FBIAS™ Fact-Based Investment Allocation Strategies for the week ending 3/11/2016
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 25.56, up from the prior week’s 25.28, 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 48.00 up from the prior week’s 46.13.
In the intermediate picture:
The intermediate (weeks to months) indicator (see graph below) turned positive on January 26th. The indicator ended the week at 36 (the maximum value possible), up from the prior week’s 33. 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:
This past Wednesday, March 9th, was the 7th anniversary of the stock market low in the depths of the financial crisis. The bull market of the last 7 years has been showing distinct signs of aging, but the rally of the last 4 weeks (which has been in lockstep with oil) has given hope to many that the old bull will live on. In any event, it was a positive week for US indices. The Dow Jones Industrial Average tacked on an additional 206 points, up +1.21%. The large cap S&P 500 cleared the 2000-level and gained +1.11%. MidCaps and SmallCaps also participated in the rally as the S&P 400 and Russell 2000 were up +0.57% and +0.52%, respectively. Utilities, traditionally a “defensive” sector, nonetheless rallied +2.23% and Transports were up +0.54%.
In international markets, Canada’s TSX gained +2.34% on strength in the oil sector. In Europe, after large see-saw reactions to ECB pronouncements on Thursday and Friday, France’s CAC 40 index rose +0.81%, Germany’s DAX ended the week near unchanged up +0.07%, and Italy’s Milan FTSE index rallied +3.88%. Among the relatively few international losers, the United Kingdom’s FTSE ended down -0.96%, China’s Shanghai stock exchange declined 2.22% and Japan’s Nikkei lost 0.45%.
In commodities, oil – bringing stocks along with it – managed to rally for a fourth straight week, up an additional +5.95% to $38.49 a barrel. Precious metals retreated slightly, with Gold declining -$9 to $1251.10 an ounce and silver also closed down -0.23% at $15.51.
In U.S. economic news, jobless claims continued the optimistic tone from the previous week, falling by 18,000 to 259,000. The smoothed 4-week average fell to 267,500 from 270,000. Continuing claims were 2.225 million, a decrease of 32,000 from the prior week. Weekly initial claims are at the lower end of the 250,000 to 300,000 range that has been in place since July of 2014.
In housing, mortgage applications showed a slight uptick in home buying demand as total mortgage applications rose +0.2%, according to the Mortgage Bankers Association. The purchase index rose +4.2% for the week last week and was up a strong +30% compared to the year earlier. Demand for refinancing declined 2.3% last week, but remained +13% higher than a year earlier. The average interest rate for 30-year conforming loans climbed +6 basis points (100ths of a %) to 3.89%.
The closely-watched “rig count” continues to decline as oil drilling rigs in three of the nation’s most prominent shale formations continued to shut down in the wake of announcements from some of the major energy companies of plans to scale back operations. The rig count in the Eagle Ford formation in South Texas fell by one to a total of 40 for the week ended March 4. Permian Basin rigs, located in West Texas and southeastern New Mexico, declined by six to 156, while the Williston basin, located in eastern Montana, southern Canada and the Dakotas, saw rigs fall by three to 33.
Consumer credit growth surprisingly slowed – and sharply – in January as consumers cut back on credit card use, according to the Federal Reserve. Overall consumer credit increased just +3.6% in January, whereas December had seen a gain of +7.3%. This is the weakest percentage increase since March of 2013. Credit card borrowing declined -1.4% in January following average gains of +7.5% over the past 2 months, the first decline since early last year. Economists often view credit card use as a proxy for consumer confidence. Non-revolving consumer credit, which includes auto and student loans, grew a smallish +5.4% in January after a +7.4% gain in December.
The Commerce Department reported that wholesale inventories rose in January as sales fell, suggesting that efforts by businesses to reduce inventory overhang could last through the year. Inventories rose +0.3% to a seasonally adjusted $584.2 billion. The inventory-to-sales ratio rose 0.3% to 1.35:1 in January, the highest ratio since April 2009. The time it takes to unwind wholesale inventories rose to the highest level since the recession. A rising ratio can have positive or negative implications. It could mean companies stocking up in advance of a pickup in sales growth — or it could mean an inability to sell goods. The highest ratio is in machinery, where sales have dropped -1.4% over the trailing 12 months.
Small business optimism fell to a two-year low in February, according to the National Federation of Independent Business (NFIB). Owners of small firms reported hiring and compensation plans weakening sharply since the end of last year—an indication that labor markets might not be as healthy as official government data indicates. NFIB’s sentiment gauge fell one point to 92.9, the lowest since early 2014 and well below historical norms. NFIB Chief Economist William Dunkelberg stated, “A ho-hum outcome this month confirms that the small business sector is not performing with any strength.” A net 21% still see the economy weakening, the worst since late 2013. Small firms have reported falling sales since June 2012. A big shift so far this year in the NFIB survey is in labor outlook, with only 10% of small businesses planning to add staff, down from 11% in January and 15% in December. This is the lowest labor outlook since last June.
In Canada, the dark clouds that hung over the Canadian economy are beginning to clear. Exports are rebounding, fear of a global recession is abating, and the price of oil has rebounded strongly. The federal government is also expected to inject a potent dose of fiscal stimulus in its March 22 budget to help the sluggish economy. As a result, the central bank decided to keep its overnight interest rate unchanged at 0.5%. “The global economy is progressing largely as the bank anticipated in its January Monetary Policy Report,” the bank said in a statement accompanying the rate announcement.
In Europe, the European Central Bank (ECB) was determined not to disappoint markets and announced a multi-faceted stimulus plan. On Thursday, the ECB cut the overnight lending rate to zero from 0.5%, cut the interest rate on bank reserves stored at the central bank further into negative territory (from -0.3% to -0.4%), and increased by one third its monthly asset purchases (from $66 billion to $88 billion). The ECB expanded its asset purchases to include investment-grade corporate bonds, as well as sovereign government debt. Finally, the ECB announced it would originate long-term loans to European banks that will let them borrow for four years at rates between 0% and -0.4% (in effect paying banks to borrow as an incentive to increase lending). At first, the positive stimulus effect seemed to be short-lived as the euro strengthened and stocks dove to the downside, but investors had reconsidered by Friday and drove European markets much higher on Friday. Germany’s DAX, for example, was down -2.2% on Thursday, but up +3.5% on Friday.
In Germany, the German banking association (BdB) said that the German economy will likely grow at a slightly slower pace this year, citing a slowdown in China and other emerging markets. The BdB said it expects Europe’s largest economy to grow by 1.6% this year, down 0.1% from last year. BdB chief Michael Kemmer stated “Globally, we are witnessing an unusual bundle of risks.”
In the United Kingdom, the British Chamber of Commerce predicted a lower rate of domestic growth in 2016 and 2017, up +2.2% and +2.3%, respectively. The revisions are down slightly from forecasts it had made in December. Adam Marshall, acting Director-General said the U.K.’s economy is being hurt by weaker global growth.
In Asia, Japan’s fourth-quarter GDP growth was revised higher on Tuesday to a still-negative -1.1% from the 1.4% annualized pace reported last month. Japan’s economy has contracted two of the past 3 quarters. Consumer sentiment plunged as consumer confidence fell to 40.1 from 42.5, well below the 42.2 forecast. This was the steepest decline in Japanese consumer sentiment since October 2013.
In China, a worse-than-expected monthly trade report on Tuesday was the latest sign of China’s struggling growth. February exports plunged nearly -25% from a year ago, the biggest monthly drop in more than 6 years. China’s trade surplus narrowed sharply as imports also posted a double-digit drop.
Finally, as the bull market enters its 7th year, a troubling case of Déjà Vu has emerged in the tech sector, which is flashing a warning last seen during the “dot com” bubble era. According to Credit Suisse’s Eugene Klerk, the share of IPOs in the U.S. that are losing money in their ongoing operations is now greater than 70% and almost back to the peak last seen during the “dot com” years. Klerk writes, with considerable understatement, “All else being equal, these companies represent greater earnings and cash flow risk than seasoned, more established companies.” To which one might reply, “Well, duh!”
(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 9.8 from the prior week’s 8.5, while the average ranking of Offensive DIME sectors rose slightly to 10.8 from the prior week’s 11. The Defensive SHUT sectors continued to lead the Offensive DIME sectors, but by a very small 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®