FBIAS™Fact-Based Investment Allocation Strategies for the week ending 10/23/2015

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 26.2, up from the prior week’s 25.7, 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 57.59, up from the prior week’s 56.80, 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 27, up substantially from the prior week’s 21.  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.

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), 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:

Friday’s 157 point gain in the Dow Jones Industrial Average marked the end of a strong week on Wall Street.  The Dow gained over 430 points to close at 17,646.  The Nasdaq surged over +2.9% ending the week back above the psychologically-important 5000 number at 5031.  The LargeCap S&P 500 added +2.07%.  However, the gains were concentrated in the LargeCap space, as the S&P 400 MidCap index gained only +0.38% and the SmallCap Russell 2000 rose an anemic +0.32%.  A particularly weak September job gains number is believed by some market watchers to have been the death knell for a 2015 interest-rate increase, and the interest rate cut by the People’s Bank of China added to the buying rush.

In international markets, Canada’s TSX gained +0.84% to close at 13953.  Much bigger returns for the week were found in Europe, where Germany’s DAX vaulted over +6.8%, followed by France’s CAC40 jumping +4.7%.  The United Kingdom’s FTSE gained +1.04%.  In Asia, Japan’s Nikkei gained +2.92% and China’s Shanghai Stock Exchange rose a more modest +0.62%.     

In commodities, Gold declined more than -$14 to $1,162.80 an ounce.  Silver likewise declined -1.27% to $15.83 an ounce.  A barrel of West Texas Intermediate crude oil declined more than -6.5% to $44.60 a barrel.

In US economic news, jobless claims remained near their recent lows as initial claims rose only 3,000 to 259,000 last week.  Analysts had expected a reading of 265,000.  There were 2.17 million continuing claims, while the 4-week moving average of claims reached a 15-year low of 2.184 million.

Housing starts for September came in at an annual rate of 1.206 million in September, which was the second strongest monthly reading since 2007 and well above expectations.  Starts were +17.5% higher versus a year ago.  On the other hand, new construction permits fell -5% at 1.1 million, missing expectations.  This may indicate a slower pace of building in the future.  Existing home sales were up +4.7% last month to an annual rate of 5.55 million according to the National Association of Realtors.  That was the second highest reading since 2007 and handily beat estimates of 5.35 million.  Mortgage and refinance applications both jumped for the week, too, up +11.8% and +16.4% respectively.  More good news on the housing front came from the Homebuilder Confidence reading from the National Association of Home Builders, which jumped to a new decade high in October.

The early reading on October US manufacturing activity, the “flash” Purchasing Managers Index (PMI), saw its sharpest pickup in new business conditions since May.  The reading increased nearly a point to 54.0, beating estimates of an unchanged reading.  Strong output was mostly driven by demand from the domestic US market.

The Conference Board’s US Leading Economic Indicators (LEI) fell -0.02% in September to 123.3.  Expectations had been for a flat reading.  The September reading suggests that growth will continue but at a tepid pace—around +2.5%, according to the Conference Board.

In Canada, wholesale shipments fell -0.1% in August, missing expectations of a slight gain.  Canada’s economy continues to struggle with the effects of low oil prices.  However, retail sales rose +0.5% in August, beating expectations.  The yearly gain increased to +2.8% suggesting better growth for the 3rd quarter.

In the Eurozone, The European Central Bank left rates and its bond buying program unchanged, as expected.  ECB President Mario Draghi suggested an increase in bond buying would be considered in December.  He stated that monetary policy alone wouldn’t be enough to spur the Eurozone to stronger growth.  ECB Governing Council member Ewald Nowotny stated that fiscal policy must become looser.  Previously fiscal policies were “restrictive”, and are now “neutral”, but there may be a need for it to become “expansive”, he was quoted as saying. 

Eurozone construction output declined -0.2% in August.  Building was down 0.2% during the month, and civil engineering fell 0.3%.  Construction activity has remained relatively weak along with the broader Eurozone economy.  Consumer sentiment also lost ground as October’s reading slipped to -7.7 from -7.1.  This was the lowest reading since January.  Germany, struggling to get even a little inflation in its economy, reported that producer prices fell -0.4% last month, more than expected.  The yearly decline now stands at -2.1%, the biggest year-over-year reading since January.  Excluding energy, which fell -1.1%, the producer price index was still down 0.1%.

In China, GDP grew at an annualized rate of +6.9% in the 3rd quarter.  That’s slightly below the official target of +7%, and the slowest rate of GDP growth since 2009.  Industrial production missed expectations, increasing only +5.7% versus last September.  Retail sales rose +10.9% versus last year, matching expectations.  The People’s Bank cut interest rates for the 6th time in a little less than a year and relaxed reserve requirements for banks making China’s stimulus levels the most accommodative since the financial crisis. 

Finally, this past week Italian luxury sports car maker Ferrari had its initial public offering priced at $52 a share, under the ticker symbol RACE.  However, Ferrari’s IPO was one of the declining number of IPOs in the current bull market.  According to Dealogic data, to this point in 2015 just 153 deals have been brought public, versus 242 at this same time last year, and 173 the year before.  The cooling in the IPO market is attributed by analysts to a disconnect between company expectations and current market reality.  Supermarket chain Albertson’s wished to raise $1.95 billion through a public sale of stock last week, but delayed its IPO until later this month or next.  Volatile markets, marked by a steep sell-off in late August, have led potential investors to demand better prices from the companies aspiring to go public.  Also not helping the IPO market is the fact that this year’s overall IPO returns are negative.  Renaissance Capital estimates that half of the companies that have gone public this year are trading below their IPO price, and even more are trading below their “first trade” prices (the price assigned to the public IPO-buyer not in on pre-trade share allocations).  In the case of Ferrari, the first-trade price was $60, yet Ferrari closed the week at $56.38, meaning that all public buyers of the IPO at the “first trade” price are under water already.

(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 9.8 from the prior week’s 11.3, while the average ranking of Offensive DIME sectors fell to 13.5 from the prior week’s 11.3.  Despite the market gains of the week, the Defensive SHUT sector have regained a slight rankings lead overs 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 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.

Sincerely,