Monthly Market Commentary for February, 2015

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.

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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 26.2, down from the prior week’s 27.0, 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.

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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 Fig. 3 below) is at 54.5, down from the prior week’s 56.9, 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 Fig. 4 below) is Positive and ended the week at 23, 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), 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), all major equity markets are in Cyclical Bull territory.  In the Intermediate (weeks to months) timeframe (Fig. 4), US equity markets are again rated as Positive.  The quarter-by-quarter indicator gave a positive signal for the 1st quarter:  US equities were in an uptrend, while International equities were in a downtrend at the start of Q1 2015, 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 Dow Jones Industrial Average dropped 251 points on Friday to close at 17164 marking the end of a tumultuous week.  For the week, the Dow shed over 507 points–a decline of -2.9%.  The Dow is approaching two potential lines of support.  The 17050 level served as near-term support in mid-December for a significant bounce into the new year.  In addition, that level marks the current 200-day moving average, a long-term measure of support used by technical traders.  The other major U.S. indexes were negative across the board.  The S&P 500 lost -2.8% to close at 1994, below the psychologically important 2000-level.  Apple and Amazon’s positive earnings reports weren’t enough to save the Nasdaq as it lost -2.6%.  The small cap Russell 2000 lost -2.0% to close at 1165.

Canada’s TSX closed the week down -0.7%.  Canadian monthly GDP fell -0.2%, largely the result of declines in manufacturing, mining, and oil and gas extraction, Statistics Canada said Friday.  Developed International closed down -0.2%, and Emerging Markets lost -4.3% for the week.

In the US, corporate earnings reports garnered most of the headlines.  Apple blew away analyst expectations with a surge in quarterly profit to $18 billion, up 38% from a year earlier.  According to S&P Capital IQ, “that is more than 435 of the companies in the S&P 500 index each made in total profits since 2009”.  Apple closed the week up 3.8%.  Facebook reported fourth-quarter profits of $701 million, up 34% year over year, but a steep rise in expenses weighed on the stock as it gave up -2.5% for the week.  Shares of the construction and mining machinery equipment giant Caterpillar were hit as the company forecast a -9% drop in sales and a -22% drop in per-share earnings in 2015.  Caterpillar is reeling from the effects of falling oil and other commodity prices, as well as slowing growth in China.  Caterpillar lost -6.6% for the week.

US Durable goods orders for December declined -3.4%, missing consensus views.  On the economic calendar for next week, the Institute for Supply Management (ISM) manufacturing index will be reported on Monday, with a consensus forecast of 54.5.

Gold lost some of its luster as it gave up a bit of its recent gains to close down -0.80% for the week at 1283.70.  Gold’s more volatile cousin Silver gave up -5.84% for the week, with much of the loss attributed to a hike in Silver margin rates by the CME.  Crude oil enjoyed a big rebound this week, all due to market action on Friday, closing up +5.7% for the week.  Oil-field services company Baker Hughes, in its weekly rig count report said domestic drilling rigs in operation fell to the lowest level in three years.  Crude rallied on the news, anticipating a reduction in supply.

On Friday the government reported 4th quarter GDP of +2.6%, vs expectations for a gain of +3.2%.  Full-year 2014 GDP was reported as a rather anemic +2.4%.  The current recovery from 2009 has been very sluggish compared to previous recoveries, as this chart from the Wall St. Journal shows:

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European markets were mostly lower — for the week the FTSE 100 ended down -1.2%, the French CAC 40 down -0.8%, Spain’s IBEX down -1.78%, but the German DAX managed  gain of  +0.4%.  Across the Eurozone the unemployment rate for December was 11.4%, down from 11.5% in November.  Germany was at 4.8%, France 10.3%, Spain 23.7%, and Greece 25.5%.  The big story last week out of Europe was the Greek election.  The far-left Syriza party headed by Alexis Tsipras finished first with the largest percentage of the vote at 36.3%.  It was a populist backlash and anti-austerity vote against its European creditors.  The new Prime Minister wants to renegotiate the nation’s debt and bailout agreement.  Prime Minister David Cameron of Britain put it succinctly: “The Greek election will increase economic uncertainty across Europe.”  On Wednesday, Greek’s four biggest banks saw their stock prices plummet 25% on average, the third day of double-digit share slides for the banks.  Greek banks have been experiencing large withdrawals by depositors and have been tapping the European Central Bank’s “emergency liquidity assistance” facility.  Access to those funds may end February 28 unless Greece extends its bailout program.

China’s industrial profits fell -8% in December year over year according to the National Bureau of Statistics.  China’s e-commerce behemoth Alibaba plummeted -13.6% for the week.  China’s Ministry of Commerce said it will boost regulation of the e-commerce sector as it alleged Alibaba is selling fake goods through one of its subsidiaries.  Yahoo also announced it would spin off its $40 billion stake.

(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, pensionpartners.com; Figs 3-5 source W E Sherman & Co, LLC)

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 the world 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.

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