FBIAS™ Fact-Based Investment Allocation Strategies for the week ending 11/6/2015
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 26.5, up from the prior week’s 26.3, 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 63.57, up from the prior week’s 60.57, 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 35, up from the prior week’s 31. 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:
Stock market gains were widespread for the first week of November. The SmallCap Russell 2000, which had not been participating in the rally off October’s lows jumped +3.26% last week. The Nasdaq composite added another +1.85% to end the week at 5,147. The Dow Jones Industrial Average gained +246.79 to end the week at 17,910. The S&P 400 MidCap index, which with SmallCaps had been relatively weak of late, added +1.28%, and the LargeCap S&P 500 added +0.95%. The only major US index to the downside was the Dow Jones Utilities Index, which plunged 4.14%. Canada’s TSX lagged the US indexes, gaining +0.18% for the week.
Among international markets, the big winner was China which lead the way with a +6.1% surge in the Shanghai Stock Exchange. Brazil also shook off recent weakness and gained +2.29%. France and Germany gained +1.77% and +1.27%, respectively. The United Kingdom was the only major European market in the red for the week, down, 0.11%.
In commodities, West Texas Intermediate crude oil was unable to build on last week’s strength and declined -4% to end the week at $44.52 a barrel. Precious metals also got hit as an ounce of gold declined -$52.80 an ounce to $1,088.90 and silver dropped -5.12% to $14.74 an ounce. The industrial metal copper also declined -3.15%.
In economic news, all eyes were on the Friday jobs report, taken as a harbinger of a possible December rate hike. The U.S. Department of Labor reported that employers added 271,000 jobs in October, blowing away forecasts of 190,000 and sending the official jobless rate to a 7 year low of 5.0%. Wage growth improved as well, with average hourly earnings rising +2.5% versus a year earlier. Most industries saw job growth. Chicago Fed President Charles Evans stated that the strong jobs report was “very good news” and that rising wages should help push up inflation. The lack of inflation in the recovery has hindered the Fed’s ability to raise interest rates. St. Louis Fed President James Bullard stated that the concerns that quelled a rate hike in October “have mostly passed”. The jobs report coincided with congressional testimony by Fed Chair Janet Yellen who told the House Financial Services Committee that the prospect of a December rate hike was a “live possibility” if the economy continued to perform well.
Payment processor ADP reported that private employers added 182,000 jobs in October. This was down slightly from the 190,000 added in September, but it met expectations. Small businesses made up half of those gains, while construction added 35,000 jobs. Manufacturing lost 2,000 jobs. Job placement firm Challenger reported that announced layoffs fell 14% to 50,504 last month, down from an average of 68,000. About a quarter of the cuts were related to the weakness in the oil market.
Nonfarm productivity jumped to a +1.6% annual rise in the 3rd quarter, more than the 0.1% expected, and following a 3.5% gain last quarter. Unit labor costs rose 1.4%, less than the 2.2% expected. The self-employed reported a drop in hours worked for the first time since the recession ended. Manufacturing reported productivity gains to the fastest rate since 2011.
Real Estate research firm CoreLogic reported that home prices were up +6.4% nationally last month versus a year ago. This is at the higher end of the annual increases that prices have averaged the past 15 months. CoreLogic forecasts a +4.7% yearly rise from August 2015 to September 2016. The Mortgage Bankers Association reported that home purchase applications fell -1% and refinancings fell -1% as well. The composite index declined 0.8% last week. The average 30 year fixed rate mortgage rose 3 bps to crack the 4% level, to 4.01%.
US Manufacturing barely held on to expansion as the Institute for Supply Management (ISM) factory gauge declined -0.1 point to 50.1 last month—just slightly beating expectations for an even 50 reading. New orders increased +2.8 points to 52.9, a good sign for future growth, but employment contracted to 47.6 (sub-50 is contraction territory). This is only the second time that employment has fallen into contraction since May of 2013. Exports improved a point to 47.5, but remained in contraction as well.
The service sector continued showing strength as the Purchasing Managers’ Index (PMI) for nonmanufacturing jumped +2.2 points to 59.1 last month. Production was up +2.8 points to 63 and new orders surged +5.3 points in a sign of strong activity in the future.
US factory orders were down -1% in September, the second-straight monthly decline, according to government figures. Transportation orders were down -3.1%; orders excluding transportation fell -0.6%. October marked the ninth straight month of year-over-year declines for core capital goods orders. This category is often used as a proxy for business investment. Those declines have accelerated from -1.2% in January to -7.5% in September.
However, market research firm Markit’s survey disagreed, with its manufacturing PMI rising +1 to 54.1. According to Markit, new orders rose the most since this spring. Export orders increased, but at a slower pace due to the stronger dollar. Employment and backlogs also both increased, said Markit.
In Canada, hiring jumped by +44,000 last month, blowing away expectations of a slight decline. Participation rose to the strongest rate in over a year at 66%. The jobless rate ticked down -0.1% to 7%.
In the Eurozone, Markit’s final manufacturing PMI for October was 52.3, a gain of +0.3 point. Several countries saw multi-month highs. New business and new export orders also improved, along with employment. In the major Eurozone economies, German manufacturing decreased slightly to 52.1 from 52.3, French manufacturing was unchanged at 50.6, and manufacturing in the United Kingdom surged 4 points to 55.5. Ireland, Spain and Germany had the strongest composite (services + manufacturing) readings.
In Asia, factories in China are still struggling as the official government PMI was unchanged at 49.8 in October, remaining slightly in the contraction range. The Caixin-Markit manufacturing gauge for China’s private firms also remains in contraction for the eighth straight month, at 48.3.
Finally, this week Bloomberg published a research note reporting that the U.S. earnings season is on track to be the worst since 2009. So far roughly three-quarters of the S&P 500 have reported results, with aggregate profits down -3.1% on a share-weighted basis. This marks the biggest quarterly drop in earnings since late 2009, and the second straight quarter of declines for this metric.
The one bright spot in the report is that damage seems to be heavily concentrated in the companies comprising the energy and commodity sectors. The energy sector is showing a -54% drop in quarterly earnings so far this earnings season, and profits in the materials sector are down -15%. On the flip side, the consumer discretionary and telecom sectors have been showing robust growth, with earnings per share growth up +19 percent and +23 percent respectively.
(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 15 from the prior week’s 12.3, while the average ranking of Offensive DIME sectors rose to 10.5 from the prior week’s 13.3. The Offensive DIME sectors took the lead over the Defensive SHUT 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®