FBAIS™ Fact-Based Investment Allocation Strategies for the week ending 3/4/2016
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 25.28, up from the prior week’s 24.62, 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 46.13 up from the prior week’s 43.75.
In the intermediate picture:
The intermediate (weeks to months) indicator (see graph below) turned positive on January 26th. The indicator ended the week at 33, up from the prior week’s 27. 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 recorded a third consecutive week of strong gains. All major indexes were up more than +2% and the LargeCap index is close to erasing its losses for the year to date. The Dow Jones Industrial Average rose +366 points to end the week at 17,006. The LargeCap S&P 500 gained +2.67% and closed just shy of the 2,000 level. MidCaps and SmallCaps rallied even more strongly, up +4.4% and +4.3% respectively, as investors appeared to focus on stocks that had suffered the steepest declines in recent months – and traders who were “short” those stocks scrambled frantically to cover their downside bets (this is called a “short squeeze”). The rally was broad-based as Transports rallied +3.3% and even “defensive” Utilities were up +2.26%. The NASDAQ 100 index rose +2.2% for the week, while the broader NASDAQ Composite gained +2.76% to close at 4,717. Many U.S. market indexes are now down just a couple of percent for the year. The Dow Jones Industrial Average is down -2.4%, the S&P 500 is down -2.15%, and the S&P 400 midcap index is down just -0.34%. But Tech stocks and SmallCaps have had a more difficult time as the NASDAQ is still down -5.8%, and the SmallCap Russell 2000 is still down -5.04%.
In international markets, Canada’s TSX joined the rally in oil and added +3.24%. In South America, Brazil’s Bovespa stock index surged +18% after police detained former president Luiz Inacio Lula da Silva as part of a corruption investigation that could ultimately trigger great political change in the country, according to analysts. In Europe, the United Kingdom’s FTSE was up +1.7%, Germany’s DAX gained +3.27%, and France’s CAC 40 added +3.29%. In Asia, Singapore rallied over +7%, Japan’s Nikkei rose +5.1%, and China’s Shanghai index gained +3.86%. Thanks largely to Brazil, the Emerging Markets index took the “index with the biggest gain” trophy for the week, at +9.2%.
In commodities, the big news was in oil as it tacked on another +10%, up $3.49 to $36.33 per barrel of West Texas Intermediate crude oil. Industrial metal copper rallied +6.7%, as did precious metals. An ounce of silver rose +5.9% to $15.55 an ounce, and gold gained over +$37, ending the week at $1,260 an ounce, an upmove of +3.05%.
The month of February, if you were to look at just the monthly price change data, must have been very dull in most markets. In truth, it was anything but, as February saw a deep dive in the first half, and a very strong rally in the second half. The fact that most indexes closed the month with relatively little change masked very large intra-month moves. The Dow Industrials finished with just a +0.30% change for February, and the S&P just moved 0.41%. The best U.S. index for February was the MidCap 400 index, which rose +1.25%, and the worst was the NASDAQ Composite at -1.21%. Developed International sank -3.33% for February, but Canada’s TSX rose +0.30%.
In U.S. economic news, the Labor Department reported the U.S. economy added +242,000 jobs last month solidly beating expectations of +190,000. The unemployment rate remained at 4.9%. The strong jobs number, along with an upward revision to January’s gain to 172,000 eased concerns of many that the financial market plunge in the beginning of the year might have had a serious effect on the overall economy. The labor force participation rate rose +0.2 point to 62.9% continuing its lift-off from multi-decade lows but still far below pre-recession levels. One of the flies in the jobs ointment, however, was the continuing stagnation in manufacturing employment, while services provided the bulk of employment gains.
The private-employer survey from payroll processing firm ADP reached similar conclusions about the private economy. Private employers added 213,800 jobs in February, up from 193,400 in January, reported ADP. The services sector accounted for virtually all of the gains; employment in manufacturing declined. The services sector added 208,500 jobs up +20% from January’s downwardly revised 174,400. But manufacturing lost 8,900 jobs, up just +0.1% from a year earlier—the smallest year-over-year gain in more than 5 years.
In housing, pending home sales unexpectedly dropped -2.5% in January, according to the National Association of Realtors (NAR). Economists had expected a half percent gain last month. Lawrence Yun, chief economist for NAR stated that inclement weather likely impacted Northeast sales, but accelerating home prices and limited inventory appeared to be the main impediments to would-be buyers. Pending sales were up +1.4% compared with this time last year.
Manufacturing remained in contraction according to the Institute of Supply Management (ISM) manufacturing index, which came in at 49.5 (below 50 is contraction). However, this was an improvement over last month’s reading of 48.2 and beat expectations by +1.5 points. U.S. manufacturers have been hurt by a strong U.S. dollar and weak global demand. On a positive note, while the headline number is still below the neutral 50 level, new orders and production both expanded at the fastest pace in 6 months.
ISM’s Non-Manufacturing Index fell for the fourth straight month to a two-year low last month, signaling slower growth and a small probable decline in jobs. The services-sector gauge for February declined -0.1 point to 53.4, beating expectations by 0.3 points, but the lowest reading since February of 2014.
In Europe, the European Central Bank meets on Thursday, March 10, and is expected to cut the deposit rate even further into negative territory. Analysts are concerned that financial markets may be expecting more aggressive stimulus such as quantitative easing and may be disappointed.
The Eurozone PMI for manufacturing was 51.2, down from 52.3 last month but still in expansion territory. The service reading was 53.3, down -0.3 from the prior month. Eurostat’s flash reading on Eurozone inflation for February was -0.2% annualized, down from +0.3% and largely due to falling energy prices. The volume of retail trade was up +0.4% in January. Eurozone unemployment was at 10.3% in January, the lowest in over 4 years, but more than twice that of the US. Individually, Germany’s was the lowest at 4.3%, France was at 10.2%, Italy at 10.5%, and Spain was at 20.5%.
In Asia, Moody’s Investors Services cut China’s government credit ratings to negative from stable, citing rising government debts, declining foreign reserves and doubts about authorities having the “capacity to implement reforms”. Perversely, China’s Shanghai stock market index greeted the downgrade with a +4.3% rally on Wednesday.
China’s manufacturing PMI was just 49.0 last month, the worst since January of 2009. Services declined -0.8 point to 52.7. On Monday, the Chinese government reported that a total of 1.8 million workers in China’s coal and steel sectors are expected to lose their jobs as part of China’s efforts to reduce industrial overcapacity.
In Japan, the February PMI for manufacturing was 50.1 down 2.2 points. The services reading was 51.2, down -1.2 points. In a milestone event, the Japanese government sold 10-year bonds with a negative yield of -0.024% for the first time ever.
Finally, to say 2016 has been an interesting year in the financial markets would be an understatement. The year began with the most substantial market rout in years, raising serious concerns that another Bear market plunge perhaps as serious as the financial crisis of 2008 may be upon us. However, the last 3 weeks has seen a significant rally that has brought most of the major indexes back to just modestly lower for the year.
So, is this would-be Bear Market already over?
Oh, if only it were that easy!
Morgan Stanley’s Andrew Sheet points out that “Bear market corrections (i.e., rallies) have typically lasted about 35 days for the S&P 500, with the markets moving up an average 14% from local trough before the sell-off resumes.”
As of this writing, the S&P 500 has rallied 15 market days from its low on February 11. Stay tuned.
(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 8.5 from the prior week’s 7.8, while the average ranking of Offensive DIME sectors fell to 11 from the prior week’s 10.8. The Defensive SHUT sectors continued to lead the Offensive DIME sectors, but by a smaller 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®