those stocks, and that is what appears to be happening over the past decade or so, paralleling the rise in Index ETFs and Mutual Funds, according to this chart by FactSet, using Bloomberg data:

(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 from the prior week’s 6.8, while the average ranking of Offensive DIME sectors rose to 16.3 from the prior week’s 17.3.  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.

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 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.

Sincerely,