Lorintine Capital SITREP for the week ending 3/20/2015
SITREP: n. a report on the current situation; a military abbreviation; from “situation report”.
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. See Fig. 1 for the 100-year view of Secular Bulls and Bears.
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 27.8, up from the prior week’s 27.1, 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 (see Fig. 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 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) is at 55.9, up from the prior week’s 54.5, 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) is Positive and ended the week at 33, 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 January for the prospects for the first quarter of 2015.
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 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:
It was an impressive week for both domestic and international markets as all major indices tacked on significant gains. For the week, the Dow Jones Industrial Average added 378 points to close at 18127, up +2.13%. The Nasdaq has now closed solidly above the 5000 level, ending the week at 5026, up +3.17%. The S&P 500 tacked on 54 points at 2108, a +2.66% gain for the week. The S&P Midcap 400 index gained +3.25% for the week, and the small cap Russell 2000 gained +2.78%. Canada’s TSX also rose, though not with the same vigor as its neighbor to the south, ending the week at 14942 up +1.43%.
In international markets, Developed International rebounded +4.07%, and Emerging markets were up a very strong +4.65%. The German DAX ended up +1.16%. The French CAC40 added +1.54%. Gold halted its descent, rising +2.01% last week and closing at $1,181.70 per ounce of the yellow metal. Silver bounced hard, gaining +6.94% last week, ending at $16.73 per ounce. West Texas Intermediate crude oil gained +3.22% last week, closing the week at $46.45 a barrel.
In US economic news this week, initial jobless claims were 291,000 for the March 14 week, 1000 more than last week but below forecasts of 293,000. There were 2.417 million continuing claims, down 11,000 from the prior week. The strong dollar has widened the trade gap as imported goods cost fewer dollars and exported goods cost more in foreign currencies. The deficit ended the fourth quarter at $113.5 billion, which was the most in two years and more than forecast—a +14.7% increase over Q3.
The Philadelphia Fed index, a measure of business activity in the Mid-Atlantic region, dropped -0.2 point to 5 vs expectations for a rise to 7.0. New orders came in weak, but shipments were worse, plunging to -7.8 from 8.1. Industrial production rose +0.1% in February, less than the +0.3% expected. January’s numbers were revised down to reflect a -0.3% decline rather than the slight increase originally reported. Manufacturing was down -0.2% in February for its third-straight monthly decline. Capacity utilization, which can indicate how long firms will continue using existing plant equipment before upgrading also missed, coming in at 78.9% vs. a downwardly revised 79.1% in the prior month. Similar to the Philadelphia Fed index report, the New York Fed’s Empire State manufacturing survey fell to 6.90 in March, down from 7.78 and below the 7.0 expected. New orders fell into contraction; however employment surged to 18.56 from 10.11.
The housing market index from the National Association of Home Builders dropped 2 points to 53 in March, missing forecasts of a 1-point increase. “Supply chain issues” and tighter mortgage lending standards were blamed. Housing starts sank -17% in February; this was the biggest monthly plunge in 4 years. There were 897,000 starts in February, vs. expectations for 1.048 million. However, permits came in stronger than expected with 1.092 million beating the forecast of 1.058 million. The Mortgage Bankers Association’s composite index that tracks mortgage applications fell -3.9% last week with purchases down -2% and refinancings down -5%.
The Federal Reserve cautiously stepped towards normalizing interest rates after years of its easy money policy, dropping the word “patient” about raising interest rates from near zero but simultaneously signaling that the pace of tightening will be slow. An April meeting rate hike is “unlikely”, the central bank said. Fed Chair Janet Yellen clarified the terminology by stating that “just because we removed patient doesn’t mean we are going to be impatient.”
A cautionary milestone was recorded this past week, when the S&P 500 price-to-sales (P/S) ratio set a new record, now sitting above the pre-crash highs of 1999 and 2007. Many analysts view this ratio to be a more “truthful” view of company valuations, as it is less subject to the blatant earnings manipulations than is the more widely-used price-to-earnings (P/E) ratio. Like the long-term CAPE mentioned elsewhere in this report, the current level of the composite P/S has historically preceded very low future annual gains in the US stock market.
Canadian wholesale activity gave up -3.1% in January, the biggest monthly drop in 6 years and mostly driven by a plunge in car and building materials shipments. Canadian retail sales dropped -1.7% in January, well below expectations of a -0.5% fall. For the year sales are +1.2% higher than the comparable year-ago period.
In the Eurozone, the International Monetary Fund (IMF) chief Christine Lagarde stated that the world and emerging markets in particular must prepare for market volatility as the Federal Reserve considers raising interest rates. “Vulnerabilities” that accumulate during periods of easy money policies “can unwind suddenly” when those policies are tightened, she ominously said.
According to media reports, the IMF has called Greece “the most unhelpful” recipient of its aid in IMF history. Eurozone officials have had much difficulty getting more information on the country’s finances. Officials are set to tell their Greek counterparts that “time and patience are running out,” according to Reuters. Further muddying the waters, Greek officials have been suggesting that Germany owes Greece further reparations from World War II!
German producer prices increased +0.1% in February. This was the first gain in over 12 months. Forecasts were for a +0.2% increase. Nonetheless, prices remain -2.1% lower for the year, retaining the specter of deflation.
The Bank of Japan (BOJ) continued with its bond buying program and stated that plunging oil prices could ruin chances of achieving its inflation goal of 2%. On the positive side, BOJ officials hope that lower energy costs could prompt an uptick in consumer spending, sorely needed by the Japanese economy.
(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)
The ranking relationship (shown in Fig. 5) between the defensive SHUTsectors (“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 fell to 15.8 from the prior week’s 15, while the average ranking of Offensive DIME sectors fell to 15 from the prior week’s 14. The Offensive DIME sectors continue to lead the defensive SHUT sectors, but by less than one ranking point. Note: these are “ranks”, not “scores”, so smaller numbers are higher ranks and larger numbers are lower ranks.
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.