FBIAS™ Fact-Based Investment Allocation Strategies for the week ending 10/9/2015
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 25.6, up from the prior week’s 24.8, 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 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 53.97, up from the prior week’s 51.81, 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) returned to positive on October 5. The indicator ended the week at 15, up sharply 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 negative indication on the first day of October for the prospects for the fourth 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 rated as Negative. The quarter-by-quarter indicator gave a negative signal for the 4th quarter: neither US equities nor ex-US equities were in an uptrend at the start of Q4 2015, sufficient to signal a higher likelihood of a down quarter than an up quarter.
In the markets:
Stocks recorded their biggest weekly gains in several months as investors became more confident that the Federal Reserve would not raise interest rates for the remainder of the year. The small cap Russell 2000 (+4.6%) and Mid Cap 400 index (+4.07%) outperformed their large cap counterparts. The Dow Jones Industrial Average regained the 17,000 level up over 600 points for the week. The S&P 500 gained over +3.2%. The tech heavy Nasdaq was the laggard up “only” +2.6%.
In commodities, Gold rose $18 to end the week at $1,155.60. Silver gained +3.8% to end the week at $15.82 an ounce. The industrial metal copper also recorded a strong gain, up over +3.1%. A barrel of West Texas Intermediate crude oil skyrocketed more than +8% to $49.49 a barrel.
In US economic news, first time unemployment benefit claims fell by -13,000 to 263,000 last week, according to the Labor Department. The reading is close to the 3 ½ year low set earlier this summer. Analysts had expected 271,000 new claims.
Home prices rose by +6.9% in August versus a year earlier, and +1.2% versus July, according to industry watcher CoreLogic’s Home Price Index. CoreLogic is also predicting a further +4.3% rise in home prices over the next 12 months. Home price appreciation in New York, Los Angeles, Dallas, Atlanta, and San Francisco remain strong. Also in housing, mortgage applications surged +25% amid worries about new mortgage regulations and the possibility that the Federal Reserve may boost interest rates. The Mortgage Bankers Association reported that refinance applications surged +24% and purchase applications rose +27%. The applications were filed just before significant changes to the Truth in Lending Act and the Real Estate Settlement Procedures Act (known in the industry by the jaw-breaking acronym “TILA-RESPA”) took place on Oct 3. The changes require, among other things, that lenders disclose all of a loan’s details at least three days before closing. The changes went into effect on Oct. 3.
The Institute for Supply Management’s (ISM) US nonmanufacturing index fell -2.1 points in September to 56.9, slightly lower than expected but still above the neutral 50 as services continue to remain largely insulated from global economic concerns. The new orders index fell -6.7 points to 56.7, the lowest level since early last year. The employment gauge picked up +2.3 points to a strong 58.3. The ISM nonmanufacturing reading follows a disappointing ISM manufacturing index, which fell to a barely-positive 50.2 as was reported here last week.
The US trade deficit rose sharply in August, attributed to weakness in exports and a surge in Apple iPhone imports. The trade gap widened +15.6% to $48.3 billion in August. It was the 2nd biggest imbalance since March 2012. Overall imports rose +1.1%, but exports sank -2% versus last month and -6.2% versus a year earlier—the worst reading since October 2009.
Former Federal Reserve Chairman Ben Bernanke stated he sees no reason to raise interest rates as service sector growth slowed and overall global activity continues to weaken. Ex-Fed chief Ben Bernanke told CNBC he sees no reason for central bank policymakers to increase interest rates right away “Easy money is justified” because inflation is so low. He also highlighted last Friday’s weak jobs report.
In Canada, caution and restrained expectations for prices and sales dominated the Bank of Canada’s Q3 Business Outlook Survey. No firms reported higher sales from this time last year, down 12% of firms in July. Planned investments rose slightly, but were far short of last year’s readings. The Canadian Central Bank sees the economy as on a “slow upward turn”. Canada’s unemployment rate increased to 7.1% in September from 7.0% in August. Canada added 12,000 jobs to its payrolls last month, while the labor force participation rate remained steady at 65.9%. Inside the numbers, however, the balance between part-time and full-time jobs was not good. Part-time positions rose +74,000 while full-time positions fell -61,900 (the steepest decline since October 2011). The weakness in oil continued its damaging effects.
In the United Kingdom, the Bank of England kept interest rates at a record low of 0.5%. The Monetary Policy Committee voted 8-1 to keep rates unchanged, citing cost pressures in the labor market that it said were rising too slowly. The BoE expects inflation to remain below 1% until spring ’16. British rates have remained steady for more than six years.
In the Eurozone, the composite Purchasing Managers Index (PMI) fell to 53.6 in September, down -0.7 point. Employment grew for the 11th straight month. The European Central Bank confirmed that it was committed to fully implementing its 60-billion-euro a month quantitative easing program at least through September of next year, according to the minutes of the ECB’s Sept. 2nd and 3rd meeting. Emerging markets and China along with the oil market were mentioned as risks to “price stability”.
Germany is still growing, however its composite PMI fell to 54.1 from 55. Backlogs and job creation were the strongest since 2011. German factory orders dropped an inflation-adjusted -1.8% following a -2.2% drop in July, whereas forecasts had expected a modest rebound.
Finally, we’ve all heard of “bandwidth hogs” – applications, programs or people that consume an outsize portion of total available internet capacity. Some internet providers have loudly complained that they feel like they are working for – but not getting paid by – Netflix and YouTube. Indeed, as the chart below shows, those two “bandwidth hogs” have accounted for a steadily-increasing proportion of total internet consumption over the last few years, breaching the 50% level for the first time this year. (note: the “HTTP” and “SSL” slices represent plain vanilla internet browsing). One of the surprises in this chart is how the peer-to-peer file-sharing application BitTorrent has fallen off over the past few years – now just 2.5% of total bandwidth use. At one time, BitTorrent was the #1 bandwidth-consuming application on the internet, topping 40% in 2009. But because BitTorrent was widely used to illegally share movie and music files, it came under concentrated and relentless attacks from movie and music industry groups who vowed to defeat it. The legal attacks by the industry groups were largely under the rights granted them by the Digital Millennium Copyright Act, but it is widely accepted that the industry groups also conducted very successful guerrilla warfare, as well. It is rumored that the industry groups planted defective movies and music everywhere in the BitTorrent network, making the user experience so poor that demand largely dried up. Resourceful, if not entirely kosher!
(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 slightly to 11.5 from the prior week’s 11.3, while the average ranking of Offensive DIME sectors rose sharply to 13 from the prior week’s 17.8. The Defensive SHUT sectors’ lead over the Offensive DIME sectors is now very slim, at 1.5. 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®