Lorintine Capital SITREP for the week ending 4/2/2015
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 27.2, up slightly 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 53.7, down from the prior week’s 54.4, 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, 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:
For the holiday-shortened week, the Dow Jones Industrial Average recovered some of its losses from the previous week, gaining +0.48% to end the week at 17763. The Nasdaq composite gained an identical +0.48% to close at 4886. The LargeCap S&P 500 advanced +0.53% to 2066. The MidCap S&P 400 and SmallCap Russell 2000 each notched larger gains of +1.47% and +1.92% respectively, continuing their recent outperformance. Canada’s TSX rose +1.45%, reflecting better Energy and Mining prospects as oil and gold stabilized.
Oil benchmark West Texas Intermediate crude increased +$1.12 a barrel to $49.55, its third straight weekly gain. Gold also recorded a third straight weekly gain, up +0.35% to $1202.50 an ounce. Silver diverged from gold, however, giving up -1.30% to close at $16.75.
Around the world, Developed International had a small gain of +0.08%, but Emerging Markets surged +4.51%. The most notable among the internationals were Germany’s DAX and Japan’s Nikkei, each managing to hold their recent highs with gains of +0.83% and +0.77%, respectively. Brazil, very volatile recently, roared higher to the tune of +9.74% for the week
For the month of March, only the US MidCap (+1.6%) and SmallCap (+1.2%) indices gained ground, and they are the leaders for the 1st quarter as well, at +4.9% and +4.0% respectively. Although the Dow 30 lost ground for the 1stquarter, at -0.3%, all other US and Canada indices recorded modest gains (S&P 500: +0.4%, Nasdaq: +3.5%, TSX: +1.9%).
Developed International and Emerging International groups followed the overall US pattern: down in March, up for the 1st quarter. Developed International did particularly well, at +5.5% for the 1st quarter, buoyed by exceptionally strong German and Japanese performances.
In US economic news, pending home sales rose +3.1% in February, the highest level since June 2013 according to the National Association of Realtors—expectations were for a +0.3% gain. Purchases were up +6.0% and refinances gained +4%.
Manufacturing activity increased in March as the Purchasing Managers Index (PMI) rose +0.6 point to 55.7. PMI publisher Markit stated the report demonstrated “robust and accelerated expansion of manufacturing production levels.”
US Personal incomes increased +0.4% in February, slightly better than expected, and up +4.5% vs. year-ago levels. However, consumer spending remained subdued with a mere +0.1% rise that missed expectations by a tick. It appears that consumers aren’t spending the extra cash; they’re saving it. In February the savings rate rose to a two-year high of 5.8%.
The biggest US economic news of the week came on the Good Friday market holiday: the March Non Farms Payroll (NFP) report. The NFP report was shocking to all, with just 126,000 jobs created, basically half the number forecast and the first time in 13 months below 200,000. The unemployment rate remained unchanged at 5.5%. Including downward revisions for January and February of 69,000 apiece, the average monthly gain in the first quarter was 197,000, down sharply from 324,000 in the months of the fourth quarter of 2014. The 197,000 first-quarter average monthly gain, clearly weather impacted, was virtually identical to the 193,000 monthly average in the first quarter of 2014 – another brutal winter for large parts of the country.
There was one piece of good news in the March data, though. Average hourly earnings rose+ 0.3%, but are still at just a +2.1% annualized pace the last 12 months, which happens to be the same pace for the past half-decade (+2.0%/yr). U6, the figure for underemployment (including those looking for full-time work but stuck with part-time) fell to 10.9%, the lowest since August 2008.
Canadian industrial prices surged +1.8% in February as energy prices rose, handily beating the forecast for a +0.5% rise. The Canadian trade gap fell to $C984 million from $C1.48 billion as energy exports surged +14.9%. Total exports rose +0.4% and imports fell -0.7%.
In the Eurozone, the EU’s economic sentiment index rose 1.6 points to 103.9 in March, the 4th straight increase and the highest level since July 2011. Sentiment among industry respondents improved to -2.9 from -4.6 previously.
The Eurozone consumer price index was -0.1% in March’s flash estimate, more than the -0.3% change for February, but still in deflation territory. European manufacturing also picked up as the final March PMI was reported as 52.2, up 1.2 points over February. New business grew at the fastest pace since April and exports the strongest since July.
The Eurozone unemployment rate dipped to 11.3% in February, missing expectations of a decline to 11.1%. Greece and Spain had the highest jobless rates, 26.0% and 23.2%. Youth unemployment across the entire Eurozone was 22.9%.
Lastly, the National Association of Business Economists (NABE) is currently forecasting GDP growth of 3.1% in 2015, stronger than the 2.4% achieved in 2014. However, a model used by the Federal Reserve Bank of Atlanta strongly disagrees – at least for the Q1 component. The bank uses a model called “GDPNow” to prepare its forecasts. GDPNow aggregates the same 13 subcomponents used by the government to construct its official GDP reports, but when a data point is not available, the GDPNow model uses “bridge equations” to fill the gap in order to get closer to a real time estimate.
The following chart shows that the Atlanta Fed’s GDPNow forecast is significantly lower than the so-called “Blue Chip” consensus of leading economists, and is widening. The GDPNow Q1 GDP forecast hit 0.0% on April 1, and nudged up to 0.1% on Friday.
GDP growth may not actually reach zero for the first quarter of 2015, but there seems to be solid evidence that it will end up below where the NABE and Blue Chip forecasts are currently putting it.
(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.