Monthly Market Commentary for January, 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.

comm_jan2015_1

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 27.0 down from the prior week’s 27.4, 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.

comm_jan2015_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 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 61.8, down from the prior week’s 63.1, 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 Fig. 4 below) is Positive and ended the week at 25, up 2 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), 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 month of December was the first negative December since 2007 for the US market, but capped a reasonably good year – in the States, anyway.  With an above average +11.4% gain in the S&P 500, and a so-so +7.5% gain in the Dow, the US was nonetheless the star performer among most major global indices.  Canada regained some of its earlier mojo by finishing the year with three straight weekly gains and a 2014 gain of +7.4% for the TSX index.  However, the large international indices were negative for 2014.  The Developed International index shed -6.2% for 2014, while the Emerging International index fared slightly better at -3.9%.  Worst hit were countries with large commodity export dependencies, like Russia and Brazil.  The so-called “BRIC” countries (Brazil, Russia, India and China) were a study in contrasts.  Brazil and Russia, commodity exporters, were down significantly, while India and China, commodity importers, were up strongly.  Some major commodity indices have been down four years in a row.  Both oil and steel prices have been cut in half.  Hard to imagine that two giant industries – oil and steel – could suffer a halving of their product prices in any circumstances other than a recession or a depression!

A jokester at the New York Stock Exchange was circulating this graphic toward the end of the year, a take-off on the famous British “Keep Calm and Carry On” posters of Winston Churchill’s war-time government (a less-vulgar version is also shown):

comm_jan2015_34

The humor was well-founded.  The following chart shows that the Fed-inspired “Buy The Dips” mentality has been firmly in charge for the past couple of years:

comm_jan2015_5

An interesting feature of these dips is that the recoveries have generally been quicker than the declines that preceded them; historically, the market takes longer to recover than it does to decline.  The old Wall St saying “stairs up, elevator down” has been reversed – recently, it has been “stairs down, elevator up”!

Lastly, a reminder of the foolishness of predictions: a year ago, the only universal consensus among market forecasters was that interest rates were absolutely, positively certain to rise during 2014.  Exactly the opposite occurred, of course, and in dramatic fashion, as this international comparison of 10-year rates shows:

comm_jan2015_6

(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.

Fig. 3

Fig. 3

Fig. 4

Fig. 4