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 Fig. 1 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 23.80, down from the prior week’s 24.56, 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 Fig. 2).
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 Fig. 3) turned negative on January 15th, and remains in Cyclical Bear territory at 41.15, down from the prior week’s 42.73.
In the intermediate picture:
The intermediate (weeks to months) indicator (see Fig. 4) turned positive on January 26th. The indicator ended the week at 12, up from the prior week’s 6. 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), 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), 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) is positive. Therefore, with two of the three indicators negative, the U.S. equity markets are rated as Mostly Negative.
In the markets:
Stocks declined as investors reacted early in the week to further weakness in the energy complex and later in the week to a mixed job report and severe weakness in technology and biotech shares. For the week, the Dow Jones Industrial Average declined -261 points to 16,204 (at -1.6%, this was the least-damaged index in the US). The LargeCap S&P 500 declined -3.1%, the MidCap S&P 400 declined -2.9%, and the SmallCap Russell 2000 ended down over -4.8%. The tech heavy NASDAQ, which was being propped up by a few highfliers, collapsed this week by -5.4% as the air came out of those highfliers in a big way. See the “Finally” section for more.
In international markets, Canada’s TSX remained relatively flat, down -0.45% for the week, as natural resources – particularly precious metals – held up. Markets were under pressure in Europe as Italy plunged -7.5%, Germany’s DAX declined -5.2%, and France’s CAC 40 gave up -4.9%. The United Kingdom’s FTSE 100 ended down -3.8%. In Asia, Japan’s Nikkei declined -3.9%, while Hong Kong’s Hang Seng lost -2%. However, China’s Shanghai Stock Exchange, an exchange with little foreign involvement, ended the week up +0.95%.
In commodities, precious metals are beginning to shine as an ounce of silver rose +5.4% and Gold gained +$55.70 an ounce to $1174.10 an ounce. Crude oil, though, continued its decline as a barrel of West Texas Intermediate dropped more than -$2 in the course of the week (after having been down more than -$4 in mid-week).
In U.S. economic news, job growth slowed more than expected last month with the economy adding only 151,000 jobs, but the report came in strong in other ways that some analysts felt may give the Federal Reserve the evidence it needs to raise rates again. The jobless rate fell to 4.9%, the lowest since February 2008, and the labor force participation index improved for a 3rd straight month to 62.7%. Retail added 58,000 jobs last month; however some analysts question that number due to the announced layoffs of several major retailers which surged last month. Retailers announced 22,246 layoffs after the holiday season, up from just 6,700 a year ago. Wal-Mart alone is cutting 10,000 jobs and closing 154 stores. Macy’s is eliminating 4,500 positions and closing 40 stores. Transportation and warehousing added 45,000 jobs, and according to the Labor Dept., even manufacturing added jobs – a surprising 29,000 —the best gain since early 2012. A tighter labor market “should” lead to higher wage growth and “should” put upward pressure on inflation – but there’s no sign of either yet.
But the U.S. private-sector jobs picture as reported by payroll processing firm ADP from surveys of clients is not as positive in the manufacturing space as the government’s report. According to ADP, instead of expanding as reported by the government, manufacturing jobs actually fell fractionally, down -0.1% versus a year earlier -matching the worst reading since September 2010.
The Institute for Supply Management (ISM) report also showed manufacturing contracting, for the 4th straight month in January. The index rose +0.2 point in January, but the slight improvement was from a downwardly revised 48 that matched the worst reading since June 2009 (sub-50 readings = contraction). Export orders deteriorated while the jobs reading was the worst since May 2009. Manufacturing has taken a hit as a strong dollar and weak global growth has weighed on manufacturing and the rest of the economy hasn’t taken up the slack. On a positive note, the new orders and output sub-indexes rose back above 50 into expansion, and Markit’s U.S. manufacturing index climbed to 52.4 in January from December’s 3-year low of 51.2.
Growth in the service sector fell to a 2-year low as the Institute for Supply Management’s nonmanufacturing index declined 2.3 points in January to 53.5—the lowest since February 2014. Of particular concern to economists is that this was the measure’s 3rd straight decline. Export orders had their sharpest decline since March 2009. Import orders were their weakest since summer of 2012. The jobs index indicated slower hiring. Markit’s services index, similar to ISM’s, also declined -1.1 points to 53.2, confirming ISM’s number and the weakest reading in over 2 years.
Personal income matched economists’ estimates rising 0.3% in December according to the Commerce Department. Consumer spending was unchanged and spending on consumer durables declined. The Commerce Department reported that consumer spending slowed to an annual growth rate of 2.2% in the 4th quarter.
Construction spending missed expectations of +0.6% growth, but remained ever so slightly positive in December up +0.1% to an annualized $1.12 trillion. IHS Global Insight economist Patrick Newport stated that the construction sector “lost all momentum in the fourth quarter.” Private residential spending gained 0.9%, bringing the annual gain to +8.1% – the weakest since May 2012. Private nonresidential spending slipped -2.1%, while public construction spending rose +1.9%.
In the Eurozone, the Purchasing Managers Index (PMI) fell -0.9 in January to 52.3. The reading matches the flash reading and signals a slower rate of expansion – still positive, but not robustly so. Output growth and orders weakened and the output prices gauge hit a 1-year low. Overall, analysts believe the report won’t prevent the ECB from adopting an even more accommodative monetary easing policy, perhaps as early as March. On a positive note, Eurozone unemployment decreased to a 4 year low in December, to 10.4%. It’s the lowest overall unemployment rate since September 2011.
In China, the government’s official manufacturing index remained in contraction for a 6th straight month, falling ‑0.3 point in January to 49.4 (sub-50 readings = contraction). The China National Bureau of Statistics reported that the latest reading reflected weak export orders and efforts to curb overcapacity. The services gauge declined to 53.5 from December’s 16-month high of 54.4. Private-sector research firm Caixin reported that its manufacturing index came in at 48.4. It was the 11th straight month of declining activity, per Caixin. Caixin’s index focuses on small and midsize private firms, versus the government’s reading that focuses on larger state-owned enterprises.
Finally, this week’s overall market declines, bad as they were, masked a much worse development in the tech space. While the overall NASDAQ dove -3.25% on Friday, tech names such as LinkedIn and Tableau Software each plunged by over -40% – in a single day. Thirteen other U.S. software companies sank by at least -10%, and another 15 dropped over -5% on Friday. Newly public companies such as New Relic, HubSpot, and Zendesk were all down over ‑20%. Tableau’s comments were of particular concern to analysts because the company warned of “some softness in spending, especially in North America.” Analyst Matthew Hedberg, of RBC Capital Markets, stated “This is the first time we have heard a high-quality enterprise software firm cite a slowdown in I.T. spending.”
LinkedIn’s -43.6% plunge was the steepest drop in its 5 year history and wiped away almost $11 billion in market value and all gains since 2012 – in one day. The business/social network forecast 2016 revenue growth of 20-22%, but expectations had been for 30% growth. LinkedIn cited global weakness as one of its chief concerns. The following graphic illustrates the recent plunges in many of high-tech’s previous highfliers:
(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 fell to 9.5 from the prior week’s 6.3 (thanks to the carnage in the Biotech slice of Health Care), while the average ranking of Offensive DIME sectors rose to 14.3 from the prior week’s 16.3. The Defensive SHUT sectors continued to lead 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.