Monthly Market Commentary for May, 2015

The very big picture:

In the “decades” timeframe, the question of whether we are in a continuing Secular Bear Market that began in 2000 or in a new Secular Bull Market has been the subject of hot debate among economists and market watchers since 2013, when the Dow and S&P 500 exceeded their 2000 and 2007 highs.  The Bear proponents point out that the long-term PE ratio (called “CAPE”, for Cyclically-Adjusted Price to Earnings ratio), which has done a historically great job of marking tops and bottoms of Secular Bulls and Secular Bears, did not get down to the single-digit range that has marked the end of Bear Markets for a hundred years, but the Bull proponents say that significantly higher new highs are de-facto evidence of a Secular Bull, regardless of the CAPE.  Further confusing the question, the CAPE now has risen to levels that have marked the end of Bull Markets except for times of full-blown market manias.

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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 CAPE is at 27.3, barely changed from the prior week’s 27.4, and approximately at the level reached at the pre-crash high in October, 2007.  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 the CAPE 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 more typical of a rip-snorting 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 54.8, down from the prior week’s 55.3, 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 markets have yet to top 2007’s levels – particularly in the Emerging Markets area.

In the intermediate picture:

The intermediate (weeks to months) indicator (see Fig. 4 below) is Positive and ended the week at 32, down 1 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 April for the prospects for the second quarter of 2015.

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 rated as Positive.  The quarter-by-quarter indicator gave a positive signal for the 2nd quarter:  both US equities and International equities were in uptrends at the start of Q2 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:

On Friday the Dow rose 183 points to regain the 18,000 level closing at 18,024, but ended down -0.31% for the week.  The NASDAQ likewise regained the psychologically important 5000 level, but gave up 86 points or 1.7% to end the week at 5005.  The small-cap Russell 2000 bore the brunt of the selling giving up -3.11% for the week.  The S&P MidCap 400 index also ended the week down -1.33%.  Both the S&P 500 and Canada’s TSX shed -0.44% for the week.

In international markets, for the week Developed International was down -0.22%, while Emerging Markets slid 1.61%.  Individually, the German DAX was down a heavy -3.02%, the French CAC 40 fell 2.98%, and the London FTSE fell -1.20%.  In Asia, the Chinese Shanghai stock exchange composite had its eighth weekly gain up +1.09% and Hong Kong’s Hang Seng index also notched a slight gain, up +0.26%.  Japan’s Nikkei was unable to hold the 20,000 level ended the week down -2.44% to close at 19,531.

Turning to commodities, gold gave up $2.70 an ounce, to close at $1177.20.  Silver managed a $0.41 gain, to close at $16.12 an ounce, up +2.61%.  Oil continues its recent rebound, up +3.20%, ending the week at $59.26 a barrel.

For the month of April, the US continued this year’s pattern of underperformance relative to the rest of the world (a contrast to the prior 4 years of US outperformance).   US indices were the laggards again, finishing the month between -2.6% (SmallCaps) and +0.9% (S&P500 LargeCaps).  On the other hand, most non-US indices were substantially better than the US.  Canada’s TSX rose +2.2%, Developed International climbed +3.7%, and Emerging International rocketed higher by an impressive +6.9%

In US economic news, the headline for the week was the shockingly low Gross Domestic Product (GDP) for the first quarter.  It was reported at just an annualized +0.2%, missing the already-reduced consensus forecast of just +1%.  Exports dropped -7.2%, likely due to the stronger dollar and West Coast port labor issues.  Government spending at all levels fell and business investment sank 3.4%, its worst quarterly performance since the ’08-’09 recession.  Government spokesmen expressed hope that GDP might follow the path it took last year when contraction in Q1 was followed by strong rebounds in the following two quarters.

The Institute for Supply Management (ISM) April manufacturing index remained at 51.5, the same as in March, while exports swung back into expansion territory.  The April Purchasing Managers Index (PMI) manufacturing report noted that manufacturing lost momentum in April.  Factory output and new orders both rose at slower rates and new export business declined for the first time since November. The PMI report for the Services sector, however, remained extremely strong at 57.8.

The Federal Reserve wants to see wages rising faster than inflation so that consumers can feel comfortable about their spending habits.  The core inflation gauge favored by the Fed increased +1.4% versus a year ago, the same rate as in February.  Annual wage growth rose just +0.7% in one report, but the Wages and Salaries component of the Employment Cost Index was up +2.5%., the best since 2008, giving rise to hope that wage gains may soon top inflation.  In another hopeful sign, household debt continues to decline.  Cleveland Fed Pres. Loretta Mester stated that better household finances will help drive US economic growth.  Mester noted that “Household debt relative to disposable personal income has fallen to near its longer-run trend.”

In Canada, the Industrial Product Price Index ticked up +0.3% in March as petroleum prices rebounded.  The index remains 1.8% lower for the year.

Eurozone unemployment remained at 11.3% in March, with the youth unemployment component being twice that at 22.7%.  Germany had the lowest jobless rate at 4.7% while Greece and Spain had the highest at 25.7% and 23.0%.  In Germany, retail sales dropped -2.3% in March versus expectations of a +0.5% increase, but sales remain +3.5% higher than year ago and consumer confidence remained high.  In France, producer prices gained +0.1% in March as expected, but are still -2.2% lower versus a year ago.

Japan’s sovereign debt rating was cut to single-A by Fitch Ratings as the government delayed a planned tax hike to reduce its debt burden.  Fitch stated that the government’s reliance on stimulus spending to support its economy was the reason for the downgrade.  Japan’s retail sales had a large -9.7% yearly decline in March, worse than the 6.8% expected.  March was the third straight month to record year-on-year declines.

Finally, tech behemoth Apple released its second-quarter revenue numbers last week.  Revenues for the quarter came in at $58 billion and earnings came in at $13.6 billion.  Since the beginning of the fiscal year about 70% of Apple’s revenues came from iPhone sales and sales in China were up a huge +70% from a year ago.  Apple CEO Tim Cook has described Apple’s revenues as a “three-legged stool” with revenues from the iPhone, iPad and Mac.  Business Insider dug a little deeper into the numbers and discovered that Cook’s iPad “leg” is a weak one, with negative year-over-year sales growth in most quarters of the last two years.

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Further, since Mac sales are puny compared to iPhone sales, Business Insider concludes that contrary to Cook’s assertion, Apple instead is a “one-legged stool” with that one leg being described by an analyst as “CHINA’S MIDDLE CLASS LOVES IPHONES”.

(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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