NOTE: Areas with blue text show the most recent market updates since the August Capital Highlights email.
“Be wary of strong drink. It can make you shoot at tax collectors…and miss”
– Robert Heinlein
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 is 26.5, up slightly 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 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 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 (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 64.9, up from the prior week’s 63.1, and still solidly 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 Fig. 4) returned to Positive status during the week, and ended the week at 23, up two 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 first quarter of 2013.
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 returned to Positive status on August 25. The quarter-by-quarter indicator gave a positive signal for the 3rd quarter: both US and International equities were in uptrends at the start of Q3, which signals a higher likelihood of an up quarter than a down quarter.
In the markets:
Global markets gained during the final week of August. US indices gained +0.8% on average, with SmallCaps leading at +1.2% and the Dow Industrials bringing up the rear at +0.6%. Canada’s TSX gained +0.6%, Developed International averaged +0.4% and Emerging International averaged +0.7%. The best significant market was Brazil at +6.5% and the worst China at -1.0%.
The month of August started out very poorly, with markets retreating rapidly from yearly highs set in late July. But the decline halted abruptly on August 5, and an equally rapid rise took many markets back to recent highs by the end of the month. In fact, the month was the strongest August in the US since 2000. US indices gained from +3.2% to +4.9% for the month, and the Nasdaq Composite closed the month above 4500, a level last seen in March of 2000. Emerging International markets also had a good August, gaining +2.8% on average, while Developed International averaged only a +0.2% gain. Canada’s TSX gained +1.9% for the month.
US economic news featured a huge jump in durable goods for July – up a whopping +22.6%! But the report should have been named the “Boeing Goods Report”, since a closer examination revealed that the entire jump was due to aircraft orders (Boeing signed a record 324 contracts during the period). When Boeing’s aircraft orders are removed, the durable goods figure actually declined by -0.8%. The second revision of second-quarter US GDP edged up to +4.2%, vs expectations of a decline from +4.0% to +3.8%. Consumer spending fell slightly, -0.1%, vs a forecast of a slight gain. This was the first decline in six months. The Chicago Purchasing Managers’ Index survey (“PMI”) bounced back to a very healthy 64.3 from the prior month’s 56.0, and the Richmond Fed’s survey of regional manufacturing activity was reported at 12, the highest level in more than 3 years.
Statistics Canada released Q2 Canadian GDP, surprising to the upside at +3.1% and exceeding expectations. This was the highest GDP reading in almost 3 years. The segment of Canada’s economy showing the biggest burst of activity was exports, surging +17.8% via gains in the automotive, agricultural and forestry sectors.
The economic news with the most ominous portent came from the Eurozone, where the first estimate of August inflation was reported at just +0.3% year-over-year. This number is perilously close to deflation, and nowhere near the approximately +2% target of the European Central Bank (“ECB”). Several countries actually did report falling prices year-over-year, the biggest of which was Spain, reporting a -0.5% fall in prices from a year ago. ECB chief Mario Draghi has repeatedly talked about further monetary stimulus to ward off deflation, but so far no actions have been taken. Meetings of economic officials on September 4th will be watched closely for signs of action to accompany all the talk. The Eurozone (ex-UK) unemployment rate remained unchanged at 11.5% in July vs. June, but down slightly from the year-ago mark of 11.9%. The jobless rate was a low 4.9% in Germany (the German government calculates it at 6.7%), but more than twice that most everywhere else: 10.3% in France, 12.6% in Italy, 24.5% in Spain, and 27.2% in Greece. Youth unemployment rates were 53.8% in Spain, 53.1% in Greece, 42.9% in Italy and 35.5% in Portugal.
One little-reported measurement of US economic activity is called the “Architectural Billings Index”, which measures design-stage activity for US commercial developments of all sorts (retail, office and industrial). It is generally regarded as a 1 to 3 year preview of future construction activity. It was reported this week that the index has regained levels last seen in 2007 (see chart below), representing a completed round-trip recovery in pre-construction planning and design.
(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, calculatedriskblog.com; Figs 3-5 source W E Sherman & Co, LLC)
The average ranking of Defensive SHUT sectors slipped to 14 from the prior week’s 13 while the average ranking of Offensive DIME sectors declined to 14.3 from the prior week’s 13.5. Institutional investors remain cautious, and the Defensive SHUT group retains a slight lead over the Offensive DIME group ranking.
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.
About The Blakeley Group, Inc.:
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