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.
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.
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.
Dave Anthony, CFP®, RMA®