FBIAS™ Fact-Based Investment Allocation Strategies for the week ending 4/8/2016
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 25.86, down from the prior week’s 26.18, 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 49.50, down from the prior week’s 51.21.
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 positive indication on the first day of April for the prospects for the second 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 positive for Q2, and the Intermediate (weeks to months) timeframe (Fig. 4 above) is positive. Therefore, with two of the three indicators positive, the U.S. equity markets are rated as Mostly Positive.
In the markets:
This week was marked by broad weakness in the U.S. equity market as all major indexes lost ground. The Dow Jones Industrial Average lost -215 points to end at 17,577, down -1.2%. The NASDAQ declined -1.3% to close at 4,850. Both Transports and Utilities lost ground, declining -1.9% and -1.6%, respectively. Large caps showed slight relative strength with the S&P 500 declining “only” -1.2%, while the S&P 400 midcap index declined 1.69% and the small cap Russell 2000 gave up -1.8%. It was the S&P 500 Index’s biggest weekly drop in over 2 months.
In international markets, Canada’s Toronto Stock Exchange declined -0.3%. The United Kingdom’s FTSE was the only major market to shrug off the broad weakness closing up +0.95%. Germany’s DAX gave up -1.7% and France’s CAC 40 lost -0.44%. In Asia, all major markets were likewise down with China’s Shanghai Stock Exchange declining -0.8%, Japan’s Nikkei dropped -2.1%, and Hong Kong’s Hang Seng losing -0.6%.
In commodities, the industrial metal copper was down a third straight week, losing -3.78%. Precious metals, though, were higher with Gold up +1.65% to $1,243.80 an ounce. Silver rose +2.22% to end the week at $15.38 an ounce. Oil was the big winner in commodities with a barrel of West Texas Intermediate crude oil rising +8.4% to end the week at $39.72.
In U.S. economic news, the American Bankers Association reported that home-equity loan delinquencies fell below their 15-year average in the 4th quarter, down -0.23% to just 2.86% of all accounts. James Chessen, ABA’s chief economist stated, “It’s been a long, rocky road, but home equity delinquencies have finally worked their way back to historical norms.”
The Commerce Department reported that new orders for manufactured goods fell -1.7% in February, marking the 3rd decline in 4 months. Ex-transportation, factory orders fell -0.8%, down a 4th straight month. Core capital goods orders, which are viewed as a proxy for future business investment, declined -2.5% versus January. But on a positive note, overall factory orders were slightly higher versus a year earlier – the first positive year-over-year reading in a year and a half. Contrary to the Commerce Department’s reports, the Institute for Supply Management’s (ISM) manufacturing index and several regional factory gauges, industrial activity may have rebounded in March with ISM’s national report pointing to solid gains in orders coming in at 51.8, the highest in seven months. In the details of the report, the employment gauge pointed to new hiring, new order growth picked up, and the export gauges rose to a new one-year high to 58.5.
ISM’s service sector index showed faster growth in March after a two-year low last month, supporting evidence that the U.S. economy may be firming up as it heads into the spring. The services gauge rose +1.1 last month to 54.5, rising further into expansion.
Wholesale inventories tumbled at their fastest rate in nearly 3 years, hinting that economic growth in the first-quarter was probably weaker than expected. Wholesale inventories have fallen for the last 5 months as companies work to reduce high stockpile levels.
In international economic news, Canada’s economy added 41,000 jobs last month – more than 4 times what economists were expecting. Statistics Canada’s Labour Force Survey showed there were more people employed in Alberta, Manitoba, Nova Scotia, and Saskatchewan. Employment declined in Prince Edward Island and was little changed in the other provinces. By sector, health care was the winner with 25,000 new jobs. Manufacturing, which had been showing some encouraging signs the last few months, lost 32,000. The natural resources sector, which includes mining and oil and gas, lost 2,100 jobs.
In the United Kingdom, there was a double-dose of bad economic news as factory output fell to the lowest level since 2013, while the trade gap remained large. The duo of disappointing reports added to the recent spate of negative news including the worst decline in productivity since 2008 and the service sector’s slowest growth in 3 years.
On the European mainland, there was positive news in Germany where rating agency Moody’s said that Germany expected a slight acceleration of its growth to +1.8% due to robust domestic demand. In France, stuck in economic doldrums for years, the popular economic minister Emmanuel Macron has launched his own political movement to promote “fresh ideas” ahead of next year’s presidential election. The movement is known as En Marche! (In Motion) and is “neither right-nor left-wing” and aims to promote “economic, social, and political freedom.”
In Asia, China’s Premier Li Keqiang reported that economic indicators showed signs of improvement in the first quarter, but complained that a sluggish world economy and volatile markets are not providing a firm foundation. Li said the overall economic situation was nonetheless better than expected and he was confident the government would be able to maintain medium to high economic growth despite the difficulties.
Japanese finance minister Taro Aso is dealing with the difficult situation of a rising Yen which threatens the government’s hopes of stronger growth. The currency hit a fresh high of 107.6 against the dollar this week. Aso said that the government, which wants a lower yen in order to spur export demand, would take steps as needed to counter what he termed “one-sided” moves in the currency market. The Bank of Japan surprised investors earlier this year when it announced a move towards negative interest rates in an attempt to spur investment and keep the yen low, and the recent runup in the value of the yen has been very frustrating to Japan’s central planners.
Finally, it has been noted several times in this space that corporate profits are falling (called by some an “earnings recession”). Intuitively, one would think that falling earnings would result in a falling market since, as CNBC’s Larry Kudlow frequently says, “Profits are the mother’s milk of the stock market.” But Mark Hulbert of marketwatch.com, citing data from Ned Davis Research, says “not so fast!” It turns out that the stock market’s sweet spot, in terms of earnings growth, is a fairly tolerant range of year-over-year profit change from +5% down to 20%, as shown in the following chart.
(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 rose to 10.8, up from the prior week’s 12.3, while the average ranking of Offensive DIME sectors fell to 11.8 from the prior week’s 10.3. The Defensive SHUT sectors retook the lead from the Offensive DIME sectors. Note: these are “ranks”, not “scores”, so smaller numbers are higher ranks and larger numbers are lower ranks.
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.
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Dave Anthony, CFP®, RMA®