FBIAS™ Fact Based Investment Allocation Strategies for the week ending 2/19/2016
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 24.24, up from the prior week’s 23.61, 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 40.78, up from the prior week’s 39.24.
In the intermediate picture:
The intermediate (weeks to months) indicator (see graph below) turned positive on January 26th. The indicator ended the week at 19, up sharply from the prior week’s 8. 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. 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:
Stocks bounced back from 2 weeks of losses with the S&P 500 managing strong gains the first 2 trading days of the holiday-shortened week. All major indexes were in the green with the Dow Jones Industrial Average rising 418 points to 16,391, up +2.6%. SmallCaps and MidCaps outperformed LargeCaps, as did technology. The LargeCap S&P 500 index rose +2.85%, the MidCap S&P 400 gained +3.47%, the SmallCap Russell 2000 surged +3.9%, and the tech-heavy Nasdaq 100 advanced +3.6%.
In international markets, Canada’s TSX rose +3.49% with the help of strong gains in the important energy sector. Major European and Asian markets were strong across the board, too, as the United Kingdom’s FTSE 100 surged +4.25%, Germany’s DAX jumped +4.69%, and France’s CAC 40 rallied +5.7%. In Asia, China’s Shanghai Stock Exchange rose +3.49%, Japan’s Nikkei surged +6.79%, and Hong Kong’s Hang Seng enjoyed a +5.7% gain.
In commodities, the industrial metal copper gained +2.29%, but precious metals declined slightly as Gold declined $11.90 an ounce to $1,226.60. Silver, the more volatile of the two, retreated 2.75% to $15.36 an ounce. Oil had a big week as rumors circulated that Saudi Arabia, Russia, and Venezuela had agreed to freeze oil output and that Iran is also considering joining the effort. Oil rallied over +10%, up $2.94 to $31.96 a barrel.
In U.S. economic news, initial claims for jobless benefits fell 7,000 to 262,000 last week, the lowest since November and a rate consistent with a healthy job market, according to the Labor Department. The smoothed four week average fell 8,000 to 273,250. However, analysts at TrimTabs Investment Research have dug deeper into a different metric, and what they have found is concerning. The growth of federal income and employment tax withholdings has been dropping at an alarming rate. For most of last year, tax withholdings had been rising at a rate of +5% versus the year ago period. Revenue inflows to the Treasury Department began to steadily decline through last fall, bringing the annual growth rate to just below +4% by the beginning of this year. From the beginning of this year, growth has been just +1.8%, far less than the +5% gains a year ago. “The slower pace of year over year gains in tax withholdings has pointed to a significantly slower pace of hiring since September,” says TrimTabs Investment Research, which estimates that 820,000 jobs were added from September to January. In contrast, the Labor Department estimates 1.137 million new jobs were added over that span, or almost 40% more.
The National Association of Home Builders reported single-family home construction starts fell -3.9% in January to an annualized 731,000. This is an increase of +3.5% versus a year ago. Multi-family starts were down -2.5% for the month and down -3.8% annualized. Homebuilder sentiment slipped to a nine month low. On a positive note, building permits were up +13.5% from year ago. Single-family permits were down -1.6% last month, but remain +9.6% above year ago levels.
Housing starts fell more than expected in January, declining -3.8% to an annualized 1.099 million, according to the Commerce Department. Housing permits, an indicator of future building activity, beat expectations by declining only -0.2% to 1.202 million.
The Mortgage Bankers Association reported that the 30 year fixed-rate mortgage stands at just 3.83%, the lowest since last April.
Core U.S. consumer prices, which exclude food and energy, rose +0.3% in January, up +2.2% from year ago. This is the fastest annual rise since June 2012, according to the Labor Department. Overall prices were unchanged for the month and up +1.4% from year ago. Core prices were driven by gains in the cost of medical care, health insurance and housing. Health insurance costs rose +1.1% for the month and are up +4.8% from year ago, the largest increase in nearly three years.
US-wide industrial production recovered much more strongly than expected in January, up +0.9%, according to the Federal Reserve. The gain was led by a +5.4% jump in utilities output. Factory activity returned to growth, up +0.5% after falling the two previous months. Mining output, which includes oil drilling, was flat last month, and down -9.8% versus a year earlier.
Many regional manufacturing reports continue to be poor, however. The New York Federal Reserve’s Empire state manufacturing index improved less than expected from January’s worst reading since the Great Recession. Overall business conditions improved to -16.6 from -19, however this is still the second worst reading since 2009. New orders and shipments remained firmly in negative territory, suggesting continued contraction.
Likewise, the Philadelphia Fed Manufacturing Index remains in contraction but improved to -2.8 from -3.5. Shipments increased, but new orders fell 4 points to -5.3. The employment index fell to -5 from -1.9, the lowest since May 2013. The inventory gauge fell further, suggesting that manufacturers continue to deplete stocks of goods. The business outlook index fell to its lowest level since November 2012.
In Canada, the Canadian dollar’s sharp drop over the past year is beginning to stoke inflation. The consumer price index rose +2% in January from the same time last year, according to Statistics Canada. It is now at its highest level since November of 2014 and approaching the central bank’s target, and puts the Canadian central bank in a difficult position as it has been attempting to prop up growth with low borrowing costs.
In the Eurozone, an interesting fact came to light last week: the United States became the top destination for German exports in 2015, the first time since 1961 that the U.S. has held that spot. Analysts believe that an upturn in the U.S. economy and a weaker euro led to the change. In France, Christine Lagarde who managed a tumultuous first term as Managing Director of the International Monetary Fund was officially named to a new term at the global emergency lender. Lagarde’s second five years is not anticipated to be any quieter than her first term.
Finally, much has been written in recent years along the lines of “if this is an expansion, why does it feel like we’re still in a recession?” Young people and low-wage workers in particular have felt this way. One answer is that the expansion in the years since the recent recession has been very weak, and nothing like the expansions that have followed many other recessions.
For example, President Ronald Reagan took office in 1981 in the midst of raging inflation and a deep recession. Similarly, President Barack Obama took office in 2009 in the midst of the recent global financial crisis. President Reagan’s first 7 years in office averaged +7.9% GDP growth, while President Obama’s first 7 years in office have averaged less than half as much, at +2.9%. The worst year of GDP growth in Pres. Reagan’s first 7 years, at +4.2%, was greater than the best year of growth under Pres. Obama’s first 7 years, which was +4.1%. The recovery during President Obama’s tenure has been so comparatively anemic that the “why does it feel like we’re still in a recession” question becomes much more understandable.
(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 slightly to 8.8 from the prior week’s 8.5, while the average ranking of Offensive DIME sectors rose to 11.8 from the prior week’s 12.5. The Defensive SHUT sectors continued to lead the Offensive DIME sectors, but by a much-narrowed margin. 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 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®