FBIAS™ for the week ending 12/18/2015
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 25.5, little changed from the prior week’s 25.4, 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 around 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 57.11, down from the prior week’s 59.89, and continues in Cyclical Bull territory.
In the intermediate picture:
The intermediate (weeks to months) indicator (see graph below) turned negative on Friday, December 11. The indicator ended the week at 18, down sharply from the prior week’s 27. 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 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:
As expected, the Federal Reserve raised interest rates on Wednesday, ending the nearly decade-long zero-rate policy. Fed Chairwoman Janet Yellen stated that the conditions for a rate hike had been met, such as improving labor markets. The Fed made it clear that it is in no hurry to raise rates again and that its favorite gauge of inflation still remains below its 2% target. Stocks rose sharply in the days leading up the announcement, and on the day of the announcement rose another 1.5% as investors appeared to cheer the vote of confidence in the U.S. economy and the Fed’s dovish comments. But the day after, reality set back in and the market gave back all those gains on Thursday and Friday.
For the week, the Dow Jones Industrial Average declined -136 points to end the week at 17,128. Counterintuitively, the Dow Transports sold off even with the continued weakness in oil, down -2.13%. Utilities rebounded +3% as investors rotated into defensive sectors. The LargeCap S&P 500 declined a third of a percent but remained barely above 2000 at 2005. MidCaps and SmallCaps declined -1% and -0.23%, respectively. The Nasdaq was unable to defend the 5000-level, closing at 4923, down -0.21%. Canada’s TSX recovered some lost ground from last week’s plunge, gaining +1.83% to close at 13,024.
In international markets, strength was found in European markets as Germany’s DAX gained +2.59%, France’s CAC40 rose +1.66%, and the United Kingdom’s FTSE increased 1.67%. Major markets in Asia were mixed with China rallying +4.2%, but Japan’s Nikkei declining -1.27%.
In commodities, precious metals were mixed as Silver gained +1.37% to $14.08 an ounce, while Gold went down $8.10 to end at $1,065.60 an ounce. A barrel of West Texas Intermediate crude oil reached a new 6-year low of $34.53 a barrel last week, but rebounded closing up +1.33% to $35.83.
In US economic news, new unemployment claims declined 11,000 last week to 271,000 the smoothed 4-week average remained flat at 270,500 according to the Labor Department. It was the 41st consecutive week of jobless claims below 300,000, the longest run since the early 1970’s.
The Commerce Department reported that builders of houses and apartments increased construction by +10.5% in November after the -12% plunge the previous month. Single-family starts and building permits rose to their best levels since December of 2007. Housing permits gained +11% to an annualized rate of 1.289 million, beating forecasts of 1.146 million. Homes under construction rose +2.2% for the month, and is up +18.3% for the year. The National Association of Home Builders Housing Market Index declined a point to 61 in December, still in expansion but at a slightly slower pace. All 3 components of the index declined–six-month sales outlook, current conditions, and buyer traffic.
The Labor Department reported that core inflation rose at an annualized rate of 2% last month, reaching the Federal Reserve’s target, an important milestone that set the stage for Wednesday’s first interest rate increase in a decade. However, the Consumer Price Index (CPI) was unchanged versus October as energy prices fell -1.3%.
Several regional Fed surveys of the state of manufacturing in their respective areas were released this week. The Philadelphia Fed’s manufacturing index came in worse than expected as weak global demand, a strong dollar, and falling commodities prices impacted U.S. manufacturers. The index sank to -5.9, the 3rd negative reading in 4 months. Analysts had expected a reading of 1.2. New orders plunged to -9.5, the 3rd straight month in negative territory. Shipments were up as manufacturers worked through their backlogs, but unfilled orders fell to -17.7, inputs declined to -9.8, and final goods came in at -8.7. The New York Fed’s Empire State Manufacturing Survey was similarly negative, though less so than the prior report. The Kansas City Fed’s manufacturing index plunged to 8, the eighth contraction in the last 9 months. Confirming these regional surveys, the Fed reported that the US-wide Industrial sector was weak in November as output contracted -0.6%, worse than the -0.2% drop expected.
Markit’s Purchasing Managers Index (PMI) for manufacturing 51.3 for December, the lowest reading in over 3 years and widely missing estimates of 52.8. New orders showed the weakest rate of monthly expansion in 6 years. Backlog orders were in contraction for the second consecutive month. Markit’s flash PMI for services slowed to 53.7 from November’s 56.5, the lowest services reading in a year. The weak overall reading reflects 5 months of contraction in backlog orders along with the slower growth in new orders.
In Canada, the consumer price index declined -0.1% in November, but was up +1.4% compared to the same time last year. The decrease was attributed to seasonal factors.
In the Eurozone, industrial production ex-construction rose +0.6% in October, beating expectations of a +0.2% gain, and was the first increase since July. Year over year industrial production rose +1.9%. Output increased +1.4% in capital goods and +1.8% in durable goods over September. December’s flash PMI composite report slightly missed estimates, coming in at 54. Manufacturing was at 53.1 and the services component was at 53.9, both in the “greater than 50” expansion area.
Finally, “Bonds is Bonds” is the attitude many investors have when it comes to fixed income investments. That attitude has been dangerous this year, as the bond market has bifurcated dramatically along “quality” lines.
Higher quality bonds – Treasuries and high-grade Corporates – have maintained their values well during 2015, but the lower-quality end of the market, commonly called the “Junk Bond” market, has suffered badly. One Junk Bond mutual fund, the Third Avenue Focused Credit Fund, even announced that it was halting redemptions and would proceed into liquidation – after dropping about 50% in value.
Overall, the Junk Bond area has lost about -12% in the last 6 months, while high-grade bonds have maintained their value and the stock market has pulled back about -5% during the same period. See the chart below for the comparison.
(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 12.0 from the prior week’s 14.8, while the average ranking of Offensive DIME sectors fell to 15.0 from the prior week’s 13.5. The Defensive SHUT sectors have taken back the lead from the Offensive DIME 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®