FBIAS™ Fact-Based Investment Allocation Strategies for the week ending 4/22/2016
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 26.25, little changed from the prior week’s 26.28, 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 52.99, up from the prior week’s 51.12.
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, up 1 from the prior week’s 35. 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:
The major U.S. market benchmarks ended the week mostly higher. Poor performance from some of the first technology stocks to report earnings weighed on the NASDAQ, which ended the week with a moderate loss, but the other benchmarks established multi-month highs by the middle of the week. For the week, the Dow Jones Industrial Average rose 106 points (+0.59%) and retook the 18,000 level, closing at 18,003. The LargeCap S&P 500 index added half a percent to close at 2,091. The NASDAQ composite, weighed down by earnings misses from Microsoft and Alphabet/Google lost -0.65%, closing at 4,906. MidCaps and SmallCaps were strong as the S&P 400 MidCap index gained +0.84% and the Russell 2000 SmallCap index tacked on +1.39%.
International markets were also mostly higher. Canada’s TSX had a strong week, up +1.74%. In Europe, the United Kingdom was the only major market that ended down, losing -0.53%, but mainland European bourses were strong with Germany’s DAX rising +3.2%, Italy’s Milan FTSE gaining +2.35%, and France’s CAC 40 adding on +1.66%. Major markets in Asia were mixed with Japan’s Nikkei rallying +4.3%, but China’s Shanghai Stock Exchange fell -3.86%.
Commodities were mostly in the green with the industrial metal copper up an impressive +5.34%. Precious metals were mixed, as Silver rallied +4.77%, now over $17 an ounce at $17.03, but Gold retreated slightly to $1,233.70 an ounce, down -0.17%. Oil had its 3rd straight week of gains, up +4.79%, ending the week at $43.75 per barrel of West Texas Intermediate crude.
In U.S. economic news, initial jobless claims fell 6,000 to 247,000 last week to the lowest level since 1973, according to the Labor Department. Economists had forecasted a rise to 265,000. This multi-decade low in claims suggests that the labor market is continuing to tighten, which should be reflected positively in higher wages as well as encouraging unengaged workers to re-enter the workforce.
In housing, homebuilder sentiment held steady for a third straight month in April with the National Association of Home Builders (NAHB) index coming in at 58, while expectations were for a reading of 59. Readings over 50 indicate growth. The NAHB index hit a 10-year high of 65 last October. The current sales index declined 2 points to 63, but the future sales gauge gained a point to 62. Also in housing, existing home sales rose +5.1% last month to an annualized rate of 5.33 million units, according to the National Association of Realtors, beating expectations for a rise to 5.268 million. Prices of existing-home sales rose +5.7% versus the same time last year to an average of $222,700 as the supply of homes in the market remained relatively tight at 1.98 million, or about 4 and ½ months’ worth. However, the Commerce Department reported late in the week that builders broke ground on an annualized 1.089 million new-home units in March, which was down -8.8% and at the lowest level since last October. Economists had expected a 1.1167 million rate. Building permits also fell, down -7.7% to 1.086 million, missing expectations of 1.2 million.
In manufacturing, the Philadelphia Federal Reserve’s manufacturing index fell into contraction at -1.6 in April from 12.4 in March. Analysts had expected a reading of 9. March’s positive reading had followed a string of 6 consecutive negative readings. New orders came in flat from March’s relatively strong 15.7. The jobs index crashed to -18.5 from March’s -1.1—the worst reading since July 2009. Markit’s flash US-wide Purchasing Managers Index (PMI) seems to have confirmed the bad news as their reading of manufacturing sentiment fell in April to its lowest level in 6 ½ years. The underlying U.S. manufacturing PMI fell to 50.8 in April from 51.5 in March—that is its lowest level since September 2009. Softer rates of output and new business growth along with a weaker gain in employment were the main factors weighing on the index, according to Markit.
In Canada, Prime Minister Justin Trudeau’s Liberals introduced a budget that sharply boosts spending on a variety of initiatives from infrastructure to social benefits. Because of that fiscal stimulus, the Bank of Canada refrained from cutting interest rates, helping to send the Canadian dollar sharply higher. Economists suggest that Canada’s move benefits the global economy as much as it does its own. They suggest that the higher dollar will be a drag on Canada’s trade sector, diluting the stimulative impact, but that Canada’s loss will be the world’s gain. Canada appears to be executing the agreement that finance ministers and central bankers reached when the top 20 economies met just recently in Washington, namely that they should rely less on monetary and more on fiscal policy to rejuvenate growth.
In Europe, Mario Draghi, President of the European Central Bank (ECB) said the ECB remains ready to step up stimulus if the outlook for the area worsens. The ECB president told reporters that “it is essential to preserve an appropriate degree of monetary accommodation” after policymakers kept interest rates unchanged at record lows and maintained their asset purchasing program at 80 billion euros (US$90 billion) a month. The Governing Council “if warranted to achieve its objective, will act by using all instruments available within its mandate,” he said. German politicians have been especially critical of the ECB’s policies, which they say burdens savers and wreaks havoc on retirement plans.
In the United Kingdom, manufacturing, housing, and other economic measurements have shown clear signs that the UK economy has been losing momentum in recent months. During that time, the unemployment figures have remained the lone bright spot with the jobless rate slipping to 5.1%. It was only a matter of time, though, before the labor market caught up to the rest of the economy and that moment appears to have arrived. The latest figures from the Office of National Statistics were poor. Unemployment rose on both measures used by the government, the labor force survey and the claimant count. The Labor Force Survey increased by 21,000 – the first increase in nearly a year.
In Germany, the finance ministry said that it expects the country’s economy to post robust growth for the first quarter of 2016 due to strong consumption amid an improving labor market, rising wages, and lower crude oil prices. On a negative note, though, it lowered the country’s GDP growth forecast for 2016 and 2017 to +1.7% and +1.5%, respectively. The ministry’s monthly report also forecast that overall tax revenue will increase by a robust +7.1% year-over-year in March.
In China, billionaire investor George Soros said China’s debt-fueled economy resembles the U.S. in 2007-08, just before credit markets seized up and spurred a global recession. China’s March credit-growth figures should be viewed as a warning sign, Soros said at an Asia Society event in New York. He asserted that “most of the money that [Chinese] banks are supplying is needed to keep bad debts and loss-making enterprises alive.”
In Japan, exports fell for a 6th straight month last month, but an even sharper decline in imports pushed the trade surplus to its highest level in more than 5 years. Customs data showed exports fell -6.8% from a year earlier to 6.46 trillion yen ($59.2 billion) while imports plunged -14.9% to 5.7 trillion yen ($52.2 billion). The resulting balance was the highest since fall of 2010, but this is not how anyone would want to expand the trade surplus!
Finally, should you “kick ‘em when they’re down”, or “pick ‘em when they’re down”? Recent research has shown that asset classes (not individual stocks) that have been down for 3 or more consecutive years are extremely good buys. Researcher and money manager Meb Faber has recently published work that shows that asset classes that have been down 3 years in a row, (which is quite rare, only occurring 2% of the time per Faber), produced an average of more than +50% return in the following 2 years. Asset classes down 4 and even 5 years in a row, even rarer, produce even higher subsequent 2-year returns. Some 2-year return examples from the last several decades: US Bonds (down 1978, 1979, 1980): +48%; US equities (down 2000, 2001, 2002): +43%; Foreign Developed (down 2000, 2001, 2002): +69%; Foreign Emerging (down 2000, 2001, 2002): +96%. Individual country indices are similar: if down 3 years in a row, +56%. Sectors and industries: if down 3 years in a row, +59%.
Which brings us to the present: the Emerging Market and Commodities asset classes have both been down 3 years in a row. The last time that Emerging Markets were down 3 in a row (as noted above), that asset class rocketed +96% in the next 2 years. Commodities have never been down 3 years in a row before, so we have no precedent to look back on, but there is no good reason to believe commodities shouldn’t participate in this “mean reversion” behavior, as well!
(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 16.5, down from the prior week’s 12.5, while the average ranking of Offensive DIME sectors rose to 9.5 from the prior week’s 10.3. The Offensive DIME sectors expanded their ranking lead over the Defensive SHUT 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®