FBIAS™ Fact Based Investment Allocation Strategies for the week ending 12/26/2014

The very big picture:

In the “decades” timeframe, we may still be in the Secular Bear Market which began in 2000 when the P/E ratio (using Shiller’s Cyclically-Adjusted P/E, or “CAPE”) peaked at about 44.  The job of Secular Bear markets is to burn off outrageously high P/E ratios over one or two decades, until finally the P/E ratio arrives back at a single-digit level, from which another Secular Bull Market can emerge.  See graph below for the 100-year view of this repeating process.

Even if we are in a new Secular Bull Market, market history says future returns are likely to be modest at best.   The Shiller P/E is at 27.4 up from the prior week’s 27.2, and approximately at the level reached at the pre-crash high in October, 2007.  Even though P/E’s are substantially lower than their crazy peak in 2000, they are nonetheless at the high end of the normal historical range and leave little if any room for expansion.  This means that the stock market is unlikely to make gains greater than corporate profit growth percentage, if that.  (note: all P/E references are to the Shiller P/E values, sometimes called PE10 or CAPE, which are calculated so as to remove shorter-term fluctuations; see robertshiller.com for details).

In fact, since 1881, the average annual returns for all ten year periods that began with a CAPE at 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 P/E’s 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 typical of a 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 US Bull-Bear Indicator (see graph below) is at 63.1, up from the prior week’s 62.3, and continues in cyclical Bull territory.  The current Cyclical Bull has taken the US and some of Europe to new all-time highs, but many of the world’s major indices have yet to top 2007’s levels.  The most widely followed international indexes, the Morgan Stanley EAFE Developed International index and the Morgan Stanley Emerging Markets Index, are both still below their 2007 peaks.

In the intermediate picture:

The intermediate (weeks to months) indicator (see graph below) is Positive and ended the week at 23, up 1 from the prior week’s 22.  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 October for the prospects for the fourth quarter of 2014.

Timeframe summary:

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.  In the Cyclical (months to years) timeframe (Fig. 3 above), all major equity markets are in Cyclical Bull territory.  The Bond market returned to Cyclical Bull territory as of February 28th.  In the Intermediate (weeks to months) timeframe (Fig. 4 above), US equity markets are again rated as Positive.  The quarter-by-quarter indicator gave a positive signal for the 4th quarter:  US equities were in an uptrend, while International equities were in a downtrend at the start of Q4, and either one being in an uptrend is sufficient to signal a higher likelihood of an up quarter than a down quarter. 

In the markets:

Santa came calling on Wall Street, bringing in his bag of goodies a modest rally that – if history is a guide – may continue into year-end.  For the first time in a month, the US was not the biggest worldwide gainer.  That distinction is held by China, gaining +3.5% on news of the easing of Central Bank lending restrictions.  China pulled Emerging International into the lead amongst the world’s broad indices with a gain of +1.5%.  The US indices gained +1.1% on average, with the Small Cap Russell 2000 leading the charge for the third week in a row.  Beaten-down US Small Caps have staged a late-year revival, but still are the year-to-date laggards amongst US indices.  Developed International brought up the rear with a gain of +0.9%, held back by Japan’s lackluster +0.4% gain.  Canada’s TSX rose +1.0% as many energy stocks stabilized or gained.  Both Emerging International and Developed International indices are in the red for 2014 and look unlikely to pull into the green in the remaining three trading sessions of this year.

US economic news was dominated by the “final” reading of third-quarter GDP: a whopping +5.0%.  That is the best since Q3 of 2003, 11 years ago.  The Q2+Q3 combined performance was also the best two-quarter performance since 2003, so Q3 was not just a singular fluke.  Consumer spending rose at a strong +3.2% annual pace in Q3, up from the +2.5% pace of Q2.  A CNN/ORC poll revealed that – for the first time in seven years – a 51% majority of Americans have a positive view of the economy, a sharp increase from the 38% who felt that way in October.  It is not a coincidence that the rise in economic views coincided with the collapse in oil and gasoline prices.  On the negative side, November durable goods orders were down -0.7% when an increase was expected, and November existing and new home sales were both less than forecast and down vs October, despite a record-low 30-year fixed mortgage rate of just 3.8%.

Canada’s stock market remains largely tied to the materials sector, which makes up a third of the Toronto Stock Exchange weighting.  And this year has not been good for materials producers or processors.  Everyone is aware of the plunge in energy prices, but many other materials produced in Canada have also had a rough ride in 2014.  Iron ore lost nearly half its value to reach the lowest price in more than five years.  Coal, silver, potash, copper and lead prices also weakened in the past year.  The carnage wasn’t universal, however, as nickel, uranium, aluminum and zinc managed to hold steady or gain this year.

Christmas week meant no economic news was released in Europe.  But in Japan, there was a slew of bad news.   Industrial production was down -0.6% in November vs October where a gain was expected, retail sales were down 0.3%, consumer prices ex-fresh food (their core) were up only +0.7% after stripping out the effects of April’s sales-tax increase vs the government’s +2% target, while real wages fell the most since 2009, down -4.3% last month vs a year earlier.  Japan has already had two down quarters in a row and now growth in the fourth is very much in question.  Also, for the first time since records were collected in 1955, Japan has a negative savings rate. Japan is a country that is aging rapidly and the Japanese are drawing down their savings.  Household spending is correspondingly down -2.5% as well.  This is a look into the future of many other countries, particularly those in Northern Europe.  Japan’s Cabinet on Saturday approved about 3.5 trillion yen in fresh stimulus to fight the recession.

China’s overcapacity problem is becoming critical.  Factory-gate prices, as producer prices are known in China, have fallen in year-over-year terms for 33 consecutive months.  An op-ed in the Financial Times notes that “The consequences of China’s deflation problems are ubiquitous and spilling into the rest of the world. Slower economic growth and a steady decline in the [Chinese] economy’s commodity intensity is already affecting commodity producers from Perth to Peru, with negative multiplier effects arising from lower revenues and reduced capital spending by resource companies. Moreover, as Chinese companies cut prices to clear excess supply, global competitive pressures intensify, forcing foreign manufacturers to do so too.  China’s structural deflation, along with factors such as excess debt and rapid aging, will continue to have repercussions for monetary policy in advanced economies worldwide…The U.S. Federal Reserve and other western central banks have failed to anticipate this deflation environment…and appear powerless to reverse the trend.”

As many have suggested, falling energy prices are a boon to consumers.  A surprise to some, though, is the fact that falling energy prices also are a boon to the stock market despite their obvious negative implications for the stocks of energy producers and processors.  Here is a look at 6-month forward historical performance of the S&P 500 (in blue) and the Consumer Discretionary sector (in red) following 6-month periods of rising crude prices and 6-month periods of falling crude prices (source: Strategas Partners).

(sources: 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, wantchinatimes.com, BBC, 361capital.com, S China Morning Post, St. Louis Fed)

The ranking relationship (shown in Fig. 5 below) 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 9.5 from the prior week’s 8.5, while the average ranking of Offensive DIME sectors rose to 16.5 from the prior week’s 18.3. Institutional investors remain cautious, and the Defensive SHUT group continues to rank higher than the Offensive DIME group ranking.   This caution is reflected in the fact that institutional investors are underperforming market averages for 2014, having been cautious and defensively positioned with lots of cash while market averages have gone on to new highs – leaving them behind.

Note: these are “ranks”, not “scores”, so smaller numbers are higher ranks and larger numbers are lower ranks.

Summary:

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 even as new highs are reached in the US.

Because we 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.

FBIAS™ Fact Based Investment Allocation Strategies for the week ending 12/19/2014

The very big picture:

In the “decades” timeframe, we may still be in the Secular Bear Market which began in 2000 when the P/E ratio (using Shiller’s Cyclically-Adjusted P/E, or “CAPE”) peaked at about 44.  The job of Secular Bear markets is to burn off outrageously high P/E ratios over one or two decades, until finally the P/E ratio arrives back at a single-digit level, from which another Secular Bull Market can emerge.  See graph below for the 100-year view of this repeating process.

Even if we are in a new Secular Bull Market, market history says future returns are likely to be modest at best.   The Shiller P/E is at 27.2 up from the prior week’s 26.3, and approximately at the level reached at the pre-crash high in October, 2007.  Even though P/E’s are substantially lower than their crazy peak in 2000, they are nonetheless at the high end of the normal historical range and leave little if any room for expansion.  This means that the stock market is unlikely to make gains greater than corporate profit growth percentage, if that.  (note: all P/E references are to the Shiller P/E values, sometimes called PE10 or CAPE, which are calculated so as to remove shorter-term fluctuations; see robertshiller.com for details).

In fact, since 1881, the average annual returns for all ten year periods that began with a CAPE at 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 P/E’s 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 typical of a 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 US Bull-Bear Indicator (see graph below) is at 62.3, up from the prior week’s 62.0, and continues in cyclical Bull territory.  The current Cyclical Bull has taken the US and some of Europe to new all-time highs, but many of the world’s major indices have yet to top 2007’s levels.  The most widely followed international indexes, the Morgan Stanley EAFE Developed International index and the Morgan Stanley Emerging Markets Index, are both still below their 2007 peaks.

In the intermediate picture:

The intermediate (weeks to months) indicator (see graph below) is Positive and ended the week at 22, down 1 from the prior week’s 23.  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 October for the prospects for the fourth quarter of 2014.

Timeframe summary:

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.  In the Cyclical (months to years) timeframe (Fig. 3 above), all major equity markets are in Cyclical Bull territory.  The Bond market returned to Cyclical Bull territory as of February 28th.  In the Intermediate (weeks to months) timeframe (Fig. 4 above), US equity markets returned to Positive status on October 17th.  The quarter-by-quarter indicator gave a positive signal for the 4th quarter:  US equities were in an uptrend, while International equities were in a downtrend at the start of Q4, and either one being in an uptrend is sufficient to signal a higher likelihood of an up quarter than a down quarter. 

In the markets:

For most markets this past week, this is all one needs to know:

A rise in the price of oil and the stocks of energy companies helped, too, especially in Canada and other locales sensitive to oil prices.

Prior to Wednesday, Dec 17th, US stocks had declined six out of seven sessions.  But the Fed’s benign language and Janet Yellen’s non-threatening press conference was enough to put in another “V”-shaped bottom, and it was off to the races.  The subsequent Wed-Fri rally was the best since March, 2009.  For the week, US indices gained an average of more than +3%, with the SmallCap Russell 2000 index leading at +3.8%.  Surprisingly, despite the breathtaking rally US indices did not quite recover all of their losses from the prior week, but are nonetheless back to within spitting range of their all-time highs.  Canada’s TSX rallied the most in 5 years, gaining +5.4% on the double shot of good news from the US and from the jump in both oil prices and energy company stocks.  The Energy stocks in the TSX gained an eye-popping +13% for the week.  However, neither Developed nor Emerging International indices fared as well as did the US and Canada.  Developed International gained +1.2% for the week, and Emerging International +1.3%, but neither came lose to overcoming their prior-week losses of -6.2% and 4.7% respectively.

US economic news was benign on balance, as has been the norm for some time.   Industrial production rose +1.3% vs expectations for a +0.7% increase – the +1.3% gain was the biggest monthly increase since May 2010.  Initial jobless claims were reported at 289,000 vs expectations of 295,000.  Capacity Utilization came in above 80% for the first time since 2008.  The 80% level is often seen by economists as a level at which new capital spending must occur for the creation of additional capacity, with that very spending becoming an economic boost.  US manufacturing output rose +1.1% in November, finally surpassing its pre-recession peak.  On the negative side, November’s Purchasing Managers Index (PMI) for manufacturing was reported at 53.7, the lowest reading in more than a year, and the PMI for Services fell to 53.6, the lowest in 9 months.

The Canadian dollar fell for the fourth week in a row, to 0.862 US dollars.  November Canadian consumer prices rose 2% from the year-ago level, down from the October pace of 2.4% annualized.  The modest increase is well within the Bank of Canada’s target range, seen as giving the central bank continued leeway with interest rates.

Eurozone economic data continues to be lackluster.  The “flash” Eurozone composite PMI for December was 51.7 vs. 51.1 in November, with the manufacturing reading going from 50.1 to 50.8 and the service sector rising to 51.9 from 51.1.  Despite these rises, they remain barely in expansion territory (50 is flat).  The readings for the two biggest Eurozone economies, Germany and France, were dispiriting as well.  France saw its manufacturing PMI fall to 47.9 when an increase had been expected, while Germany’s composite PMI rose to 51.2 from 49.5, but the services PMI fell from 52.1 to 51.4.  Deflation remains a major concern as euro area inflation for November was just 0.3% annualized, vs. 0.4% in October and 0.9% a year ago.  Prices declined in Greece (-1.2%) and Spain (0.5%), while they rose just 0.4% annualized in France and 0.5% annualized in Germany.

In China, the government has declared that small particles from the smog in many Chinese cities have surpassed smoking as the primary cause of skyrocketing lung cancer diagnoses.  Lung cancer now tops the list of all cancers in China, and has been increasing at an annual clip of almost 27% in recent years according the China’s National Cancer Registration Center.  It is most likely no coincidence that the rate of lung-cancer cases in Beijing, which is plagued by some of the nation’s worst smog, went from 39.6 per 100,000 in 2002 to 63.1 in 2011, an increase in rate much higher than the national average.

Amazon has done a great – if so far unprofitable – job of becoming the dominant online retailer.  Its “Amazon Prime” service, incorporating free shipping, special discounts, and music/video streaming services, has jumped in popularity, rising from 20 million members to almost 60 million just in 2014.

Given that level of penetration, it seems inevitable that Santa would receive this letter:

(sources: 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, wantchinatimes.com, BBC, 361capital.com, S China Morning Post, St. Louis Fed, Business Insider)

The ranking relationship (shown in Fig. 5 below) 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 slightly to 8.5 from the prior week’s 9.0, while the average ranking of Offensive DIME sectors fell to 18.3 from the prior week’s 17. Institutional investors remain cautious, and the Defensive SHUT group continues to rank substantially higher than the Offensive DIME group ranking.   This caution is reflected in the fact that institutional investors are underperforming market averages for 2014, having been cautious and defensively positioned with lots of cash while market averages have gone on to new highs – leaving them behind.

Note: these are “ranks”, not “scores”, so smaller numbers are higher ranks and larger numbers are lower ranks.

Summary:

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 even as new highs are reached in the US.

Because we 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.

FBIAS™ Fact Based Investment Allocation Strategies for the week ending 12/12/2014

The very big picture:

In the “decades” timeframe, we may still be in the Secular Bear Market which began in 2000 when the P/E ratio (using Shiller’s Cyclically-Adjusted P/E, or “CAPE”) peaked at about 44.  The job of Secular Bear markets is to burn off outrageously high P/E ratios over one or two decades, until finally the P/E ratio arrives back at a single-digit level, from which another Secular Bull Market can emerge.  See graph below for the 100-year view of this repeating process.

Even if we are in a new Secular Bull Market, market history says future returns are likely to be modest at best.   The Shiller P/E is at 26.3, down from the prior week’s 27.3, and approximately at the level reached at the pre-crash high in October, 2007.  Even though P/E’s are substantially lower than their crazy peak in 2000, they are nonetheless at the high end of the normal historical range and leave little if any room for expansion.  This means that the stock market is unlikely to make gains greater than corporate profit growth percentage, if that.  (note: all P/E references are to the Shiller P/E values, sometimes called PE10 or CAPE, which are calculated so as to remove shorter-term fluctuations; see robertshiller.com for details).

In fact, since 1881, the average annual returns for all ten year periods that began with a CAPE at 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 P/E’s 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 typical of a 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 US Bull-Bear Indicator (see graph below) is at 62.0, down from the prior week’s 65.5, and continues in cyclical Bull territory.  The current Cyclical Bull has taken the US and some of Europe to new all-time highs, but many of the world’s major indices have yet to top 2007’s levels.  The most widely followed international indexes, the Morgan Stanley EAFE Developed International index and the Morgan Stanley Emerging Markets Index, are both still below their 2007 peaks.

In the intermediate picture:

The intermediate (weeks to months) indicator (see graph below) is Positive and ended the week at 23, down 3 from the prior week’s 26.  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 October for the prospects for the fourth quarter of 2014.

Timeframe summary:

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.  In the Cyclical (months to years) timeframe (Fig. 3 above), all major equity markets are in Cyclical Bull territory.  The Bond market returned to Cyclical Bull territory as of February 28th.  In the Intermediate (weeks to months) timeframe (Fig. 4 above), US equity markets returned to Positive status on October 17th.  The quarter-by-quarter indicator gave a positive signal for the 4th quarter:  US equities were in an uptrend, while International equities were in a downtrend at the start of Q4, and either one being in an uptrend is sufficient to signal a higher likelihood of an up quarter than a down quarter. 

In the markets:

For the US and many other markets, the week ending Dec 12th was the worst week in several years.  The Dow Industrials suffered its worst loss since November 2011, -3.8%, while the S&P 500 lost -3.5%, its worst performance since May 2012, with both indices snapping seven-week winning streaks after each hit a new high the prior Friday.   The Nasdaq Composite index fell a second consecutive week, losing -2.7%.  The Russell 2000 SmallCap index was the best performing US index, at -2.5%, but fell back into the red for the year to date.  The rest of the world fared even worse.  Once again, commodity-dependent markets performed the poorest, led by Brazil at -9.3%.  Emerging Markets as a whole dropped -6.2% while Developed Markets on average retreated          -4.7%.  The Greek stock market, for political rather than commodity reasons, crashed -20%, the worst performance since 1987.  Canada’s TSX index declined by -5.1%, and has given up almost all of its gains for the year.

Even in the midst of the stock market gloom, there were good US economic reports away from the news-dominating price of oil.  US retail sales rose +0.6% month over month, better than expected.  Consumer confidence came in at 93.88, which was much better than expectations.  The National Federation of Independent Business (NFIB) small business optimism index was reported at 98.1, the highest in almost 8 years.  Initial jobless claims were 294,000, down 3,000 from last week and a bit lower than expected.  The Mortgage Bankers Association reported that home-refinance applications rose +13.2% week-over-week.  And, of course, oil fell          -12.6% just this week and is off more than -40% from its 2014 highs.

The Canadian dollar (the “Loonie”) fell to a 5 1/2 year low of 86.42 cents US.  The Loonie has tumbled almost a full US cent just this week as oil prices continued to plummet.  Partially offsetting the negative Loonie news was a government forecast of stronger non-petroleum exports on the back of new competitiveness from the lower Loonie.

In Europe, poor economic reports for the Eurozone continued.  Eurozone industrial production for the month of October was released, up just +0.1% month over month (and up a scant +0.7% year over year).  German industrial production for October was also up a less-than-expected +0.2% from September.  The New York Times reported on a French poll revealing an astonishing 90% public disapproval of French President Hollande’s economic policies. 

China’s national statistics bureau released a number of reports this week, none of which were particularly good.  November exports rose +4.7% year over year, far less than expected, while imports fell -6.7%.  Exports to the US rose +2.6% year over year, but this was far less than October’s +10.9% pace.  Another key barometer of economic activity, electricity output, rose only +0.6% in November vs last year.  Producer prices (called “Factory Gate” prices in China) fell an amazing 33rd consecutive month, down -2.7%.  This is outright industrial deflation, brought about by severe overcapacity, lower commodity prices, and no pricing power.  Nonetheless, the Shanghai stock exchange index is up +39% for the year to date after having lain dormant for the prior several years.  Unlike most other investor populations around the world, the majority of domestic Chinese individual investors are…women.  Middle-aged women, in particular, called “dama”.  The Beijing Economic Information Daily publication identifies these “dama” investors as the main factor behind the Chinese market’s recent bullish behavior.

Although this past week was a bust for the markets worldwide, it also is the only week in December which is historically negative.  The remainder of December has historically straightened up and sailed profitably through the end of the year, as this chart from SentimentTrader.com illustrates:

(sources: 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, wantchinatimes.com, BBC, 361capital.com, S China Morning Post, St. Louis Fed, Barclays)

The ranking relationship (shown in Fig. 5 below) 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 slipped to 9.0 from the prior week’s 6.5, while the average ranking of Offensive DIME sectors fell to 17 from the prior week’s 16.5. Institutional investors remain cautious, and the Defensive SHUT group continues to rank substantially higher than the Offensive DIME group ranking.   This caution is reflected in the fact that institutional investors are underperforming market averages for 2014, having been cautious and defensively positioned with lots of cash while market averages have gone on to new highs – leaving them behind.

Note: these are “ranks”, not “scores”, so smaller numbers are higher ranks and larger numbers are lower ranks.

Summary:

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 even as new highs are reached in the US.

Because we 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.

FBIAS™ Fact Based Investment Allocation Strategies for the week ending 12/05/2014

The very big picture:

In the “decades” timeframe, we may still be in the Secular Bear Market which began in 2000 when the P/E ratio (using Shiller’s Cyclically-Adjusted P/E, or “CAPE”) peaked at about 44.  The job of Secular Bear markets is to burn off outrageously high P/E ratios over one or two decades, until finally the P/E ratio arrives back at a single-digit level, from which another Secular Bull Market can emerge.  See graph below for the 100-year view of this repeating process.

Even if we are in a new Secular Bull Market, market history says future returns are likely to be modest at best.   The Shiller P/E is at 27.3, up a little from the prior week’s 27.2, and approximately at the level reached at the pre-crash high in October, 2007.  Even though P/E’s are substantially lower than their crazy peak in 2000, they are nonetheless at the high end of the normal historical range and leave little if any room for expansion.  This means that the stock market is unlikely to make gains greater than corporate profit growth percentage, if that.  (note: all P/E references are to the Shiller P/E values, sometimes called PE10 or CAPE, which are calculated so as to remove shorter-term fluctuations; see robertshiller.com for details).

In fact, since 1881, the average annual returns for all ten year periods that began with a CAPE at 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 P/E’s 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 typical of a 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 US Bull-Bear Indicator (see graph below) is at 65.5, up from the prior week’s 63.3, and continues in cyclical Bull territory.  The current Cyclical Bull has taken the US and some of Europe to new all-time highs, but many of the world’s major indices have yet to top 2007’s levels.  The most widely followed international indexes, the Morgan Stanley EAFE Developed International index and the Morgan Stanley Emerging Markets Index, are both still below their 2007 peaks.

In the intermediate picture:

The intermediate (weeks to months) indicator (see graph below) is Positive and ended the week at 26, down 1 from the prior week’s 27.  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 October for the prospects for the fourth quarter of 2014.

Timeframe summary:

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.  In the Cyclical (months to years) timeframe (Fig. 3 above), all major equity markets are in Cyclical Bull territory.  The Bond market returned to Cyclical Bull territory as of February 28th.  In the Intermediate (weeks to months) timeframe (Fig. 4 above), US equity markets returned to Positive status on October 17th.  The quarter-by-quarter indicator gave a positive signal for the 4th quarter:  US equities were in an uptrend, while International equities were in a downtrend at the start of Q4, and either one being in an uptrend is sufficient to signal a higher likelihood of an up quarter than a down quarter. 

In the markets:

In a repeat of the prior week, markets with little dependency on commodities (especially oil) gained, while those with such dependency declined.  US markets gained an average of +0.2%, with the S&P 500 up +0.4% and the Dow Jones up +0.7% (the seventh straight week of gains for those two indices), but the Nasdaq 100 indexed slipped      -0.6%.  Canada’s TSX retreated by -1.8%, having given up all its earlier year-to-date lead over the US as a consequence of the slide in oil and other commodities.  Despite gains in some European indices, both the Developed and Emerging Market averages slipped for the week, -0.1% and -1.5% respectively.

US economic news was positive on balance, capped off by a blowout November jobs number (as long as you don’t read the “household survey” too closely, which was considerably less enthusing).  The Non-Farm Payroll (NFP) figure for November showed a seasonally adjusted gain of 321,000, the strongest month since January 2012, and the 10th consecutive monthly gain of 200,000+.  October’s figure was revised up to 243,000 and September’s to 271,000.  As economists had been expecting November’s figure to be in the 225,000 range, this was a large expectation-beater.  The unemployment rate was 5.8%, unchanged, though still at the lowest level since mid-2008.  For 2014, the economy is on track to produce the strongest annual payroll growth since 1999.  Average hourly earnings rose +0.4%, a solid gain, and are now up +2.1% year-over-year – closer to a level that will generate higher spending by wage-earners.

Canada, on the other hand, surprised with a negative November jobs report.  Employment declined by -10,700 in November after jumps of +43,100 and +74,100 the last two months, as reported by Statistics Canada. The unemployment rate rose to 6.6% from a six-year low of 6.5%.  The Canadian dollar, the “Loonie”, dropped to a 5-year low concurrent with oil dropping to a 5-year low, and few think it to be a mere coincidence.

In the Eurozone, the November Purchasing Managers Index (PMI) was reported to be just 50.1 vs. October’s 50.6, barely above the 50 dividing line between growth and contraction.  Germany was 49.5, a 17-month low, Italy clocked in at 49.0, Greece 49.1, and France 48.4 – all in contraction territory.  Ireland, Netherlands and Spain are bucking the trend and reported decent PMI numbers at multi-month highs, but they are by far the exceptions to the rule.  A composite reading that includes both new orders and the service sector was 51.1 vs. 52.1 in October, the lowest for the Eurozone in 16 months.

In China, HSBC Bank’s final reading on the November manufacturing PMI was at the flat-line of 50.0, a 6-mo. low and down from 50.4 in October. The services reading was 53.0 vs. 52.9. The government’s official manufacturing PMI was 50.3, an 8-month low, vs. 50.8.

By a wide margin, this year’s most important economic story has been the slide in oil prices, from a high this year of $107 down to the current $67 – a -38% decline that has had significant positive and negative consequences for countries, companies and people.  Many industry experts claim that booming oil production in the US – particularly from the spreading of fracking extraction techniques and from the shale-oil areas of the country – have been the major factor pushing prices down.  A look at a 30-year chart of US oil production tells the story:

Many high-yield bond investors have been wondering why their high-yield mutual fund and ETF holdings have been declining steeply for the past 4 months (now off almost 20% for many ETFs and mutual funds).  One non-obvious reason is that energy-related loans now comprise triple the share of the high-yield universe compared with just 10 years ago, and with falling energy prices comes a higher expectation of loan defaults from energy-industry borrowers.  This chart shows the steep rise in energy-related borrowers within the high-yield universe:

(sources: 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, wantchinatimes.com, BBC, 361capital.com, S China Morning Post, St. Louis Fed, Barclays)

The ranking relationship (shown in Fig. 5 below) 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 6.5 from the prior week’s 7.5, while the average ranking of Offensive DIME sectors fell to 16.5 from the prior week’s 15.8. Institutional investors remain cautious, and the Defensive SHUT group continues to rank substantially higher than the Offensive DIME group ranking.   This caution is reflected in the fact that institutional investors are underperforming market averages this year, having been cautious and defensively positioned with lots of cash while market averages have gone on to new highs – leaving them behind.

Note: these are “ranks”, not “scores”, so smaller numbers are higher ranks and larger numbers are lower ranks.

Summary:

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 even as new highs are reached in the US.

Because we 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.

FBIAS™ Fact Based Investment Allocation Strategies for the week ending 11/28/2014

The very big picture:

In the “decades” timeframe, we may still be in the Secular Bear Market which began in 2000 when the P/E ratio (using Shiller’s Cyclically-Adjusted P/E, or “CAPE”) peaked at about 44.  The job of Secular Bear markets is to burn off outrageously high P/E ratios over one or two decades, until finally the P/E ratio arrives back at a single-digit level, from which another Secular Bull Market can emerge.  See graph below for the 100-year view of this repeating process.

Even if we are in a new Secular Bull Market, market history says future returns are likely to be modest at best.   The Shiller P/E is at 27.2, up a little from the prior week’s27.1, and approximately at the level reached at the pre-crash high in October, 2007.  Even though P/E’s are substantially lower than their crazy peak in 2000, they are nonetheless at the high end of the normal historical range and leave little if any room for expansion.  This means that the stock market is unlikely to make gains greater than corporate profit growth percentage, if that.  (note: all P/E references are to the Shiller P/E values, sometimes called PE10 or CAPE, which are calculated so as to remove shorter-term fluctuations; see robertshiller.com for details).

In fact, since 1881, the average annual returns for all ten year periods that began with a CAPE at 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 P/E’s 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 typical of a 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 US Bull-Bear Indicator (see graph below) is at 63.3, up from the prior week’s 61.1, and continues in cyclical Bull territory.  The current Cyclical Bull has taken the US and some of Europe to new all-time highs, but many of the world’s major indices have yet to top 2007’s levels.  The most widely followed international indexes, the Morgan Stanley EAFE Developed International index and the Morgan Stanley Emerging Markets Index, are both still below their 2007 peaks.

In the intermediate picture:

The intermediate (weeks to months) indicator (see graph below) is Positive and ended the week at 27, up from the prior week’s 25.  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 October for the prospects for the fourth quarter of 2014.

Timeframe summary:

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.  In the Cyclical (months to years) timeframe (Fig. 3 above), all major equity markets are in Cyclical Bull territory.  The Bond market returned to Cyclical Bull territory as of February 28th.  In the Intermediate (weeks to months) timeframe (Fig. 4 above), US equity markets returned to Positive status on October 17th.  The quarter-by-quarter indicator gave a positive signal for the 4th quarter:  US equities were in an uptrend, while International equities were in a downtrend at the start of Q4, and either one being in an uptrend is sufficient to signal a higher likelihood of an up quarter than a down quarter. 

In the markets:

Markets that are not dependent upon commodities advanced modestly last week, while those that are commodity-dependent declined, some quite hard.  The US market indices advanced +0.7% on average, with the Nasdaq leading at +1.7% and the S&P 500 at a more modest +0.2%.  Canada’s TSX was battered by both the oil freefall and a decline in gold prices, and declined by -2.4%.  Emerging markets, many of which are commodity producers, fell by -2.2%, while Developed markets gained +0.3%.  DBC, the PowerShares Commodity Tracking ETF, fell -6.1% for the week.  DBC tracks a composite of energy, precious metals, industrial metals and agricultural commodities.

The month of November was positive for most markets worldwide.  In the US, the Dow and the S&P 500 both gained +2.5%, with only the SmallCap Russell 2000 index losing ground at -0.02%.  Despite the setback in the last week of the month, Canada’s TSX managed to gain +0.9%.  Emerging markets fell by -1.5% for November, but Developed markets eked out a slight gain of +0.1%.  As the markets enter the final month of the year, many observers are wondering if the S&P 500 index can finish the year without 4 down days in a row.  There hasn’t been a single year since 1950 without the S&P 500 experiencing at least 4 down days in a row.

US economic data included the first revision to third-quarter GDP, and it was an expectation-beating +3.9%.  Coupled with the second quarter’s +4.6% rise, this represents the biggest back-to-back advances in GDP since late 2003.  October durable goods and consumer spending came in lighter than expectations but still positive.

Canada’s economy grew an annualized 2.8 percent in the third quarter, faster than economists had forecast, as exports of crude oil grew and consumers bought more cars and big-ticket items.   However, the rout in oil and renewed decline in precious metals are playing havoc with large segments of the Canadian economy.  Oil is at a 5 year low, copper at a 5 year low, and the Bloomberg commodity index has fallen to the lowest level since May 2009. Many energy and mining company shares have fallen 10%-20% in the last three weeks.

The crash in oil prices is by far the most important global economic news.  West Texas Intermediate (WTI) oil plunged below $70.00 a barrel to finish the week at $66.15 – a decline of a whopping -14% on the week, with the price having fallen over $40 since the mid-June weekly closing highs of nearly $107.00, or off about 38% in just five months.

US imports of crude oil from OPEC nations are at the lowest levels in almost 30 years, according to a Financial Times analysis of Department of Energy data, with OPEC’s share of the imports dropping to 40%, the lowest since May 1985. At its peak in 1976, OPEC represented 88% of U.S. oil imports. 

The plunge in the price of oil is not universally good news, of course:  Deutsche Bank warned in a study “that if oil fell to $60, there could be a 30% default rate among borrowers in the energy sector, who loaded up on debt to fund their operations and acquire new acreage in states like North Dakota.”

But it is certainly being taken as good news by retailers, who stand to gain from the increased spending power of consumers who are presumably spending a lot less at the gas pump.  Another bit of good news, at least to retailers, has been the early and harsh arrival of winter in the US.  Retailers expect the sales of winter-season apparel to rise dramatically, and have greatly expanded their stocks of heavier clothing and outerwear.  Terry Lundgren, CEO of Macy’s, said “We now have much higher expectations for the fourth quarter.”

This chart shows what Macy’s and other retailers already know:  November was cold!  In fact, it was the second coldest November on record for the US, trailing only 1911.

(sources: 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, wantchinatimes.com, BBC, 361capital.com, S China Morning Post, St. Louis Fed, fivethirtyeight.com)

The ranking relationship (shown in Fig. 5 below) 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 7.5 from the prior week’s 6.5, while the average ranking of Offensive DIME sectors rose to 15.8 from the prior week’s 16.5. Institutional investors remain cautious, and the Defensive SHUT group continues to rank substantially higher than the Offensive DIME group ranking.   This caution is reflected in the fact that institutional investors are underperforming market averages this year, having been cautious and defensively positioned with lots of cash while market averages have gone on to new highs – leaving them behind.

Note: these are “ranks”, not “scores”, so smaller numbers are higher ranks and larger numbers are lower ranks.

Summary:

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 even as new highs are reached in the US.

Because we 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.

FBIAS™ for the week ending 11/21/2014

The very big picture:

In the “decades” timeframe, we may still be in the Secular Bear Market which began in 2000 when the P/E ratio (using Shiller’s Cyclically-Adjusted P/E, or “CAPE”) peaked at about 44.  The job of Secular Bear markets is to burn off outrageously high P/E ratios over one or two decades, until finally the P/E ratio arrives back at a single-digit level, from which another Secular Bull Market can emerge.  See graph below for the 100-year view of this repeating process.

Even if we are in a new Secular Bull Market, market history says future returns are likely to be modest at best.   The Shiller P/E is at 27.1, up from the prior week’s 26.7, and approximately at the level reached at the pre-crash high in October, 2007.  Even though P/E’s are substantially lower than their crazy peak in 2000, they are nonetheless at the high end of the normal historical range and leave little if any room for expansion.  This means that the stock market is unlikely to make gains greater than corporate profit growth percentage, if that.  (note: all P/E references are to the Shiller P/E values, sometimes called PE10 or CAPE, which are calculated so as to remove shorter-term fluctuations; see robertshiller.com for details).

In fact, since 1881, the average annual returns for all ten year periods that began with a CAPE at 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 P/E’s 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 typical of a 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 US Bull-Bear Indicator (see graph below) is at 61.1, up from the prior week’s 58.8, and continues in cyclical Bull territory.  The current Cyclical Bull has taken the US and some of Europe to new all-time highs, but many of the world’s major indices have yet to top 2007’s levels.  The most widely followed international indexes, the Morgan Stanley EAFE Developed International index and the Morgan Stanley Emerging Markets Index, are both still below their 2007 peaks.

In the intermediate picture:

The intermediate (weeks to months) indicator (see graph below) is Positive and ended the week at 25, 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 October for the prospects for the fourth quarter of 2014.

Timeframe summary:

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.  In the Cyclical (months to years) timeframe (Fig. 3 above), all major equity markets are in Cyclical Bull territory.  The Bond market returned to Cyclical Bull territory as of February 28th.  In the Intermediate (weeks to months) timeframe (Fig. 4 above), US equity markets returned to Positive status on October 17th.  The quarter-by-quarter indicator gave a positive signal for the 4th quarter:  US equities were in an uptrend, while International equities were in a downtrend at the start of Q4, and either one being in an uptrend is sufficient to signal a higher likelihood of an up quarter than a down quarter. 

In the markets:

Markets were mostly positive around the world for the week.  Brazil paced the gainers with an eye-catching +11.9% gain, while China was among the few losers at -1.3%.  Also among the few losers were US SmallCaps, at     -0.1%, although all other US indices were positive, led by the S&P 500 at +1.3%.  European indices gained +3% to +4%, spurred by the European Central Bank (ECB) promises of an American-style QE to call their own.  Canada’s TSX was also nicely positive at +1.8%.

In US economic news, housing figures were good for the month of October with housing starts coming in at an annualized pace of 1.08 million, better than expected, led by single-family home starts rising +4.2%.  Existing home sales for October also came in above expectations at 5.26 million.  On the inflation front, October’s Producer Price Index (PPI) was up +0.2% (+0.4% for the “core” – ex-food and energy).  For the trailing 12 months the PPI is up +1.5%, and +1.8% on the core.  The Consumer Price Index (CPI) for October was unchanged, and up +0.2% ex-food and energy.  Year over year the two versions of the CPI were just +1.7% and +1.8% on core, so inflation remains unworrisome.  The Philly Fed Index of mid-Atlantic economic activity came in at 40.8, versus economists’ expectations of 20.7 – a big “beat” that is also the best reading since 1993.  As earnings season is ending, the percentage of companies in the S&P 500 beating their Q3 analysts’ expectations of their earnings is the highest since 2010.

Canada’s central bankers have expressed concerns over too-low inflation, but those fears were allayed at least for now by the October inflation report released by Statistics Canada on Friday.  Increasing costs of bacon, cigarettes and natural gas were among the many contributors that helped propel Canada’s annual inflation rate to the unexpected level of +2.4% last month, its highest level in almost two years.  A weaker Loonie helped boost prices for imports.  The +2.4% level is in the range desired by the central bank and, if it continues, will free the bank to remove disinflation from its concerns.

The ECB successfully jawboned Europe’s markets higher – much higher – on the week.  ECB President Mario Draghi used another variation of his “whatever it takes” mantra, this time saying “We will do what we must to raise inflation and inflation expectations as fast as possible, as our price-stability mandate requires.”  He went on to say that inflation expectations “have been declining to levels that I would deem excessively low.”  The ECB then announced it had purchased and will continue to purchase more asset-backed securities.  Euro-area stocks soared and bond yields fell on speculation the ECB is getting ever closer to a full-scale, U.S. style, quantitative easing program.

Japan shocked economists worldwide on Monday, when the government released an initial estimate on third-quarter growth at -1.6%, whereas an increase of +2.2% had been expected.  This follows a whopping -7.3% decline in Q2, and would put Japan back into official recession.  The final reading on Q3 isn’t until December 8, and it could be revised upwards a bit, but the number was all Prime Minister Shinzo Abe needed to delay until 2016 or even 2017 the final hike in the sales tax, from 8% to 10%, which had been slated for next October.  The sales tax hike has been a long-planned step to reduce Japan’s horrible deficit.  Japan desperately needs a return to growth and modest inflation to break the deflationary mindset that has beset Japan for the better part of 15 years.  The government also announced it is going to institute a $26 billion stimulus program focusing on childcare and other measures to help the middle class directly and boost consumer spending and business investment.

China added to the parade of government economic actions when, on Friday night China time, the People’s Bank of China cut its one-year lending rate to 5.6% from 6.0%, the first cut in the benchmark interest rate in more than two years.  Commodities in particular shot higher on Friday on the hope that the rate cut will provide fresh stimulus to China’s flagging economy.

Self-help guru Tony Robbins is out with a new book “MONEY Master the Game: 7 Simple Steps to Financial Freedom”.

Advisors are already fielding calls from clients wanting to know about his “All Weather Portfolio”, described in the book as the only investment portfolio anyone should need.  The 55% bond exposure called for in his portfolio is perfectly suited…to the last 30 years – the greatest bond bull market in history – yet seems extremely unlikely to fare as well in the future.  It appears to many observers – for example, see Barry Ritholtz’ column for Bloomberg here http://www.bloombergview.com/articles/2014-11-19/trade-against-a-selfhelp-genius – to be a prime example of “curve-fitting”, and Ritholtz also reminds readers that Mr. Robbins’ last foray into the world of investment advice was a disaster.  On August 6, 2010, when the S&P 500 was at 1121, Robbins released a flash warning to his millions of followers:  “Right now is a time you might want to take some stocks off the table in the stock market. Especially if they are in manufacturing or retail or banking or god forbid homebuilding and housing . . . I would feel bad if I didn’t warn you . . . One of the biggest bubbles in history is blowing up NOW.”  Instead, however, the S&P gained almost 90% to its present level (2063 as of Friday), presumably leaving behind Mr. Robbins and all who took his advice.

(sources: 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, wantchinatimes.com, BBC, 361capital.com, S China Morning Post, St. Louis Fed, fivethirtyeight.com)

The ranking relationship (shown in Fig. 5 below) 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 6.5 from the prior week’s 7.3, while the average ranking of Offensive DIME sectors rose to 16.5 from the prior week’s 17.8. Institutional investors remain cautious, and the Defensive SHUT group continues to rank substantially higher than the Offensive DIME group ranking.   This caution is reflected in the fact that institutional investors are underperforming market averages this year, having been cautious and defensively positioned with lots of cash while market averages have gone on to new highs – leaving them behind.

Note: these are “ranks”, not “scores”, so smaller numbers are higher ranks and larger numbers are lower ranks.

Summary:

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 even as new highs are reached in the US.

Because we 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.

FBIAS™ Fact Based Investment Allocation Strategies for the week ending 11/14/2014

The very big picture:

In the “decades” timeframe, we may still be in the Secular Bear Market which began in 2000 when the P/E ratio (using Shiller’s Cyclically-Adjusted P/E, or “CAPE”) peaked at about 44.  The job of Secular Bear markets is to burn off outrageously high P/E ratios over one or two decades, until finally the P/E ratio arrives back at a single-digit level, from which another Secular Bull Market can emerge.  See graph below for the 100-year view of this repeating process.

Even if we are in a new Secular Bull Market, market history says future returns are likely to be modest at best.   The Shiller P/E is at 26.7, up a tenth from the prior week’s 26.6, and approximately at the level reached at the pre-crash high in October, 2007.  Even though P/E’s are substantially lower than their crazy peak in 2000, they are nonetheless at the high end of the normal historical range and leave little if any room for expansion.  This means that the stock market is unlikely to make gains greater than corporate profit growth percentage, if that.  (note: all P/E references are to the Shiller P/E values, sometimes called PE10 or CAPE, which are calculated so as to remove shorter-term fluctuations; see robertshiller.com for details).

In fact, since 1881, the average annual returns for all ten year periods that began with a CAPE at 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 P/E’s 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 typical of a 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 US Bull-Bear Indicator (see graph below) is at 58.82, up from the prior week’s 56.7, and continues in cyclical Bull territory.  The current Cyclical Bull has taken the US and some of Europe to new all-time highs, but many of the world’s major indices have yet to top 2007’s levels.  The most widely followed international indexes, the Morgan Stanley EAFE Developed International index and the Morgan Stanley Emerging Markets Index, are both still below their 2007 peaks.

In the intermediate picture:

The intermediate (weeks to months) indicator (see graph below) is Positive and ended the week at25, up from the prior week’s 21.  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 October for the prospects for the fourth quarter of 2014.

Timeframe summary:

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.  In the Cyclical (months to years) timeframe (Fig. 3 above), all major equity markets are in Cyclical Bull territory.  The Bond market returned to Cyclical Bull territory as of February 28th.  In the Intermediate (weeks to months) timeframe (Fig. 4 above), US equity markets returned to Positive status on October 17th.  The quarter-by-quarter indicator gave a positive signal for the 4th quarter:  US equities were in an uptrend, while International equities were in a downtrend at the start of Q4, and either one being in an uptrend is sufficient to signal a higher likelihood of an up quarter than a down quarter. 

In the markets:

It was a dull week for markets, with much less movement than was the case just a few weeks ago when volatility was high and so was fear.  The S&P 500 index closed between 2038.25 and 2039.82 each of the 5 trading days of the week, just a 1.7 point range.  For the week, the S&P and Dow managed a +0.4% gain, while the MidCap and SmallCap indices were flat on the week, and the Nasdaq 100 index rose +1.6% – by far the best performance of any US index.  Canada’s TSX gained +1.0%, buoyed by a gain in gold and by the newly-revived Keystone XL pipeline bills now in Congress.  Developed International Markets gained an average of +0.5%, while Emerging International Markets rose +0.5%.  China led the major internationals with +3.0% rise, and Brazil brought up the rear with a loss of -4.2%.

It was an extremely light week for economic data in the U.S. with the only report of note, October retail sales, up a better than expected +0.3%.  The most important continuing economic story is the rapid decline in the price of oil.  Crude prices are down 30% since mid-June.  U.S. motorists are paying an average of $2.92 a gallon, according to the Lundberg Survey (for the two weeks ended Nov. 7, so a further decline is probable for the week just ended), or a savings of about $52 billion for U.S. consumers.  The Department of Labor reported that employees are quitting their jobs at the fastest rate since 2008, which, counterintuitively, is good news as it means the quitting employees are confident that they can promptly find another, presumably better, job.

One of the most vexing issues in the US economy has been the stubborn refusal of hourly earnings to rise more than the cost of living, thereby leaving real wages stagnant.  This chart, from fivethirtyeight.com, shows that

annual wage growth has been stuck in the 2% range since 2009 – as has annual inflation.  That’s because employers have been able to fill jobs readily, with no need to raise wages to attract and retain their employees.

However, that may change in the not too distant future.  The unemployment rate for the “least employable” – those who did not graduate from high school – has finally come down to the level at which employers may at last be required to offer higher wages as an inducement to attract applicants even at this low rung on the employment ladder.  This Fed chart shows that the unemployment rate for this group is now back to the 8% level, last seen in 2008.

Canadian factory sales advanced in September, the eighth gain in nine months, mostly due to an increase in aerospace sales.  Statistics Canada reported that manufacturing sales rose +2.1 percent to C$53.0 billion.  The upside to the recent depreciation for the Canadian dollar versus the US dollar is that exports can grow smartly, particularly of sophisticated manufactured products such as those in the aerospace category.  Canadians are rolling their eyes at the continuing folly of US politics regarding the Keystone XL Pipeline.  Suddenly, previously-obstructive Democrats in the US Senate are falling over themselves to get a bill passed in support of the project, all in a desperate attempt to save Senator Mary Landrieu’s seat.  She has made support of the project a cornerstone of her re-election campaign in the energy industry friendly state of Louisiana, and now that she is behind in the polls for a runoff vote, fellow Democrats are belatedly trying to come to her rescue.  The President, however, is not on board with this effort, and may well veto any legislation that reaches his desk.

In Europe, the first look at third-quarter GDP for the Eurozone was up +0.2% over the second quarter (which in turn was up +0.1%), according to the EU’s statistics arm Eurostat.  Year over year, GDP was up less than a percent, at +0.8%.  Germany came in with Q3 GDP up +0.1%, barely avoiding an official recession after a -0.1% performance in the second quarter.  France and Spain were also up a fraction, but Italy was down, -0.1%, after       -0.2% in Q2, so Italy remains in recession with GDP falling 11 of the last 13 quarters.

China and the US announced an agreement on greenhouse gas emissions, whereby the US will continue to cut its emissions and China will…do nothing.  The only thing China agreed to do was to use its 2030 emissions output as the benchmark against which to measure any subsequent reductions.  Perversely, this seemingly gives China an incentive to increase emissions with abandon until 2030 in order to establish a high level from which subsequent reductions can be measured – and more easily achieved.

(sources: 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, wantchinatimes.com, BBC, 361capital.com, S China Morning Post, St. Louis Fed, fivethirtyeight.com)

The ranking relationship (shown in Fig. 5 below) 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 was unchanged at 7.3, while the average ranking of Offensive DIME sectors rose to 17.8 from the prior week’s 20. Institutional investors remain cautious, and the Defensive SHUT group continues to rank substantially higher than the Offensive DIME group ranking.   This caution is reflected in the fact that institutional investors are underperforming market averages this year, having been cautious and defensively positioned with lots of cash while market averages have gone on to new highs – leaving them behind.

Note: these are “ranks”, not “scores”, so smaller numbers are higher ranks and larger numbers are lower ranks.

Summary:

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 even as new highs are reached in the US.

Because we 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.

FBIAS™ Fact Based Investment Allocation Strategies for the week ending 11/7/2014

The very big picture:

In the “decades” timeframe, we have been in a Secular Bear Market which began in 2000 when the P/E ratio (using Shiller’s Cyclically-Adjusted P/E, or “CAPE”) peaked at about 44.  The job of Secular Bear markets is to burn off outrageously high P/E ratios over one or two decades, until finally the P/E ratio arrives back at a single-digit level, from which another Secular Bull Market can emerge.  See graph below for the 100-year view of this repeating process.

If history is a guide, we may not yet be done with this Secular Bear Market.  The Shiller P/E is at 26.6, up a little from the prior week’s 26.4, and approximately at the level reached at the pre-crash high in October, 2007.  Even though P/E’s are substantially lower than their crazy peak in 2000, they are nonetheless at the high end of the normal historical range and leave little if any room for expansion.  This means that the stock market is unlikely to make gains greater than corporate profit growth percentage, if that.  (note: all P/E references are to the Shiller P/E values, sometimes called PE10 or CAPE, which are calculated so as to remove shorter-term fluctuations; see robertshiller.com for details).

In fact, since 1881, the average annual returns for all ten year periods that began with a CAPE at 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 P/E’s 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 typical of a 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 US Bull-Bear Indicator (see graph below) is at 56.7, up from the prior week’s 54.6, and continues in cyclical Bull territory.  The current Cyclical Bull has taken the US and some of Europe to new all-time highs, but many of the world’s major indices have yet to top 2007’s levels.  The most widely followed international indexes, the Morgan Stanley EAFE Developed International index and the Morgan Stanley Emerging Markets Index, are both still below their 2007 peaks.

In the intermediate picture:

The intermediate (weeks to months) indicator (see graph below) is Positive and ended the week at 21, up from the prior week’s 18.  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 October for the prospects for the fourth quarter of 2014.

Timeframe summary:

In the Secular (years to decades) timeframe (Figs. 1 & 2 above), the Secular Bear may still be in force as the long-term valuation of the market is simply too high to sustain a new rip-roaring Secular Bull.  In the Cyclical (months to years) timeframe (Fig. 3 above), all major equity markets are in Cyclical Bull territory.  The Bond market returned to Cyclical Bull territory as of February 28th.  In the Intermediate (weeks to months) timeframe (Fig. 4 above), US equity markets returned to Positive status on October 17th.  The quarter-by-quarter indicator gave a positive signal for the 4th quarter:  US equities were in an uptrend, while International equities were in a downtrend at the start of Q4, and either one being in an uptrend is sufficient to signal a higher likelihood of an up quarter than a down quarter. 

In the markets:

The week saw modest gains in the US and Canada, and mostly losses in International markets.  US indices gained an average +0.4%, led by the Dow at +1.1% and with the SmallCap Russell 2000 bringing up the rear at -0.02%.  The Dow and S&P 500 finished the week at new all-time highs.  On Wednesday (11/5), the Dow, the S&P 500, the Dow Transports Index and the Dow Utilities Index all simultaneously closed at new highs – the first time since 1998 that all four had done so on the same day.  Canada’s TSX gained +0.5% on the back of strong double-digit gains in many gold and oil stocks on Friday, and ended the week at a one-month high.  Internationally, Brazil was the worst at -5.2% followed closely by Japan at -4.1%.  Developed International as a whole retreated -2.2%, and Emerging International declined -1.7%.  Europe overall gave up -1.8%.

In the US, the employment report for October notched a ninth consecutive month above 200,000 (214,000), the best such stretch since March 1995. August and September were also revised up a total of 31,000.  The unemployment rate ticked down to 5.8%, its lowest level since July 2008.  However, the labor force participation rate hasn’t likewise improved.  This chart shows clearly that labor force participation (expressed as civilian employment as % of population) has not recovered from the recession of 2008-2009.  In prior post-recession periods, labor force participation has returned to pre-recession levels promptly– but it shows few signs of doing so this time.

Statistics Canada reported that the Canadian economy added 43,100 new jobs in October, a surprise to most observers, and that the unemployment rate dropped to a nearly six-year low of 6.5%.   Analysts had expected a loss of 5,000 jobs after September’s gain of 74,100 positions.  The jobless rate, down from 6.8% in September, was the lowest since the 6.4% recorded in November 2008.  The combined September and October gains were two-thirds of all the job gains in the past year.

The European Commission reduced its growth forecast for the Eurozone to just +0.8% in 2014, down from a previous projection of +1.2%, while cutting 2015 to +1.1% from +1.7%.  The Commission also reduced its inflation forecast to 0.5% this year, 0.8% in 2015 and 1.5% in 2016, all well below the European Central Banks’s 2% target.  Marco Buti, the director general of the European Commission’s economics department, said “We see growth…coming to a stop in Germany…protracted stagnation in France and contraction in Italy.”

A good barometer of China’s economy has been the health of the gambling industry in Macau – an industry that is an amazing seven times larger than that of Las Vegas.  Macau’s casinos recorded their worst monthly revenue performance on record in October, down -23.2% from a year earlier (records go back to 2005).  Anti-corruption campaigns have no doubt dampened high-rolling excesses to some degree, but few believe it is the major cause of such a drastic decline.

(sources: 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, wantchinatimes.com, BBC, 361capital.com, S China Morning Post)

The ranking relationship (shown in Fig. 5 below) 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 7.3 from the prior week’s 7.0, while the average ranking of Offensive DIME sectors fell to 20 from the prior week’s 18.5. Institutional investors remain cautious, and the Defensive SHUT group continues to rank substantially higher than the Offensive DIME group ranking.   This caution is reflected in the fact that institutional investors are underperforming market averages this year, having been cautious and defensively positioned with lots of cash while market averages have gone on to new highs – leaving them behind.

Note: these are “ranks”, not “scores”, so smaller numbers are higher ranks and larger numbers are lower ranks.

Summary:

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 even as new highs are reached in the US.

Because we 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.

FBIAS™ Fact Based Investment Allocation Strategies for the week ending 10/31/2014

The very big picture:

In the “decades” timeframe, we have been in a Secular Bear Market which began in 2000 when the P/E ratio (using Shiller’s Cyclically-Adjusted P/E, or “CAPE”) peaked at about 44.  The job of Secular Bear markets is to burn off outrageously high P/E ratios over one or two decades, until finally the P/E ratio arrives back at a single-digit level, from which another Secular Bull Market can emerge.  See graph below for the 100-year view of this repeating process.

If history is a guide, we may not yet be done with this Secular Bear Market.  The Shiller P/E is at 26.4, up from the prior week’s 25.7, and approximately at the level reached at the pre-crash high in October, 2007.  Even though P/E’s are substantially lower than their crazy peak in 2000, they are nonetheless at the high end of the normal historical range and leave little if any room for expansion.  This means that the stock market is unlikely to make gains greater than corporate profit growth percentage, if that.  (note: all P/E references are to the Shiller P/E values, sometimes called PE10 or CAPE, which are calculated so as to remove shorter-term fluctuations; see robertshiller.com for details).

In fact, since 1881, the average annual returns for all ten year periods that began with a CAPE at 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 P/E’s 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 typical of a 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 US Bull-Bear Indicator (see graph below) is at 54.6, up from the prior week’s 52.6, and continues in cyclical Bull territory.  The current Cyclical Bull has taken the US and some of Europe to new all-time highs, but many of the world’s major indices have yet to top 2007’s levels.  The most widely followed international indexes, the Morgan Stanley EAFE Developed International index and the Morgan Stanley Emerging Markets Index, are both still below their 2007 peaks.

In the intermediate picture:

The intermediate (weeks to months) indicator (see graph below) is Positive and ended the week at 18, up sharply from the prior week’s 10.  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 October for the prospects for the fourth quarter of 2014.

Timeframe summary:

In the Secular (years to decades) timeframe (Figs. 1 & 2 above), the Secular Bear may still be in force as the long-term valuation of the market is simply too high to sustain a new rip-roaring Secular Bull.  In the Cyclical (months to years) timeframe (Fig. 3 above), all major equity markets are in Cyclical Bull territory.  The Bond market returned to Cyclical Bull territory as of February 28th.  In the Intermediate (weeks to months) timeframe (Fig. 4 above), US equity markets returned to Positive status on October 17th.  The quarter-by-quarter indicator gave a positive signal for the 4th quarter:  US equities were in an uptrend, while International equities were in a downtrend at the start of Q4, and either one being in an uptrend is sufficient to signal a higher likelihood of an up quarter than a down quarter. 

In the markets:

The rush back to “risk-on” continued during the week ending October 31 for most of the world’s stock market indices.  US indices gained from +2.7% to +4.9%, and the SmallCap Russell 2000 regained positive territory for the year to date.  The Dow and S&P 500 finished the week in record territory, after kissing “correction” territory just 2 weeks earlier.  Canada’s gains were much more muted, at just +0.5% for the week for the TSX index.  Earlier in the year, Canada’s market gains had far surpassed those in the US, but that lead has vanished and Canada is now trailing the US in year to date gains.  Developed International and Emerging International both rose by +2.8% for the week, with Japan and Brazil leading the way with gains of +7.1% and +4.0%, respectively.

The rapidity with which fear left the market in the 2nd half of October was dramatic and record-setting.  Three consecutive days of 10% declines in the VIX Volatility Index (commonly referred to as the “Fear Index”) had never been experienced before, and a total drop of 48% between the 16th and the 31st was the most rapid drop in the VIX Fear Index since March of 2009.

For the month of October, the gains in the final week of the month turned a loser into a winner for US indices and many International indices.  However, Canada and Developed International still were negative for October, with Canada turning in the worst performance at -2.3%.  The fact that gold finished the week at the lowest weekly level in 4-1/2 years did not help Canada, whose market is more sensitive to the price of gold than is any other developed nation’s market.

In US economic news, September durable goods (big-ticket items) fell -1.3%, worse than expected, and September consumption (consumer spending) unexpectedly declined -0.2% when an increase had been forecast.  All other data points reported during the week, however, were very positive.  The initial reading on third-quarter GDP came in at a better than expected +3.5% whereas economists were calling for +3.0%.  The back-to-back performance of Q2 and Q3 is the best 2-quarter result since the final six months of 2003.  The Case-Shiller home price index for August showed prices rose +5.6% year over year for the 20-city index, vs. July’s +6.7%. The slowdown in price appreciation, coupled with low mortgage rates, make housing more affordable.  In another case of “the last shall be first”, home prices rose the most in Miami, up +10.5% year-over-year, and +10.1% in Las Vegas.  Friday’s Chicago Purchasing Managers Index (“PMI”) for October was reported at 66.2, a reading that not only exceeded expectations, but was the best in 12 months.  Two very important Central Bank events also occurred during the week.  First, the Federal Reserve ended its massive bond buying programs (known as “QE1” thru “QE3”) – and the stock market shrugged it off.  The Fed’s statement remained accommodating and left in language containing the magic phrase “considerable time” in describing how long interest rates may remain near zero.  The other Central Bank gift to the market came from Japan’s Central Bank, which surprised markets with the announcement of a gigantic asset purchase plan, which will include the purchase of not only domestic Japanese but also non-Japanese equities.

Statistics Canada reported a surprise decline of -0.1% in Canadian GDP for August.  Drops in oil and gas output combined with a fall in manufacturing contributed to the first shrinkage in GDP since December.  On an annualized basis, GDP was +2.2% through August.  The Retail Council of Canada reported record-setting sales of Halloween costumes, candy and accessories.  The Retail Council maintains that Canadians now outspend the US on a per-capita basis, especially over the last three years which has seen the popularity of Halloween skyrocket in Canada.

Eurostat, the statistical arm of the European Union, reported the unemployment rate for the Euro-18 was unchanged in September at 11.8%, which is only down 0.2% from September 2013’s 12.0%, indicating basically no progress in unemployment in the past year.  Some representative numbers: France 10.5%, Italy 12.6%, Spain 24.0% and Greece 26.4%.  The youth unemployment rate remains extraordinarily high in Italy (41.8%), Spain (53.7%) and Greece (50.7%). 

China’s manufacturing activity continued waning in October with the Chinese Manufacturing PMI hitting a five-month low of 50.8 in October, down -0.3 from September and -0.9 from the yearly peak of 51.7 hit in July.  Although readings above 50 indicate expansion, there’s not much of it.

(sources: 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, wantchinatimes.com, BBC, 361capital.com, S China Morning Post)

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 7.0 from the prior week’s 6.0, while the average ranking of Offensive DIME sectors rose to 18.5 from the prior week’s 19. Institutional investors remain cautious, and the Defensive SHUT group continues to rank substantially higher than the Offensive DIME group ranking.                                                                                                                                                                                                                            

Note: these are “ranks”, not “scores”, so smaller numbers are higher ranks and larger numbers are lower ranks.

Summary:

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 even as new highs are reached in the US.

Because we 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.

FBIAS™ Fact Based Investment Allocation Strategies for the week ending 10/24/2014

The very big picture:

In the “decades” timeframe, we have been in a Secular Bear Market which began in 2000 when the P/E ratio (using Shiller’s Cyclically-Adjusted P/E, or “CAPE”) peaked at about 44.  The job of Secular Bear markets is to burn off outrageously high P/E ratios over one or two decades, until finally the P/E ratio arrives back at a single-digit level, from which another Secular Bull Market can emerge.  See graph below for the 100-year view of this repeating process.

If history is a guide, we may not yet be done with this Secular Bear Market.  The Shiller P/E is at 25.7, up from the prior week’s 24.7, and approximately at the level reached at the pre-crash high in October, 2007.  Even though P/E’s are substantially lower than their crazy peak in 2000, they are nonetheless at the high end of the normal historical range and leave little if any room for expansion.  This means that the stock market is unlikely to make gains greater than corporate profit growth percentage, if that.  (note: all P/E references are to the Shiller P/E values, sometimes called PE10 or CAPE, which are calculated so as to remove shorter-term fluctuations; see robertshiller.com for details).

In fact, since 1881, the average annual returns for all ten year periods that began with a CAPE at 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 P/E’s 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 typical of a 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 US Bull-Bear Indicator (see graph below) is at 52.6, up from the prior week’s 51.4, and continues in cyclical Bull territory.  The current Cyclical Bull has taken the US and some of Europe to new all-time highs, but many of the world’s major indices have yet to top 2007’s levels.  The most widely followed international indexes, the Morgan Stanley EAFE Developed International index and the Morgan Stanley Emerging Markets Index, are both still below their 2007 peaks.

In the intermediate picture:

The intermediate (weeks to months) indicator (see graph below) is Positive and ended the week at 10, up sharply from the prior week’s 3.  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 October for the prospects for the fourth quarter of 2014.

Timeframe summary:

In the Secular (years to decades) timeframe (Figs. 1 & 2 above), the Secular Bear may still be in force as the long-term valuation of the market is simply too high to sustain a new rip-roaring Secular Bull.  In the Cyclical (months to years) timeframe (Fig. 3 above), all major equity markets are in Cyclical Bull territory.  The Bond market returned to Cyclical Bull territory as of February 28th.  In the Intermediate (weeks to months) timeframe (Fig. 4 above), US equity markets returned to Positive status on October 17th.  The quarter-by-quarter indicator gave a positive signal for the 4th quarter:  US equities were in an uptrend, while International equities were in a downtrend at the start of Q4, and either one being in an uptrend is sufficient to signal a higher likelihood of an up quarter than a down quarter. 

In the markets:

The US led a rally of most world markets from oversold levels, with the S&P 500 rocketing +4.1% higher for the biggest weekly gain in a year and a half, and the Nasdaq enjoyed its biggest weekly gain (+5.3%) since 2011.  Non-US markets were much more subdued, however.  Canada’s TSX climbed +2.2% for the week, Developed International +2.6%, but Emerging Markets rose just +0.7% (Brazil’s large -7.8% decline held it in check).  The US SmallCap Russell 2000 index is still negative for the year to date, at -3.9%, as are both Developed International and Emerging International indices.  Canada’s TSX earlier this year enjoyed a 7% lead over the US in year-to-date returns, but that has shrunk to only a 0.5% advantage as Canada’s correction was sharper and deeper than the US’s pullback.

US interest rates have fallen recently to a 1-1/2 year low, and mortgage refinance applications jumped +23.3% week-over-week in response.   Existing home sales rose to 5.17 million annualized, the highest since September 2013, though new home sales were flat.  Inflation data as represented by the Consumer Price Index (“CPI”) also was tame, with the CPI in September up just +0.1%, while the 12-month CPI was only +1.7%.  Earnings from US companies were mixed during the week, with many old-line stalwarts disappointing.  AT&T, Walmart, IBM, Coca-Cola, GE, among others did not meet expectations, but giant industrials Caterpillar and 3M reported upside surprises.  A third of the 30 companies in the Dow Jones Industrial Average have posted shrinking or flat revenue over the past 12 months, according to data from S&P Capital IQ.  Revenue growth for nearly half the Dow Industrials didn’t outpace the U.S. inflation rate of +1.7%.  It might be logical to think that the large multinationals would be reeling from the effects of European stagnation, but data from the World Bank show that Europe represents just 15% of total US foreign trade.

Canadian retail sales dropped unexpectedly in August, the second consecutive month of falling retail sales, casting some uncertainty on prospects for broader economic growth.  Retail sales dropped -0.3 percent in August, Statistics Canada said on Wednesday.  Analysts had forecast that sales would be unchanged from July.  It wasn’t all just lower gas prices, as sales were down in 7 of the 11 sub-sectors, representing 76 percent of retail trade.

Eurozone stagnation continues.  The October manufacturing Purchasing Managers Index (“PMI”) was 50.7 vs 50.3 in September, barely in expansion territory.  The service sector reading of 52.4 was unchanged over the prior month.  The specifics for Germany and France were not enthusing.   Germany’s manufacturing reading was 51.8 vs 49.9, services 54.8 vs 55.7, and a composite of the two 53.6 vs 54.1. For France, manufacturing was 47.3 in October vs 48.8 the prior month, services was 48.1 vs 48.4, and the composite of the two 48.0 vs. 48.4.

In China, GDP was reported at +7.3% in the third quarter, the weakest pace since Q1 2009, though it beat the estimate of 7.2%.  Producer, or “factory-gate”, prices fell in September for an amazing 32nd straight month.  In the critical housing sector, new-home prices fell in 69 of 70 Chinese cities monitored by the government in September from August, the most since January 2011. Nationwide, home sales fell -11% in the first nine months of the year.  Prices in the previously-overheated Beijing and Shanghai markets fell -0.7% and -0.9% respectively.  The city of Xiamen in Fujian province was the only one of the 70 cities surveyed to show an increase.

Casino revenue in the Chinese gambling mecca Macau, always a good economic barometer for China, fell -12% in September, the fourth straight month of decline, and the biggest drop since June 2009. A significant part of the decline is suspected to be the result of Chinese President Xi’s crackdown on corruption among government officials.  Beijing reported spending by officials on trips (including to Macau), lavish receptions and official cars has dropped by almost $9 billion over the past year.  The government also announced it had found and eliminated 150,000 ‘ghost jobs’, where people are paid without ever being required to show up.

As domestic West Texas Intermediate (“WTI”) crude oil hovers above $80/bbl, and foreign Brent Crude a bit higher, many energy-producing countries are facing the reality of large budgetary shortfalls vs their planned revenues that relied on much higher oil prices.  Here is a chart from Deutsche Bank that shows how many previously comfortable sovereign budgets have been thrown into turmoil by the significant slide in world oil prices.

(sources: 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, wantchinatimes.com, BBC, 361capital.com, S China Morning Post)

The ranking relationship (see graph below) 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 6.0 from the prior week’s 6.5, while the average ranking of Offensive DIME sectors rose to 19 from the prior week’s 20.3. Institutional investors remain cautious, and the Defensive SHUT group continues to rank substantially higher than the Offensive DIME group ranking.                                                                                                                                                                                                                            

Note: these are “ranks”, not “scores”, so smaller numbers are higher ranks and larger numbers are lower ranks.

Summary:

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 even as new highs are reached in the US.

Because we 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.