FBIAS™ Fact-Based Investment Allocation Strategies for the week ending 3/18/2016
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 25.90, up from the prior week’s 25.56, after having earlier reached the level also reached at the pre-crash high in October, 2007. Since 1881, the average annual return 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 50.87 up from the prior week’s 48.00.
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), unchanged from the prior week. 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:
Large-caps moved back into positive territory for 2016 as stocks scored a fifth consecutive week of gains. The major indexes all remain substantially below their record highs set last summer, but only the small-cap Russell 2000 index ended the week still in correction territory—commonly defined as a decline of -10% or more from a recent high. For the week, the Dow Jones Industrial Average tacked on an additional +389 points to close at 17,602, up +2.26%. The LargeCap S&P 500 gained +1.35%, the MidCap S&P 400 added +1.61%, and the SmallCap Russell 2000 rose +1.3%. Both the Dow Transports and Utilities were positive for the week as well, up +4.97% and +1.76%, respectively.
In international markets, Canada’s TSX declined slightly down -0.18%. In Asia, the big winner was China’s Shanghai Stock Exchange which rallied +5.15%. Hong Kong’s Hang Seng was also a good gainer at +2.34%, but Japan’s Nikkei declined -1.26%. Europe experienced a mixed week; the United Kingdom’s FTSE was up +0.81%, Germany’s DAX gained +1.22%, and the Netherlands Amsterdam Exchange rose +0.69%, but France’s CAC 40 declined -0.67% and Italy’s Milan FTSE was off -1.98%.
In commodities, the industrial metal copper continued its recent rebound, closing the week up +2.24%. Precious metals were also positive as Gold added $4.90 (+0.39%) to close at $1,256 an ounce. Silver, often the more volatile of the two, rose 2.03% to $15.82 an ounce. Oil continued its impressive rally, adding an additional +$2.64 to close the week at $41.13 a barrel for West Texas Intermediate crude oil—a gain of +6.86%.
In U.S. economic news, initial claims for jobless benefits rose 7000 to 265,000 last week, a smaller than expected rise from the prior week’s five month low. The smoothed four week average of claims rose 750 to 268,000 as claims remained below the 300,000 level for 54 weeks, the longest stretch since 1973.
It may be too early to call it a correlation quite yet, but among states where the minimum wage rose at least $.50 per hour, seven out of eight lost jobs in January according to the Labor Department. Arkansas stood out in its region of the country by hiking its wage $.50 to $8.25 an hour. It suffered the biggest job losses among those states imposing wage hikes– it reported a loss of 5,100 jobs, and the average workweek there declined to 33.7 hours, down -1.1 hours from a year earlier.
U.S. housing starts rose +5.2% to an annual rate of 1.178 million units, according to the Commerce Department. The gain was after two consecutive months of declines. Single-family home starts jumped +7.2% to their best levels since before the recession.
Consumer prices fell in February, but underlying inflation trends remain intact, the Labor Department reported. The consumer price index declined -0.2% in February as energy costs plunged the most in seven years. But core prices, which exclude food and energy, rose +0.3% for a second straight month. Year-over-year, core CPI climbed to 2.3%, the highest in nearly 4 years and slightly above the 2% Fed target inflation rate. Service costs are behind the increase in inflation, with the services ex-energy inflation rate coming in at over 3% – the most in more than seven years. Services prices, by their nature, are less exposed to commodities swings and international competition.
U.S. retail sales declined -0.1% in February, matching expectations, but concerns were raised by the January sales number which was revised sharply lower. Instead of the +0.2% gain initially reported for January, the Commerce Department now states that sales sank -0.4%. Two major sub readings also got sharp downward revisions for January. Retail sales excluding autos were revised down by a half point to a -0.4% decline. Sales ex-autos and gasoline were also revised down a half point to a -0.1% decline. For February, retail sales ex-autos improved to a 0.1%. After the release of the disappointing January numbers, economists at Barclays downgraded their outlook for US GDP in the first quarter to 1.9% growth from 2.4%. On a more positive note, core retail sales (ex-autos, gas, food services, and building materials) grew +0.3% in February, the 3rd increase in 4 months and up 4.3% from a year earlier.
Despite the bad news in the retail sector, the manufacturing sector got good news from the New York Federal Reserve’s Empire State manufacturing index, which rose +17 points to 0.62 – the first positive reading since last July. New orders and shipments both increased while employment held steady. In Philadelphia, the Federal Reserve reported its index of mid-Atlantic manufacturing rose to 12.4 from -2.8 in February, the first positive reading in seven months. In that report, the new orders index jumped 21 points to 15.7. The employment gauge for the Mid-Atlantic area rose 4 points, but still remained negative at -1.1.
Consumer sentiment unexpectedly declined for a third straight month in March according to the latest University of Michigan consumer survey. The index’s flash reading was 90, down -1.7 points from February’s final reading. It’s the lowest reading since last October and analysts had expected a reading of 92.2. The survey measures consumers’ attitudes toward current economic conditions and their future expectations.
This past week, the Federal Reserve held its key interest rate steady and signaled that it’s willing to meet markets halfway. Instead of the four rate hikes this year that Fed policymakers had signaled in December, they now see two quarter-point hikes. Relief that the pause in rate hikes may extend for another six months helped boost major stock indexes. In contrast, the January Fed meeting minutes released this week (now almost 2 months out of date), showed that one Fed member anticipated a single rate hike this year, nine predicted two hikes and seven predicted three or more hikes.
In Europe, Eurostats, the EU’s statistical arm reported industrial production in the Eurozone in January was up a solid +2.1% over December, the best reading in six years. Construction spending rose +3.6%. Inflation in the euro area came in at -0.2% annualized vs. a 0.3% rate in January as Germany, France, Italy, and Spain were all negative.
In Asia, Chinese property prices in the top cities soared as much as +57% in the trailing year thru February, according to the National Bureau of Statistics. Nationally, all prices rose at an average annual rate of +2.8%, the biggest one-month rise since June 2014 according to a review of government data by the Financial Times. Separately, Central Bank governor Zhou Xiaochuan stated that China would not rely as heavily on exports for economic growth this year since their contribution to the economy has been dwindling.
In Japan, the Bank of Japan left monetary policies unchanged after cutting interest rates into negative territory in January. Japanese department store sales improved in February from year-ago levels. Sales rose 0.2% year-over-year in February, up from -1.9% in January.
Finally, analysts looking at the US stock market gyrations this year – a big downdraft followed by an offsetting rip higher – have begun to point to a factor that seems to neatly explain it all: the dollar. Binky Chadha, Chief Global Strategist at Deutsche Bank, told marketwatch.com: “A lot of the market convulsions looked like they were coming from independent things. But they all had a common denominator and that’s the dollar.” Furthering this dollar-centric view, rumors are now circulating that finance ministers and central bankers at the late-February G-20 meeting in Shanghai settled on a so-called “Shanghai Accord” to weaken the dollar and thereby calm the financial markets. Although there is nothing official to back up this suspicion, what is undisputed is that the dollar has declined more than -3% since the G-20 gathering and that has coincided with a near-vertical rally in stocks, emerging market assets, and commodities (including oil). A weaker dollar has also been noted as a key reason in the 54% rally in U.S. crude and a 40% rally in Brent crude. The chart below shows the drop in the Dollar Index from almost 100 to less than 95, which is also below the dollar’s important 200-day moving average, with the biggest part of that drop coming after the Shanghai G-20 meeting.
(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 11 from the prior week’s 9.8, while the average ranking of Offensive DIME sectors rose to 9.3 from the prior week’s 10.8. The Offensive DIME sectors are now ranked higher than and have taken the lead from the Defensive SHUT 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.
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®