FBIAS™ Fact-Based Investment Allocation Strategies for the week ending 10/16/2015
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 25.7, little changed from the prior week’s 25.6, 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 56.80, up from the prior week’s 53.97, 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 – recently visited “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 21, up substantially from the prior week’s 15. 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 Positive. 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:
The major US benchmarks were mostly up for the week, with the LargeCap S&P 500 index adding to its gains from the previous week, up +0.9% to 2033. The Dow Jones Industrial Average gained 131 points ending the week at 17,215, a rise of +0.77%. The NASDAQ continued its run to regain the 5000-level, up +1.16% to 4886. The SmallCap Russell 2000 diverged from its larger counterparts, ending the week down -0.26%. The Nasdaq remains the only major US index with a gain year-to-date, but the losses have narrowed considerably.
In international markets, weakness prevailed in most European markets, while gains were the rule in Asia. Canada’s TSX declined -0.9%, the United Kingdom’s FTSE gave up -0.59%, and Germany’s DAX was nearly flat up +0.08%. China’s Shanghai Stock Exchange surged +6.54% and Hong Kong’s Hang Seng gained +2.7%. But South America continued to show weakness with Brazil’s Bovespa index plunging -4.26%.
In commodities, Gold had its second week of gains, up +$21.80 to $1177.40 an ounce. Silver had its third week of gains, up +1.33% to $16.03 an ounce. The industrial metal copper pulled back slightly from last week’s large gain, down -0.74%. A barrel of West Texas Intermediate crude oil declined -3.56% to $47.73 a barrel.
In US economic news, new unemployment claims fell 7,000 to 255,000 last week, matching July’s 42-year low. Analysts had expected 270,000 claims. The numbers seem to indicate a continued tightening in the labor market, but actual hiring activity has been tepid, leaving net job growth fairly weak. There were 5.4 million job openings in August, down from the all-time high reading of 5.7 million in July. Hires rose slightly to 5.08 million, quits also increased slightly. Counterintuitively, economists consider higher numbers of “quits” to be a good thing – it is a sign that workers are more confident they’ll find another job.
Consumer prices dropped the most in 8 months as prices slipped -0.2% last month compared to August. Energy fell -4.7%, and is -18.4% versus a year earlier. The core CPI, which excludes food and energy, rose +0.2%. The total CPI was unchanged versus a year earlier, while core CPI was up +1.9% versus last year. The core CPI is getting close to the Federal Reserve’s 2% target, but policymakers have been hinting that rate hikes are off the table for the remainder of 2015.
US exports fell -6.2% for August versus a year earlier, the fastest decline since 2009. Manufacturing has been hit especially hard according to recent activity gauges that have shown stagnation or outright decline. Caterpillar announced huge layoffs last week as it faces weak demand for its heavy-construction and mining equipment. DuPont also referred to overseas weakness in its earnings warning. U.S. exports are not alone–China’s exports fell -5.5% versus a year earlier and South Korea suffered a -14.9% plunge. The strong dollar has had the dual effect of stifling demand for U.S. goods and making other countries’ trade look weak in dollar terms. Whether it has triggered a manufacturing recession is not yet known, but is increasingly discussed as a real possibility.
US Small business owners were more optimistic last month according to the National Federation of Independent Business (NFIB), although sales outlooks weakened. The NFIB’s small business optimism index rose +0.2 point last month to 96.1—still historically below average. In the report, finding qualified labor continues to be a growing concern. Over 15% of smaller firms say finding qualified workers is a growing problem, up from just 9% a year earlier. Finding qualified workers is the number 3 overall worry of small business owners, following taxes and government regulations/red tape.
Retail sales disappointed in September, rising only +0.1%. Had it not been for the launch of the iPhone 6s, retail sales would have fallen. The Producer Price Index (PPI) slid -0.5% in September, the biggest decline in 8 months and worse than the -0.2% drop expected. Core PPI, which excludes food and energy, still retreated -0.3% versus expectations of a +0.1% increase. Year over year, wholesale prices have fallen -1.1%.
Industrial production decreased -0.2% in September, better than the -0.3% decline expected, but its second straight decline nonetheless. Production was +0.4% higher versus a year ago. Manufacturing declined -0.1%, less than expected, and was +1.4% higher than this time last year. The energy slump that began last year continues to impact production. Capacity utilization, which measures slack in firms’ industrial equipment, fell slightly to 77.5% from 77.8%. Regional Fed measures of manufacturing in Philadelphia and New York were both in contraction territory, though slightly improved from the prior month.
In Canada, manufacturing sales declined -0.2% in August, much better than the -0.7% loss analysts expected. This reading followed a +1.7% surge in July. For the year through August, sales were down -0.6%.
Europe continues to flirt with deflation, despite the European Central Bank’s intensive Quantitative Easing (QE) activities intended to spark activity – and inflation. In Germany, September consumer prices fell -0.2% vs. August and were flat versus this time last year. Wholesale prices declined -0.6% versus August and down -1.8% versus this time last year. In the United Kingdom, consumer prices fell -0.1% from August and down -0.1% from this time last year. Core CPI was unchanged from the previous month and rose +1% versus a year earlier.
In Asia, China’s September trade balance was $60.34 billion, up slightly from August and much higher than the forecast of $46.79 billion. In dollar terms, imports tumbled more than -20% versus a year earlier after falling over 13% in August. Exports fell -3.7% versus this time last year. The import and export figures signal weakening Chinese demand for raw materials and weaker global demand for Chinese finished goods.
Finally, this past week the Misery Index hit a 59-year low. Created in the 1970s by economist Arthur Okun, the Misery Index attempts to capture the “misery” felt by a country’s citizenry. The Misery Index is the sum of the unemployment rate and the inflation rate, and sits today at its lowest level since 1956. The index is created by adding the unemployment rate to the inflation rate over the last year. The Misery Index used to be significant and widely quoted, particularly when the US was suffering from “stagflation”. Jimmy Carter used it in his campaign against President Gerald Ford in 1976, and in the “what goes around comes around” vein, Ronald Reagan then used it very effectively against then-President Carter in 1980, famously asking “Are you better off than you were four years ago?”
But in today’s economy, the Misery Index doesn’t seem to capture the “misery”, concerns and worries of the current time. The economy presently enjoys a low unemployment rate and almost no inflation. Despite this apparently obvious good news, a recent NBC News/Wall Street Journal poll reported that a whopping 62% of Americans say the country is on the wrong track. High underemployment, weak wage growth, widening of the wage-gap, government dysfunction, and a seemingly amoral corporate culture (see recent drug-price gouging examples) are possible reasons for the apparent divergence between the presumably good numbers and their perception. In any event, it seems the Misery Index doesn’t capture the angst of the current age!
(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 slightly to 11.3 from the prior week’s 11.5, while the average ranking of Offensive DIME sectors rose again to 11.3 from the prior week’s 13. The Defensive SHUT sector has given up its lead over the Offensive DIME sectors, and the two groups are now tied. 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®