FBIAS™ Fact-Based Investment Allocation Strategies for the week ending 11/20/2015
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 26.4, up 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 60.99, up from the prior week’s 60.16, and continues in Cyclical Bull territory.
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 31, down from the prior week’s 33. 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), the US is the only major market still firmly in 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 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:
A week of strong gains nearly offset the previous week’s sharp losses and brought the LargeCap S&P 500 index back into positive territory for the year. The Dow Jones Industrial Average gained 578 points to end the week at 17,823, a gain of +3.36%. The tech-heavy Nasdaq blew through the 5000-level again, gaining 177 points and closing at 5,104, an improvement of +3.59%. The LargeCap S&P 500 gained +3.27%, the MidCap S&P 400 was up +2.92%, and the SmallCap Russell 2000 was up +2.49%. As has been the case for some time, the SmallCap and MidCap indexes have been unable to match the gains of their LargeCap brethren. Canada’s TSX gained +2.74%, at the low end of US gains.
In Europe, Germany’s DAX Composite was up a strong +3.84%, and the United Kingdom’s FTSE gained +3.54%. Doing less well, but still positive, were France’s CAC40 (+2.14%) and Italy’s Milan FTSE (+1.36%). In Asia, major markets gained across the board with China’s Shanghai Stock Exchange up +1.39%, Hong Kong’s Hang Seng rising +1.6%, and Japan’s Nikkei climbing +1.44%.
In commodities, a barrel of West Texas Intermediate crude oil gained $0.73 to $41.46 a barrel. Crude oil spent the week retesting support at the $40 a barrel level, last visited in late August. Precious metals gave up ground as both Gold and Silver were down roughly -0.6% at $1076.70 and $14.14 an ounce, respectively. Copper continued its plunge, down over -5.7% last week. If copper is a harbinger of upcoming worldwide industrial health, as many maintain it is, then the future is not bright for that segment as copper hit a low this week not seen since the Great Recession of 2008-09.
In US economic news, initial claims for state unemployment benefits fell by -5,000 last week to 271,000, according to the labor department. Initial claims have been holding near a 42-year low and have been below 300,000 for over half a year. The number of people continuing to claim benefits rose by +2,000 to 2.18 million.
Housing starts fell -11% in October to an annual rate of 1.06 million units, with the decline led by a plunge in new apartment construction. On the other hand, permits for single-family homes rose to the best level in almost 8 years. Single-family home starts fell -2.4% to 722,000, the lowest since March. The Mortgage Bankers Association reported that mortgage applications rose +6.2% last week; rising mortgage rates are encouraging buyers to act sooner rather than later. Delinquency rates for mortgage loans fell in the third quarter to their lowest rate since 2007, and mortgage foreclosures fell to the lowest rate since 2005.
The October US Consumer Price Index rose +0.2% versus September. Energy prices rose last month, but are still down -17.1% versus October of last year. Core inflation, which excludes food and energy, remained at 1.9% and is holding just below the Federal Reserve’s oft-stated 2% target.
US manufacturing rebounded in October as manufacturing output rose +0.4% after two months of declines. Motor vehicle production advanced +0.7% to a +10.9% annual gain as carmakers enjoy their strongest US sales in years. However, overall industrial production declined -0.2% last month, reflecting weakness in the mining sector and utilities.
The New York Federal Reserve’s Empire State Manufacturing Index was still in contraction at -10.74 in November. Economists had been expecting an improvement to -5. New orders and shipments improved, but were still negative for the fourth straight month. Unfilled orders, the workweek, and employment gauges were all the weakest in a year. The Empire State index is the first of several factory activity gauges scheduled for release in November.
New York Fed President William Dudley said that he Federal Reserve rate hike should show confidence in the economy, though he admits he doesn’t know how markets would react to a rate lift off. He also stated that winding down the global banking giants safely in a crisis would require more work–specifically making their legal structures “more rational and less complex.”
In their October meeting minutes, released on Wednesday of this week, Federal Reserve policymakers inserted language stating that “it may well become appropriate” to raise the benchmark lending rate in December, and largely agreed that the pace of increases would be gradual. According to the minutes, “members emphasized that this change was intended to convey the sense that, while no decision had been made, it may well become appropriate to initiate the normalization process at the next meeting.” A majority of Fed officials have now signaled that they expect to raise interest rates this year for the first time since 2006.
In Canada, September retail sales fell -0.5% after 4 months of gains, worse than expectations. Excluding price changes, retail sales volume rose a bare +0.1%. Canada’s October consumer price index rose +0.1% versus September, and sits at 1% versus a year earlier. Core CPI was up +0.2% versus September and up 1.7% versus a year earlier.
In the Eurozone, European Central Bank (ECB) policymakers will “do what we must”, as expressed by ECB President Mario Draghi, giving an indication that the ECB will ease further at its December 3rd meeting. The ECB President also stated that the bank is ready to act quickly to boost anemic inflation in the Eurozone—“If we decide that the current trajectory of our policy is not sufficient to achieve our objective, we will do what we must to raise inflation as quickly as possible.” They definitely have their work cut out for them: October consumer prices rose +0.1% versus September, while Core CPI grew +0.2%. Core inflation was an annualized 1.1% for October versus September’s 1%.
Japan has fallen back into recession as the economy contracted at a -0.8% annual rate in the third-quarter, following a -0.7% decline in Q2. Business spending fell at a -1.3% rate, worse than forecasts and the second straight decline. The data will doubtless put even more pressure on the Bank of Japan to step up its monetary easing program.
Finally, last week we noted the narrowing leadership in the LargeCap S&P 500. The largest 90 of the S&P 500 are showing gains for the year, while the remaining 410 are, on average, down substantially. The same situation – but even more narrow – exists in the Nasdaq 100, the home of the largest tech titans. A new acronym has been born – “FANG”. FANG stands for Facebook, Amazon, Netflix and Google. One could say that “without FANG, the market’s not worth a dang!” Consider this: with FANG, the Nasdaq 100 is +10% for the year; but without just these four FANG members (leaving 96 other Nasdaq 100 stocks), the Nasdaq 100 is -5% for the year.
(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 16.8 from the prior week’s 18.0, while the average ranking of Offensive DIME sectors fell slightly to 11.0 from the prior week’s 10.8. The Offensive DIME sectors continue to lead 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®