Lorintine Capital SITREP for the week ending 3/27/2015
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 27.1, down slightly from the prior week’s 27.8, 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 54.4, down from the prior week’s 55.9, 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 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 32, down 1 tick from the prior week’s 33. 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:
Friday capped a rough week during which almost all of the world’s major indices finished in the red. The Dow Jones Industrials gave up -414 points for the week, down -2.29%. The Nasdaq lost -2.69%, slipping beneath the 5000 level again. The S&P 500 LargeCap index lost -2.23%, the S&P 400 MidCap index closed down -2.02%, and the Russell 2000 SmallCap index gave up -2.05%. Canada’s TSX did better, ending the week down only -0.87%.
Developed International declined -0.79% last week. Emerging markets dropped -1.55%. The German DAX was unable to maintain its winning streak, losing -1.42%. France’s CAC40 dropped by -1.05%, and the UK’s FTSE ended the week down -2.39%, one of the worst performers among Northern Europe’s indices.
In commodities, West Texas Intermediate crude oil rebounded +4.26%, a second week of gains. Gold, up +1.4%, also notched a second week of gains, and silver was up +1.46%.
In US economic news, final 4th quarter GDP numbers revealed that the economy expanded +2.2%, just shy of the +2.4% economists had expected. For all of 2014 the economy expanded +2.4%, up from +2.2% in 2013. Consumer sentiment jumped to 93.0, up from 91.2 and was better than expectations. After-tax corporate profits declined -3% in the 4th quarter after a +2.8% rise in Q3. For all of 2014, profits fell -8.3%. Many analysts attribute this to the stronger dollar and are now speaking of a “profits recession.”
Existing home sales ran at an annual rate of 4.88 million in February according to the National Association of Realtors. This was better than the 4.82 million in January, but missed expectations of 4.94 million. Sales were up +1.2% for the month, and +4.7% for the year-over-year comparison. Experts speculate that home sales may be held back by substantial price gains: up +7.5% vs. year-ago levels in February—the 36th straight monthly gain and the biggest in a year.
New single-family home sales ran at an annual rate of 539,000 in February, easily beating forecasts of 462,000 and the highest since February 2008 according to the Commerce Department. This was a +7.8% increase over January’s number and +24.8% higher than year-ago levels.
The Mortgage Monitor publication reported that the mortgage delinquency rate was 5.36% in February, the lowest since August 2007. The percent of loans in foreclosure declined -2% in February and was down -29% for the trailing year.
The consumer price index (CPI) rose +0.2% in February, breaking a downward trend, but the CPI is still lower for the year at -0.1%. The Core CPI, which removes food and energy, rose a more-than-expected +0.2%. Core CPI is 1.7% higher vs. year-ago levels, up from 1.6% in January and closing in on the Fed’s 2% target.
US business activity has weakened. Durable goods orders declined -1.4% in February; expectations were for +0.7% rise. Core capital goods (which act as a proxy for business capital spending intentions) experienced their 6thstraight decline, falling -1.4%. The Richmond Fed’s manufacturing index declined to -8 in March, failing to meet expectations of a 2 point increase to 2. Shipments and new orders both dropped to -13 and the order backlog index was -12.
In the Eurozone, Markit’s flash composite PMI rose to 54.1 in March, beating expectations of 53.6. Manufacturing rose +0.8 point to 51.9, and services increased +0.4 to 54.3. Eurozone employment rose at the fastest rate since August 2011. Greek Prime Minister Alexander Tsipras will meet with German Chancellor Angela Merkel as Greece’s cash crunch intensifies. Earlier, Tsipras said that Greece couldn’t meet debt service obligations without help. The bloc’s finance ministers stated Wednesday that Greece cannot count on $1.3 billion from the Eurozone bailout fund to recapitalize its banks. Eurozone finance ministers want Greece to first show that it will implement significant reforms and gave the government until Monday to submit a new plan. Markets are said to have already priced in a “Grexit” – “Greek Exit” – from the Eurozone.
In Asia, China’s manufacturing slid into contraction in the HSBC/Markit PMI report for March, hitting an 11-month low of 49.2. Japan’s manufacturing PMI dropped -1.1 point to 50.4, the lowest since May, and the output component gave up -1.5 points to 52.0, the lowest since October.
As tax day approaches, stock market bulls may have a “most unlikely ally for the next couple of weeks—the IRS”, says Mark Hulbert of Marketwatch.com. Since 1955, the stock market has performed at a well-above-average rate in the first half of April, to the tune of +1.22% vs. an average gain of just +0.3%. Hulbert says that “one possible reason is that the government has a vested interest in making sure there is plenty of liquidity in the marketplace for those needing to pay what is due Uncle Sam.”
(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 rose to 15.3 from the prior week’s 15.8, while the average ranking of Offensive DIME sectors fell to 17 from the prior week’s 15. The Offensive DIME sectors have now lost their lead over the defensive SHUT sectors for the first time in 6 weeks. 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.