FBIAS™ Fact Based Investment Allocation Strategies for the week ending 1/29/2016

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 the 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 24.56, up from the prior week’s 24.16, after having earlier reached the level also reached at the pre-crash high in October, 2007.  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 the 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 U.S. Bull-Bear Indicator (see the graph below) turned negative on January 15th, and remains in Cyclical Bear territory at 42.73, up from the prior week’s 41.79.

In the intermediate picture:

The intermediate (weeks to months) indicator (see the graph below) turned positive on January 26th.  The indicator ended the week at 6, up smartly from the prior week’s 0.  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 January for the prospects for the first quarter of 2016.

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.  The Bull-Bear Indicator (months to years) is negative (Fig. 3 above), indicating a new Cyclical Bear has arrived.   The Quarterly Trend Indicator (months to quarters) is negative, and the Intermediate (weeks to months) timeframe (Fig. 4 above) is positive.  Therefore, with two of the three indicators negative, the U.S. equity markets are rated as Mostly Negative.

In the markets:

The U.S. stock market capped a volatile week with a +396 point rally on Friday.  Analysts attributed the rally to a few strong earnings reports, expectations of slower rate hikes by the Fed, and – most of all – the adoption of negative interest rates by the Bank of Japan.  For the week, the Dow Jones Industrial Average rose +2.3%, up +372 points to 16,466.  The NASDAQ Composite was the laggard of the major indexes, gaining just half a percent and ending the week at 4,614.  The LargeCap S&P 500 rose +1.75%, the MidCap S&P 400 added +2.3%, and the SmallCap Russell 2000 gained +1.4%. 

In international markets, Canada’s TSX rebounded +3.49%, helped by the rise in prices for oil and gold.  In Europe, the United Kingdom’s FTSE rose +3.1%, France’s CAC 40 gained +1.85%, and Germany’s DAX added +0.34%.  In Asia, Japan’s Nikkei ended the week up +3.3%, and Hong Kong’s Hang Seng index rose +3.1%.  But China was unable to halt its decline and fell for a 5th straight week, down an additional -6.14%.

In commodities, a barrel of West Texas Intermediate crude oil surged +4.3% to $33.62.  In precious metals, an ounce of silver rose +1.68% to $14.26, and gold tacked on +$20.20 to end the week at $1,118.40 an ounce.

The month of January was a rough one for stock markets worldwide.  The SmallCap Russell 2000 was the worst-performing US index in January, down -8.85%, followed closely by the NASDAQ Composite, down -7.86%.  The best-performing US index was the S&P 500, at “just” -5.07% (the worst month for the S&P 500 since last August, and the worst January since 2009).  After a disappointing (-11.1%) performance in 2015, Canada was the least-damaged major world market in January, at a relatively benign -1.44% for the Toronto TSX Composite.  Developed International and Emerging International were in the same ballpark as the US for January, returning -5.03% and 5.52% respectively.

In U.S. economic news, Initial claims for jobless benefits fell 16,000 to 278,000 last week according to the Labor Department.  This was a relief to economists who worried that after new claims touched a 7-month high earlier this month a softening in the labor market might have begun, but the lower claims number is new evidence that the labor market is still relatively upbeat despite a slowing overall U.S. economy. 

In U.S. housing, S&P/Case-Shiller reported that U.S. home price gains accelerated in November, slightly beating expectations.  The index, based on a sample of 20 major metro areas, saw a +5.8% annual gain—the highest since July 2014.  Portland, Denver, and San Francisco continue to lead with double-digit gains.  National Association of Realtors chief economist Lawrence Yun noted in a press release that “While sustained job creation is spurring more activity, the ability to find available homes in affordable price ranges is difficult for buyers in many job creating areas.”

Demand for long-lasting “durable” goods declined sharply in December, signaling a downturn in business investment in 2015 that worsened in the final months of the year.  The Commerce Department said orders for durable goods fell a seasonally-adjusted -5.1% last month, the biggest decline in a year and a half.  Economists had been expecting only a -1.5% decline.  Of particular concern is the orders number for core capital-goods, which remove aircraft and defense.  That metric declined -4.3% in December and is down -7.5% for the year.  This was the first annual decline in 3 years.

A dismal start to the year in the markets hasn’t impacted the U.S. consumer.  The Consumer Confidence Index beat estimates by 2 points coming in at 98.1 this month according to the Conference Board.  The number is closely watched by analysts due to the U.S. consumer driving 70% of the economy.  Less than a quarter of respondents said jobs were hard to get, but those saying they were “plentiful” fell slightly.

Crude oil’s 70% plunge since June of 2014 has hurt the Lone Star state in a big way.  The Dallas Federal Reserve’s general business activity index declined to -34.6 in January, plunging further into negative territory following December’s -21.6 reading.  The reading is the most negative since April of 2009.  The production index, which had been the last bastion of strength despite weak orders, finally capitulated into negative territory dropping 23 points to -10.2.  New orders and unfilled orders fell deeper into contraction.  The Texas employment index also turned negative for the first time in 3 months.

On Wednesday the Federal Reserve kept its key interest rate unchanged and signaled that it’s taking a time-out before resuming its effort to normalize interest rate policy.  The lack of movement was widely expected.  Fed watchers noted that one key phrase had been removed from the post-meeting statement that was present in the December minutes.  The phrase “The committee…is reasonably confident that inflation will rise, over the medium term, to its 2 percent objective.” was replaced with inflation is “expected to remain low in the near term” but still rise to the 2% in the medium term.  Though the change is subtle, it implies that the Fed is retreating from the implied projection of 4 quarter-point rate hikes in 2016.

In Japan, the Bank of Japan shocked markets around the world by taking the aggressive step of cutting interest rates below zero on Friday.  The policy essentially means that banks will have to pay for the privilege of “parking” money at the central bank, and in theory this should motivate the banks to lend more.  The move represents a last resort for the country that has struggled with weak growth for a quarter-century.  This move was also widely interpreted as being a damper on the pace at which the U.S. Fed increases interest rates, since now the European Central Bank and the Bank of Japan have gone the opposite direction as the U.S. in their respective interest rate policies.

In China, capital outflows surged $158.7 billion in December to an estimated $1 trillion for all of 2015.  The large scale of the outflows is a sign of the battle being waged among policymakers trying to manage the yuan amid slower economic growth and falling Chinese stock markets.  The entire year’s estimated trillion-dollar total is greater than 7 times the prior year’s $134.3 billion, according to Bloomberg Intelligence data.  December’s outflows increased by almost $50 billion over November after China’s central bank stated that it would refocus the yuan’s moves against a wider basket of currencies than just the dollar. 

Finally, one long-standing indicator of stock market health is the amount of money borrowed by investors and speculators for stock purchases – called “margin debt”.  The amount of outstanding margin debt reached a peak last April and has declined steadily ever since.  Originally devised in the 1970’s by market analyst Norman Fosback, the margin debt indicator has a good record of identifying Bull and Bear markets when compared to its own 12-month moving average.  The identification is even more accurate when the margin debt breach is more than a one-month aberration.  Unhappily for the Bulls, margin debt has now remained below its 12-month moving average for 5 consecutive months.

(sources: all index return data from Yahoo Finance; 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 6.3 from the prior week’s 6.5, while the average ranking of Offensive DIME sectors also rose slightly to 16.3 from the prior week’s 16.5.  The Defensive SHUT sectors have maintained their lead over 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, despite the superior US performance.  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  schedule 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,

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 24.16, up from the prior week’s 23.82, after having earlier reached the level also reached at the pre-crash high in October, 2007.  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 U.S. Bull-Bear Indicator (see graph below) turned negative on January 15th, and remains in Cyclical Bear territory at 41.79.

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 0, down prior week’s 1.  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 January for the prospects for the first quarter of 2016.

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.  The Bull-Bear Indicator (months to years) is negative, indicating a new Cyclical Bear has arrived.   In the Intermediate (weeks to months) timeframe (Fig. 4 above), U.S. equity markets are rated as Negative.  The quarter-by-quarter indicator gave a negative signal for the 1st quarter:  neither U.S. equities nor ex-U.S. equities were in an uptrend at the start of Q1 2016, sufficient to signal a higher likelihood of a down quarter than an up quarter. All three major indicators – Bull-Bear, Quarterly Trend, and Intermediate are now negative, making the current market condition very negative.

In the markets:

In U.S. markets this week, a plunge on Wednesday took the major indexes down nearly 4% to levels not seen since early 2014.  However, by late afternoon the markets had retraced a majority of the losses.  Strong rallies on Thursday and Friday gave the indexes their first weekly gains of 2016, leading some to declare that “the bottom” had been seen.  The European Central Bank’s head, Mario Draghi, can take much of the credit for the U.S. rally – see the notes further below.  For the week the Dow Jones Industrial Average added 105 points (+0.7%) to close at 16,093, but that number masks the 700+ point intra-week swing in the index.  The NASDAQ composite added 102 points to 4,591, up +2.29%.  The LargeCap S&P 500 added +1.4%, the MidCap S&P 400 index gained +1.4% as well, and the SmallCap Russell 2000 was the relative laggard, up +1.28%.  Small caps have been hit the hardest in this correction and remain down over -10% year-to-date.  Usually, the most-beaten-down index rallies the hardest in a rebound, but that was not the case here.

In international equity markets, Canada’s TSX recovered 2.6% last week.  European bourses regained some lost ground with Germany’s DAX up +2.3% and France’s CAC 40 up +3.01%.  The United Kingdom’s FTSE was up +1.65%.  In Asia, China’s Shanghai Stock Exchange index was up +0.54% for the week.  On the downside, Japan’s Nikkei gave up -1.1% and Hong Kong’s Hang Seng index ended the week down -2.26%.

In commodities, oil was finally able to halt its plunge and reversed up strongly to $32.25 a barrel for West Texas Intermediate, up 5.12%.  Copper was bid up by +2.8%, and precious metals also found strength as Gold added +$9.60 an ounce to $1098.20 and Silver gained +0.79% to $14.02 an ounce. 

In U.S. economic news, new claims for jobless benefits rose by 10,000 to 293,000 last week to the highest since July.  The reading brought the 4-week moving average of claims to its highest level since April of last year.  Continuing claims rose by 29,000 to 2.21 million.

Housing starts missed expectations of a +2.3% increase and declined -2.5% in December to a seasonally adjusted 1.149 million units, according to the Commerce Department.  Permits fell -3.9% to 1.232 million units.  But housing construction permits actually came in better than expected; analysts had forecast a decline of -5.6%.  December marked the ninth consecutive month that housing starts were above 1 million, the longest streak since 2007.

Mortgage applications increased +9% due to a decline in rates last week, according to the Mortgage Bankers Association.  Refinancing applications also rose by a seasonally-adjusted +19%, but the number remains 40% below last year’s level.  Purchase applications were down -2%.

On a positive note in housing, existing home sales jumped in December to end their best year in 10 years.  Existing home sales surged 14.7% in December to a 5.47 million annualized pace, according to the National Association of Realtors.  Analysts were quick to point out that the strong reading followed a weak November and may be due to a change in mortgage regulations that slowed purchasing closings.  For the year, the 5.26 million sales were the highest since 2006’s 6.48 million.  Tight inventories helped lift the median home sale price +7.6% to $224,100. 

Sentiment among home builders dipped as the National Association of Home Builders’ Housing Market Index declined 1 point to 60.  Sentiment remains in expansion, although economists had forecasted a 62 reading.  Prospective home buyers appeared to lose some interest as the gauge tracking them fell to 44 from last month’s reading of 46.  The 6-month outlook of by the home builders of future sales also declined to 63 from last month’s 66—it was the lowest reading since last May.

Manufacturing continued to contract, according to the Philadelphia Federal Reserve Business Outlook Survey, although at a slower rate than before.  Januarys’ headline index beat expectations, coming in at -3.5.  Though still negative, the index rebounded strongly from December’s -10.2 plunge.  The index has now logged its 5th straight month of contraction.  On the positive side, new orders had their best reading since September at -1.4, and shipments returned to expansion at 9.6.  But factories continue to reduce their stockpiles.  Destocking by factories continues to be a drag on production and will weigh heavily on 4th quarter GDP growth.

Markit’s U.S. manufacturing Purchasing Managers’ Index (PMI) flash estimate rose to 52.7 this month from a 3-year low in December of 51.2.  Manufacturers stated the improvement was due to increased orders coming from domestic demand, not exports.  Employment remained slow as manufacturers reported to Market that they prefer to take a cautious approach to see if the upturn in orders will be sustained.

CEO’s around the world have turned pessimistic on further global growth according to a new survey by PricewaterhouseCoopers LLC.  The report, released on the eve of the World Economic Forum’s annual meeting in Davos, Switzerland, polled 1409 CEO’s from 83 nations and revealed that only 27% of respondents expect the economic outlook to improve this year, a decline of 10% from the report last year.  The percentage of CEO’s that feel the economic outlook will worsen in 2016 rose 6% to 23%. 

The Consumer Price Index missed expectations of a flat reading and declined -0.1% last month as energy prices fell -2.4%, according to the Labor Department.  Core prices, ex-food and energy rose 0.1%; analysts had expected another 0.2% gain.  Consumer prices are up just +0.7% from this time last year.  The so-called “Core” CPI, which excludes food and energy, is up +2.1% from a year earlier due to an increase in the price of services.  Services prices are up +2.9% from a year earlier in December, the largest annual increase since October of 2008.  Harm Bandholz, chief U.S. economist at UniCredit Research commented, “In a service-based economy, such as the U.S., prices for services carry a much higher weight than the prices for goods.  And services are, in turn, much more dependent on the strength of the domestic economy.”

Wal-Mart (WMT) made the decision to close 154 of its stores “to keep the company strong and positioned for the future”.  Some analysts interpreted Wal-Mart’s move as a sign that the retailer may not remain in markets that adopt high minimum wages, saying that it couldn’t be just a coincidence that Wal-Mart’s closures targeted stores in areas of the country with the highest minimum wages.  Oakland, California lost its one and only Wal-Mart, and Los Angeles lost both of theirs—both areas that enforce a minimum wage of $15 an hour.

In Canada, manufacturing rebounded +1% in November, double what economists expected.  The increase ended 3 consecutive months of declines.  New motor vehicles increased +3.8%, machinery rose +1.6%, and electrical equipment-related components increased +6.5%.  The Bank of Canada left its benchmark interest rate at 0.5%.  Economists had been expecting a quarter point rate cut to 0.25%.  The Canadian dollar immediately jumped about half a penny against the U.S. dollar on the news.  Canada’s central bank is forecasting just +1.5% growth this year, but a better +2.5% in 2017.

In Europe, the European Central Bank (ECB) left its key interest rates unchanged, which was widely expected.  Following the meeting President Mario Draghi said downside risks to the Eurozone have increased and that inflation expectations had weakened.  He unexpectedly suggested that the ECB is ready to adjust policy sooner rather than later, perhaps even in March.  He said there were “no limits” to how far the ECB might go.  European markets rocketed higher on his words, and the U.S. was brought along with it.

Finally, it was bound to happen.  This past week saw a most unusual event occur in the oil market.  Crude oil producers actually had to pay refiners to take some forms of crude oil off their hands.  On January 15th, Flint Hills Resources refinery, a large processor of oil produced in the Dakotas, posted a price of -$0.50 a barrel (yes, that’s right: minus 50 cents!) to take one particular type of crude oil – “North Dakota Sour”.  North Dakota Sour is a high-sulfur grade of crude oil that undergoes a more rigorous and costly refining process, but even so, having to pay refiners to take oil off the producers’ hands is truly a sign of the times.  For some perspective, North Dakota Sour was fetching $13.50 a barrel a year ago and $47.60 a barrel in January 2014.  Overall, U.S. benchmark oil prices have plunged more than 70% in the last 18 months and fell below $30 a barrel for the first time in 12 years last week.  At the end of this past week, on January 22nd, the price had risen to a whopping $1.50 per barrel.

(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 6.5 from the prior week’s 6.8, while the average ranking of Offensive DIME sectors fell to 16.5 from the prior week’s 15.5.  The Defensive SHUT sectors have maintained their lead over 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, despite the superior US performance.  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.

FBIAS™  Fact Based Investment Allocation Strategies for the week ending 1/15/2016

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 23.82, down from the prior week’s 24.4, after having earlier reached the level also reached at the pre-crash high in October, 2007.  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 U.S. Bull-Bear Indicator (see graph below) turned negative this week, dropping into Cyclical Bear 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 1, down sharply from the prior week’s 10.  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 January for the prospects for the first quarter of 2016.

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.  The Bull-Bear Indicator (months to years) is negative, indicating a new Cyclical Bear has arrived.   In the Intermediate (weeks to months) timeframe (Fig. 4 above), U.S. equity markets are rated as Negative.  The quarter-by-quarter indicator gave a negative signal for the 1st quarter:  neither U.S. equities nor ex-U.S. equities were in an uptrend at the start of Q1 2016, sufficient to signal a higher likelihood of a down quarter than an up quarter. All three major indicators – Bull-Bear, Quarterly Trend, and Intermediate are now negative, making the current market condition very negative.

In the markets:

Stocks declined for a third consecutive week after sell-offs on Wednesday and Friday overwhelmed the market’s attempt to stabilize after a difficult start to 2016.  Small cap stocks have now officially entered bear market territory as the Russell 2000 index has declined more than 20% from its recent highs.  The other major benchmarks are all in correction territory—down greater than 10% from their highs.  For the week, the Dow Jones Industrial Average lost 358 points, or -2.19%, to end the week at 15,988.  The NASDAQ composite declined 3.34%, ending the week at 4,488.  The LargeCap S&P 500 gave up -2.17%, while the MidCap S&P 400 and SmallCap Russell 2000 continue to show relative weakness, ending down -2.95% and -3.68% respectively.  The Dow Jones Utilities Average was alone in bucking the trend and gained +0.69%, as investors sought the safety of the traditionally-defensive utility sector.

In international markets, Canada’s TSX continued to decline on weakness in the oil sector, down -2.99%.  Europe had a difficult week as well.  The United Kingdom’s FTSE was down -1.83%.  On the mainland France’s CAC40 declined -2.85%, Germany’s DAX gave up -3.09%, and Italy’s Milan FTSE lost -3.39%.  In Asia, China’s Shanghai Stock Exchange plunged -8.96%.  Hong Kong’s Hang Seng lost -4.56% and Japan’s Nikkei was down -3.11%.

In commodities, the industrial metal copper declined a further -3.3% last week.  A barrel of West Texas Intermediate crude oil lost -6.69% or $2.20 to $30.68 a barrel.  Crude oil had briefly traded below $30 a barrel last week, a low not seen since 2004.  Precious metals were also negative with an ounce of gold trading down -$15.50 to $1088.60, while silver lost a penny and closed at $13.91 an ounce.

In U.S. economic news, new jobless claims rose 7,000 to 284,000 last week, according to the Labor Department.  The final number is the highest since July.  The smoothed moving average of claims rose 3,000 to 278,750, the highest in 6 months.  Continuing claims for jobless benefits rose to the highest level since September, up 29,000. 

The Labor Department reported that 2.83 million people quit their jobs in November, up from 2.78 million and the most since April 2008 according to the latest Job Openings and Labor Turnover Survey (JOLTS).  Hires were up 29,000 from October to 5.197 million in November.  Layoffs declined to 1.69 million, down from both October’s and September’s numbers.  The number of job openings rose 82,000 to 5.431 million, slightly missing forecasts and below July’s all-time high of 5.668 million.

Last week, the number of U.S. oil rigs in production fell to the lowest level since April 2010 as the price for a barrel of crude plunged to a new low.  Last week, the number of rigs in operation dropped by 20 to 516, the 7th decline in the last 8 weeks, according to Baker Hughes.  The current number of rigs in operation is a whopping 64% lower than this time last year.  According to the EIA, U.S. shale output is expected to decline by 116,000 barrels/day (bpd) in February to 4.8 million bpd.  It would be the seventh straight monthly decline in bpd, but still only 638,000 below the March 2015 bpd peak.  In addition, the EIA reported that U.S. crude and fuel stockpiles had climbed the previous week.  Crude inventories rose 234,000 barrels to 482.6 million barrels last week.  Supplies in Cushing, Oklahoma, the delivery point for West Texas Intermediate crude oil, climbed to an all-time high of 64 million barrels.

The Commerce Department reported that retail sales were down -0.1% in December, missing expectations for a flat reading.  The bigger surprise was the -0.1% decline in sales ex-autos.  Economists were hoping for a +0.3% rise in the holiday shopping season.  Lower gas prices continued to weigh on sales, but even ex-autos and gas, sales were still flat.  Seasonally adjusted sales at motor vehicle & parts dealers remained unchanged.  Non-store sales, which are retailers such as Amazon, saw their sales rise +0.3% last month, and up +7.1% versus a year earlier—the biggest gain since October 2014.  Strong gains were also reported in food service, building materials retailers, and furniture stores, but sales at general merchandise stores declined -1%.

U.S. import prices fell -1.2% last month according to the Labor Department adding increased pressure on U.S. large global product makers such as Apple, General Electric, and Caterpillar.  The price decline wasn’t as steep as expected, but it was the 6th straight monthly decline.  Year over year, import prices are down -8.2%.  Import prices for Chinese goods declined -1.7%, and -3.4% for non-petroleum goods—the strongest yearly declines since 2009.  The stronger dollar continues to get most of the blame (or credit) for falling import prices, but also gets the blame for weakening exports. 

Factory activity in the New York area continued to sink as the Empire State Manufacturing Index declined to 19.37 for January, its lowest reading since March 2009.  It was more than a 14 point plunge from December’s reading and far worse than the expectation of a -4 reading.  The contraction has been ongoing since August.  New orders collapsed to -23.54, the 8th consecutive monthly decline and the steepest decline since early 2009.  Unfilled orders, employment, and shipments were all negative, at -11, -13, and -14.39 respectively.  The 6-month outlook also declined 26 points to 9.5—the least optimistic reading since March 2009. 

St. Louis Fed President James Bullard said “Headline inflation will return to target once oil prices stabilize, but recent further declines in global oil prices are calling into question when such a stabilization may occur.”  Bullard, considered one of the more hawkish Fed officials, said policymakers usually “look through” oil price swings, but that this is “one circumstance where one may be more concerned when inflation expectations themselves begin to change due to the changes in crude oil prices.”  Bullard’s comments lead Fed watchers to believe that the Fed will be less eager to raise rates again after their last initial hike last month. 

Finally, we certainly don’t know yet whether the recent market weakness is the opening slide into a new Cyclical Bear period (as the Bull-Bear Indicator suggests), or is just a less-damaging “correction” in a longer-running Cyclical Bull.  What we can be certain of, however, is that the U.S. market is still richly valued.  Mark Hulbert, of Marketwatch.com, published the graphic below which shows that the 6 most widely-used valuation measures are still higher – even after the current market decline – than they were at 70%-90% of all prior bull-market peaks.

(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 was unchanged at 6.8, while the average ranking of Offensive DIME sectors rose slightly to 15.5 from the prior week’s 15.8.  The Defensive SHUT sectors have maintained their lead over 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, despite the superior US performance.  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.

FBIAS™ Fact Based Investment Allocation Strategies for the week ending 1/8/2016

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 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 24.4, down from the prior week’s 25.9, 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 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 U.S. Bull-Bear Indicator (see graph below) is at 48.31, down sharply from the prior week’s 57.51, and approaching Cyclical Bear 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 10, down substantially from the prior week’s 19.  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 January for the prospects for the first quarter of 2016.

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 Intermediate (weeks to months) timeframe (Fig. 4), U.S. equity markets are rated as Negative.  The quarter-by-quarter indicator gave a negative signal for the 1st quarter:  neither U.S. equities nor ex-U.S. equities were in an uptrend at the start of Q1 2016, sufficient to signal a higher likelihood of a down quarter than an up quarter. With the Quarterly Trend Indicator and the Intermediate Indicator both negative, and only the Cyclical timeframe indicator positive, the current market condition is mostly negative.

In the markets:

Stocks in the U.S. got off to their worst start to a year – ever.  The damage hit every major index, starting with the LargeCap S&P 500, which tumbled almost 6%.  The Dow Jones Industrial Average dropped over 1,000 points to 16,346, down -6.19%.  The SmallCap Russell 2000 was the worst-performing U.S. index, plunging -7.9% (despite the so-called “January Effect”, which historically favors Small Caps), and the tech-heavy Nasdaq composite lost over 363 points to 4,643, down -7.26%.  MidCaps were also hit, with the S&P 400 declining -6.44%.

Bespoke Investment Group (BIG) reported a damage assessment of the market after the close on Friday – and it isn’t pretty.  According to BIG, stocks in the S&P 500 index are, on average, down -22.6% from their 12 month peaks.  Stocks in the S&P 400 are down -26.5% on average.  Small cap stocks are the hardest hit, down -30.7%, on average.  Eight of ten major U.S. sectors are down more than -20% from their highs.  The only 2 sectors down less than -20% are the defensive Consumer Staples and Utilities.  The average energy sector stock is down the worst, at 52.1%.

International markets were not spared the carnage.  In North America, Canada’s Toronto Stock exchange declined -4.34% and Mexico’s Bolsa fell -6.3%.  In Europe, the United Kingdom’s FTSE was down -5.28%, Germany’s DAX plunged -8.32%, France’s CAC 40 was down -6.54%, and Italy’s Milan FTSE declined -7.23%.  The real carnage was in Asia, where China’s Shanghai Stock exchange cratered almost 10%, despite repeated circuit breaker halting and interventions by the People’s Bank of China, and Japan’s Nikkei was down over -7%.

In commodities, oil continued its fall, reaching a 12-year low of $32.88 for a barrel of West Texas Intermediate crude, down -11.3% for the week.  Copper, considered by some a harbinger of worldwide economic activity, was down -5.62%.  Precious metals were the one bright spot of the market:  gold was up +$43.60, ending the week at $1,104.10 an ounce.  Silver gained +0.72% to $13.93 an ounce.

In U.S. economic news, 292,000 jobs were added last month, according to the Labor Department, handily beating expectations.  The average monthly gain in the 4th quarter was 284,000.  For the year, the U.S. added 2.65 million jobs, down from 2014’s 3.12 million, but still the second-best since 1999.  However, a concern voiced by Harm Bandholz, chief U.S. economist at UniCredit Research is that “a whopping 94%” of jobs created in 2015 were in services, up from 81% in 2014.  The dominance of hiring in the service sector helps explain the resilience of U.S. jobs amid weak global growth – service sector jobs are much less dependent upon worldwide economic conditions than are manufacturing jobs.

The Institute of Supply Management (ISM) index of U.S. factory activity declined 0.4 point to 48.2 in December—deeper into contraction (sub-50) territory, and the lowest reading since June 2009.  Economists had expected a rise to 49.  The new orders sub-index rose slightly to 49.2, but the employment gauge declined to 48.1 from 51.3.  The service sector remained in expansion but fell 0.6 point to 55.3 according to the ISM’s nonmanufacturing index.  Economists had expected a reading of 56.2.

Mortgage applications declined -12% last week after falling -17% the prior week to the lowest level since December of 2014.  Applications for loans to buy a home fell -11% following the prior week’s -4.3% decline.  Refinancing activity declined -12% after plunging -26% in the prior week.

The Commerce Department reported that U.S. construction spending fell -0.4% in November, the first decline since June of 2014.  Economists had been looking for a +0.9% increase.  November’s construction spending was still up +10.5% from the same time last year, however.   U.S. home prices rose +0.5% in November, making an annual gain of +6.3% according to real estate research firm CoreLogic.  Colorado and Washington (state) were the big gainers, up +10.4% and +10.2% respectively.  Texas and California were also strong, each up about 7%.  CoreLogic is expecting growth to moderate based on the fact that home-price gains are currently outpacing income growth by a wide margin.

In Europe, inflation rose +0.2% in December versus last year—the same as November’s final reading.  December’s reading missed analyst estimates of +0.3%.  Food, alcohol, and tobacco prices were up +1.2%, down from the previous month’s +1.5% gain.  Energy prices in Europe were down -5.9%.  The European Central Bank’ (ECB) goal of >2% inflation has not yet been met, likely to spur the ECB to take more action to boost the Eurozone’s sluggish economy.  In Germany, factory orders had a strong gain as new orders placed with German manufacturers rose +1.5% in November, handily exceeding expectations of a mere +0.1% rise.  It was the 2nd month of increases following October’s +1.7% gain.

In China, the Caixin/Markit China Purchasing Managers’ Index (PMI) contracted further to 48.2 in December from 48.6 in November.  It was the 10th straight month of contraction.  China’s services sector expanded at the slowest pace in a year and a half last month.  China’s People’s Bank of China (PBC) has been more active than usual recently in managing the value of the yuan.  Eight straight days of setting the value of the yuan lower vs the dollar helped spark the recent major selloff in Chinese stocks.  On Friday, the PBC finally set the peg a bit higher, having reached a 5-year low on Thursday, and Chinese stocks rose.  The aggressive devaluation has led to worries that China’s growth outlook is even worse than commonly thought.

Finally, on Friday the Labor Department reported that December’s unemployment rate was unchanged at 5%.  But that’s not the only measure of unemployment that economists typically look at.  One of those other measures is known as the “U-6” rate – defined by the government as “Total unemployed, plus all persons marginally attached to the labor force, plus total employed part time for economic reasons, as a percent of the civilian labor force plus all persons marginally attached to the labor force.”   Many consider it to be a broader, superior measure.  One reason frequently cited is that it includes among the unemployed those that are working part-time but who want to work full-time – the “involuntary” part-time workers.  The U-6 rate stayed level in December at 9.9%, but is still well above the sub-8% rate achieved in 2006.  Here, from CNBC, is a 10-year lookback at the U-6 unemployment rate:

(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 slipped to 6.8 from the prior week’s 6.3, while the average ranking of Offensive DIME sectors rose slightly to 15.8 from the prior week’s 16.0.  The Defensive SHUT sectors have maintained their lead over 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, despite the superior US performance.  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  schedule 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,

Dave Anthony, CFP®, RMA®

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Fig. 4