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.