NOTE: Areas with blue text show the most recent market updates since the February Capital Highlights email.
“There are two times in a man’s life when he should not speculate: when he
can’t afford it, and when he can.”
~ Mark Twain
The very big picture:
In the “decades” timeframe, we are in a Secular Bear Market which began in 2000 when the P/E ratio (using Shiller’s Cyclically-Adjusted P/E) 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 Fig. 1 for the 100-year view.
If history is a guide, we are not yet near the end of this Secular Bear Market. The Shiller P/E finished the week at 25.7, up a little from the prior week’s 25.4. Even though P/E’s are now half what they were at their crazy peak in 2000, they are nonetheless at the high end of the normal 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 Fig. 2).
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 the next 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 Fig. 3) is at 70.8, up from last week’s 69.4, and still solidly in cyclical Bull territory. Early in the year, the US Bull-Bear Indicator pushed further into Bull territory than other global asset classes, reflecting the higher strength of the US relative to the rest of the world. The current Cyclical Bull has taken the US to new all-time highs, finally exceeding the highs of 2007, but most of the world’s major indices have barely matched 2011’s highs, let alone approach 2007’s levels.
In the intermediate picture:
The intermediate (weeks to months) indicator (see Fig. 4) remains in positive status, ending the week at 27, up substantially 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 for the prospects for the first quarter of 2014.
In the Secular (years to decades) timeframe (Figs. 1 & 2), the Secular Bear still is in force as the long-term valuation of the market is too high to sustain a new rip-roaring Secular Bull. In the Cyclical (months to years) timeframe (Fig. 3), all major equity markets are in Cyclical Bull territory, with the US being far stronger than any other major market. The Bond market returned to Cyclical Bull territory as of February 28th. In the Intermediate (weeks to months) timeframe (Fig. 4), US equity markets remain in positive status. The quarter-by-quarter indicator gave a positive signal for the 1st quarter: both US and International equities were in uptrends at the start of Q1, which signals a higher likelihood of an up quarter than a down quarter.
In the markets:
With the exception of China, the world’s major markets were flat to higher for the week. In the US, all major indices gained, with SmallCaps leading the parade (and also setting a record with 14 of the prior 15 days being higher). Canada’s TSX was flat for the week, but nonetheless sits atop all North American markets with a +4.3% gain for the year to date. Once again, Emerging International markets were weakest, gaining just +0.1% for the week and still are down -5.5% on average for the year to date.
For the month of February, the Nasdaq Composite set the pace for US indices, gaining +5%. But even the worst-performing index in the US, the Dow Industrials, gained +4% although it remains slightly negative for the year to date. The worldwide winner for the month among major indices was Developed International, gaining +6.1% and nosing into positive territory for the year to date at +0.6% (equaling the S&P 500).
After the torrent of mostly bad news from the US housing market last week, a few decent data points were reported this week. US new home sales grew +9.6% vs expectations of -3.4%, the fastest pace in more than 5 years. December home prices rose +13.4% year-over-year, the 10th straight month of double digit year-over-year gains, resulting in home prices in 2013 seeing their biggest annual gain since 2005 – though still 21% below the ’06 peak. On the other hand, the Mortgage Bankers Association mortgage application index fell -8.5% last week, the lowest level since 1995.
The Chicago Purchasing Managers’ Index (“PMI”) rose to a very strong 59.8, well above expectations of 56.4. US Q4 GPD was substantially revised down to an annualized 2.4% pace, from initial estimates of 3.2%. The final quarterly annualized GDP numbers are now fixed at:
Only Q3 was above the 3% level widely seen as the level of decent expansion. On the other hand, these numbers are likely to keep the Fed gravy train continuing for some time.
In Canada, the Big Six banks and large Life Insurance companies rebounded sharply in February, gaining +6% and +8% respectively, and contributed greatly to the Canadian market’s strong year to date performance.
Eurostat, the European Union’s statistics arm, released the latest unemployment data and it remains very bad. For the Eurozone-18, the rate is still 12.0%, unchanged since October and the same rate as January 2013 for no progress year over year. The larger EU28 jobless rate is 10.8%. It was 10.9% a year earlier, so only very small progress year over year. Among the key countries are Germany at 5.0%, France at 10.9%, Italy 12.9% (the highest recorded since accurate records began in 1977), Spain at 25.8% and Greece at 28.0%. The youth rates are still a shocking 54.6% in Spain, 59.0% in Greece, 42.4% in Italy and 34.7% in Portugal.
In China, the smog crisis seems to be dangerous to not just people, but also to plants. The South China Morning Post reports that scientists are warning that smog in China is blocking light and will lead to disaster in agricultural production. A test conducted by the China Agricultural University found that “chili and tomato seeds, which normally took about 20 days to grow into full-grown seedlings under artificial light in a laboratory, took more than two months to sprout at a greenhouse farm in Beijing. The report concluded “…most seedlings in the farm were weak or sick.”
(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)
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 12.5 from the prior week’s 11.3, while the average ranking of Offensive DIME sectors rose slightly to 13.5 from the proir week’s 13.8. The Defensive SHUT sectors have overtaken the Offensive DIME sectors by a decreased margin of just 1.
Note: these are “ranks”, not “scores”, so smaller numbers are higher and larger numbers are lower.
The US led the recovery from 2011’s travails, and is the strongest among all global markets. However, the over-arching Secular Bear Market remains in place even as prior all-time highs are reached.
Because we are still 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.