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NOTE: Areas with blue text show the most recent market updates since the first January Capital Highlights email.

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.

We are nowhere near the end of this Secular Bear Market, as the Shiller P/E is now 22.0, up from the prior week’s 23.4 (see Fig. 2 – a snapshot of www.multpl.com).  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 www.robertshiller.com for details).

In fact, since 1881, the average annual returns for all twenty year periods that began with a P/E at this level have ranged from -2%/yr to +7%/yr with an average of just 3%/yr.

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 (like what 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.

Affirming this view, an August 2011 study from the San Francisco Fed titled “Boomer Retirement: Headwinds for U.S. Equity Markets?” reports on the likely effect of the coming tsunami of retiring boomers on the stock market.  The study concludes that “The model-generated path for real stock prices implied by demographic trends is quite bearish. Real stock prices follow a downward trend until 2021, cumulatively declining about 13% relative to 2010. The subsequent recovery is quite slow. Indeed, real stock prices are not expected to return to their 2010 level until 2027.”

In the big picture:

The US Bull-Bear Indicator (see Fig. 3) decreased to 64.1 from last week’s 66.5, continuing in Cyclical Bull territory.  The US Bull-Bear Indicator has pushed further into Bull territory than other global asset classes, reflecting the higher strength of the US relative to the rest of the world.  Alone among global equities, the US has reclaimed the highs of 2011 whereas most other world indices are still well below those levels.

In the intermediate picture:

The intermediate (weeks to months) indicator (see Fig. 4) remained at 24 for the week.   Three weeks ago it fell from the upper range of 30-36.  When this indicator falls out of the upper range an intermediate decline is usually in the offing, with an expectation that the indicator will eventually fall further to the lower range of 10 or below.

In the markets:

The month of April was basically flat, after a gangbusters January-March period.   April was a period of struggle between good news from the US economy, and bad news from basically everywhere else.  For April, at least, the result was a standoff.

However, May has started with a bang to the downside.

Markets worldwide declined markedly for the week, led by the US Nasdaq market, where former upside leader Apple became the downside leader.  Other US indices lost from -1.5% (Dow 30) to -4.1% (Small Caps).  International markets fared poorly also, with Developed markets losing more than -3% and Emerging markets losing more than -2%.

European data continued to be poor.  Eurozone PMI data on manufacturing was 45.9 for April, down from 47.7 in March (50 being the dividing line between growth and contraction).  Euro area unemployment is up to 10.9%, the worst in many years, with Spain at 24% and Greece nearly 22%.  11 of 27 European Union nations are now in recession, with more on the way.

But this time, US economic data couldn’t offset poor European data, because the news from the US wasn’t good either.  A surprisingly poor ISM Services reading was followed by Friday’s report on April jobs creation – and the number of 115,000 was far worse than the consensus estimates.  Although the unemployment rate dropped to 8.1%, that was only possible because 342,000 job-seekers gave up and left the labor force.

The ranking relationship (shown in Fig. 5) between the defensive SHUT sectors (“S”=Staples [a.k.a. consumer non-cyclical], “H”=Healthcare, “U”=Utilities and “T”=Telecom) and the offensive DIME sectors  (“D”=Discretionary [a.k.a. Consumer Cyclical], “I”=Industrial, “M”=Materials, “E”=Energy), is one way to gauge institutional investor sentiment in the market.

The average ranking of Defensive SHUT sectors rose to 15.5 from 16.5, while the average ranking of Offensive DIME sectors fell slightly to 17 from 16.5.  The Defensive SHUT sectors are now ranked higher than the Offensive DIME sectors, reflecting the fear that has crept into the markets this week.

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

Summary:

The US has led the recovery from last year’s travails, and is currently the strongest among all global markets.  However, the over-arching Secular Bear Market remains in place.

Because we are in a Secular Bear, we have no expectations of runs of multiple double-digit consecutive years, and we expect poor market conditions such as have been experienced recently 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.

About The Blakeley Group, Inc.:

At The Blakeley Group, we understand that every client has unique needs for wealth management. The same systematic approach will not work for everyone. That’s why we pride ourselves on taking a customized, solution-focused approach to each client’s financial situation.

Call us today to discuss your wealth management options.

We are here to help you develop a plan to meet your goals.

(408) 459-4913