FBIAS™ Fact-Based Investment Allocation Strategies for the week ending 6/17/2016
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 25.88, little changed from the prior week’s 26.19, 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 52.03, down from the prior week’s 54.5.
In the intermediate picture:
The intermediate (weeks to months) indicator (see graph below) turned negative on May 12th. The indicator ended the week at 29, down from the prior week’s 31. 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 may have arrived. The Quarterly Trend Indicator (months to quarters) is positive for Q2, and the Intermediate (weeks to months) timeframe (Fig. 4 above) is negative. Therefore, with two of the three indicators negative, the U.S. equity markets are rated as Mostly Negative.
In the markets:
The major U.S. benchmarks all recorded losses for the week, with the smaller cap indexes bearing the brunt of the selling. The Dow Jones Industrial Average fell 190 points to close at 17,675, down -1.06%. The tech heavy NASDAQ composite gave up 94 points to close at 4,800, down -1.92%. The S&P 500 LargeCap index declined -1.19%, while the S&P 400 MidCap index and the Russell 2000 SmallCap index ended down -1.28% and -1.65%, respectively. The defensive Dow Jones Utilities index gained +0.88%, and the Dow Jones Transports index fell -2.25%.
In international markets, Canada’s TSX ended down -0.97%. The United Kingdom’s FTSE continued to see weakness, down -1.55%. British voters are going to go to the polls next week to vote whether to stay in the European Union or leave – the so-called “Brexit” vote. On Europe’s mainland, weakness was seen across the board with France’s CAC 40 down -2.62%, Germany’s DAX index down -2.07%, and Italy’s Milan FTSE down -1.15%. In Asia, markets had a very difficult week where Japan’s Nikkei plunged over -6%, Hong Kong’s Hang Seng index fell over -4.15%, and China’s Shanghai index ended the week down -1.44%.
Precious metals enjoyed their third week of gains as gold climbed +$25.30 to close at $1,301.60 an ounce, up +1.98%. Silver rose +$0.19, ending the week at $17.52 an ounce, up 1.10%. The industrial metal copper regained some of last week’s plunge, rising +1.33%. Crude oil was essentially flat, down only two cents, ending the week at $48.86 a barrel for West Texas Intermediate crude.
In U.S. economic news, Initial jobless claims rose more than expected, up +13,000 to 277,000 last week, according to the Labor Department. However, analysts are quick to point out that the increase was primarily due to 19,470 claims in California that are “probably due in part to schools closing for summer recess,” a Labor Department spokesman said. The median forecast of economists surveyed had expected 270,000. Continuing claims increased by +45,000 to 2.16 million for the previous week. These claims, reported with a one-week delay, reflect people who are already receiving unemployment checks.
In housing, the National Association of Home Builders (NAHB) sentiment gauge rose 2 points to 60, the highest since January. Economists had expected a 1 point gain. Readings over 50 indicate growth. All the main sub-indexes rose, including confidence about future sales. The NAHB noted “Builders in many markets across the nation are reporting higher traffic and more committed buyers at their job sites—but some headwinds remain, including a scarcity of available lots and labor.”
Actual housing starts fell -0.3% in May to an annualized rate of 1.164 million units, according to the Commerce Department. That follows a +4.9% increase in April and is better than the 1.15 million expected by economists. Building permits, a gauge of future construction activity, rose +0.7% to 1.138 million. Monthly housing starts have hovered above 1 million for the past year, but remain below the 1.5 million that represents a very healthy housing market. On a positive note, housing starts are up +10.2% so far this year.
Small business optimism rose for a second straight month in May, according to the National Federation of Independent Business (NFIB). The NFIB’s small business index rose to 93.8 last month, up +0.2 point from April, and 12% of companies plan to add staff, up one percentage point. 27% of companies reported that they had unfilled job openings. But sales and earnings trends weakened, with fewer firms planning to step up spending, even though pessimism about the economy diminished.
Retail sales increased +0.5% last month, beating expectations as consumer spending remains strong, according to the Commerce Department. Economists had expected retail sales to rise +0.3%. Ex-autos, sales rose +0.4% and ex-autos and gas, sales were up +0.3%, both in line with expectations. Auto sales gained +0.5% versus April as industrywide demand was slightly stronger than expected. Nonstore sales, which represents e-commerce sales such as Amazon’s, continues to outpace overall retail sales– up +1.3% in April and a whopping +12.2% versus a year earlier.
Consumer prices rose +0.2% in May, missing forecasts by 0.1%, according to the Labor Department. Core consumer prices, which exclude food and energy, also rose +0.2% matching expectations. Energy prices gained +1.2% as gasoline prices increased. Shelter costs rose +0.4%, the biggest monthly gain since 2007. Year-over-year consumer prices are up +1%, but down slightly from April’s reading. Core inflation was 2.2%, up +0.1% from April.
Producer prices rose for a second straight month as the cost of energy products and services increased, but a stronger dollar and lower energy prices is expected to keep inflation in check for a while. The Labor Department said its producer price index for final demand increased +0.4% last month, following a +0.2% rise in April. Year-over-year, producer prices are down -0.1%. Economists had forecast the PPI to rise +0.3%. Excluding food, energy and trade services, producer prices dipped 0.1% last month, following a 0.3% rise in April.
Industrial production fell -0.4% last month, missing analyst expectations of just a -0.1% drop, according to the Federal Reserve. Manufacturing activity also fell _0.4%, also missing forecasts for a gain of +0.1%. Production of autos and related parts plunged -4.2%, the sharpest drop since early 2014. American producers are still battling the effects of weak energy prices, a stronger dollar, and stagnating global growth. On a positive note, mining output (including oil drilling) rose +0.2% – its first increase since August. However, drilling and servicing at wells dropped a further -7.9%. Those numbers may stabilize as analysts point to Baker Hughes rig count data that show that oil rigs are beginning to come back online. Capacity utilization, which measures the amount of plant capacity that is in use, fell to 74.9%, down -0.4%.
Manufacturing in the Empire state rebounded in June after a weak reading the prior month, according to the New York Fed. The Empire state manufacturing index swung to positive territory coming in at 6.0, up +15 points from the deeply negative May reading. A positive reading indicates improving conditions. Economists had forecast -3.5. Orders and shipments were also positive for June and the six month outlook also improved. In Philadelphia, the Philly Fed index rose to 4.7 signaling growth following May’s reading of -1.8. It was only the 2nd positive reading in the past 10 months; however, the details of the report were not optimistic. The indicators for new orders, shipments, employment and work hours all remained negative. The disparity is due to the fact that the headline value of the Philly Fed current conditions index is based on a single stand-alone question, unlike the Institute for Supply Management’s index which is based on a composite of components.
On Wednesday, the Federal Reserve voted to keep rates steady, which was widely expected. However, the Fed signaled that markets might still be too complacent about the chances for rate hikes later in the year. While economists don’t expect a hike at the next meeting in July, individual members’ projections for future policy still point to two hikes this year. Six Fed officials now see just one hike this year, up from just one back in March. Fed Chair Janet Yellen stated in a post-meeting press conference that the United Kingdom’s vote whether to leave the European Union later this month (“Brexit”), played a factor in the decision to leave rates unchanged.
In international economic news, the Conference Board of Canada stated that Canada’s economy is expected to grow by +1.5% this year, with British Columbia to lead the country in growth. Four provinces will have a GDP growth rate of more than +2%: British Columbia, Ontario, Manitoba, and Prince Edward Island. The Conference Board sees a “two-speed” Canadian economy, with resource dependent provinces in recession or growing slowly, and most of the rest of the country strengthening as manufacturing exports grow.
The Bank of England has issued a fresh warning that a vote to leave the EU in next week’s referendum risks impeding economic growth, forcing the pound lower, and sending shockwaves through the global economy. The Bank of England’s Monetary Policy Committee voted unanimously to maintain its bank rate at just 0.5% and to keep the size of its asset purchase program at 375 billion pounds.
German Chancellor Angela Merkel said China’s push to produce higher quality exports is turning the country into a competitor in global markets and underscoring European concern about Chinese trade and investment. Her three day trip to China included joint cabinet talks in Beijing and a chance to ensure that “diverging interests” between the two countries “aren’t swept under the carpet,” Merkel told reporters in Shenyang. Merkel said she and Chinese leaders had very intensive talks regarding China’s bid for market-economy status, which would make EU penalties against Chinese exports more difficult.
In Japan, the yen surged to its strongest against the dollar since the fall of 2014 as the Bank of Japan abstained from adding any stimulus that could slow its advance. Japan’s currency gained against all 31 of its major peers after Governor Kuroda and his board chose to continue to gauge the economic impact of their negative interest-rate policy. The dollar extended its losses that have made it the worst-performing currency this year behind the pound after the Federal Reserve kept interest rates steady and suggested the pace of further action will be slower than previously indicated.
Chinese domestic banks are lending large amounts of cash to boost the near-term economic outlook, despite the nation’s swelling pile of debt. New yuan loans rebounded to 985 billion yuan last month, surpassing all estimates, according to the People’s Bank of China. The central bank is determined to keep credit flowing so that its economy continues to grow, but at the cost of rising debt risks. China’s debt load is now 250% of its gross domestic product, according to Bloomberg Intelligence estimates.
Finally, are you favoring stocks right now because investment grade bonds are yielding a near 0% return? If so, Mark Hulbert, in a research piece published at MarketWatch.com, says that is a terrible rationale. To be fair, almost everyone seeks the return of stocks when bonds are yielding near zero. But his research shows that bond valuations have almost nothing to do with how the stock market is likely to actually perform. Over the past century, stocks have been just as likely to fall as rise when bonds have been less than an ideal alternative. To demonstrate this, he calculated the stock market’s performance since 1871 for various states of stock earnings yield vs the yield on the 10 year treasury note. What he found, as demonstrated by the chart below, is that there is no consistent relationship. The implications for investing are that you should base investing decisions in the stock market based on the stock market’s own valuation criteria, not on whatever the bond market may be doing.
(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 13.8, while the average ranking of Offensive DIME sectors rose slightly to 11.8 from the prior week’s 12.3. The Defensive SHUT sectors now lead the Offensive DIME sectors by a small margin. 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®