SITREP Report March, 2012
The very big picture:
In the "decades" timeframe, we are in a Secular Bear Market which began in 2000 when the P/E ratio (using Shiller's Cyclically-Adjusted P/E) 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. See Fig. 1 for the 100-year view.
We are nowhere near the end of this Secular Bear Market, as the Shiller P/E is 22.9, unchanged from the prior week (see Fig. 2 - a snapshot of www.multpl.com). Even though P/E's are now half what they were at their crazy peak in 2000, they are nonetheless at the high end of the normal 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 twenty year periods that began with a P/E at this level have ranged from -2%/yr to +7%/yr with an average of just 3%/yr.
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 (like what 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 the next Secular Bull Market.
Affirming this view, an August 2011 study from the San Francisco Fed titled “Boomer Retirement: Headwinds for U.S. Equity Markets?” reports on the likely effect of the coming tsunami of retiring boomers on the stock market. The study concludes that “The model-generated path for real stock prices implied by demographic trends is quite bearish. Real stock prices follow a downward trend until 2021, cumulatively declining about 13% relative to 2010. The subsequent recovery is quite slow. Indeed, real stock prices are not expected to return to their 2010 level until 2027.”
In the big picture:
The US Bull-Bear Indicator (see Fig. 3) increased to 68.9 from last week’s 67.1, continuing in Cyclical Bull territory. The US Bull-Bear Indicator has pushed further into Bull territory than other global asset classes, reflecting the higher strength of the US relative to the rest of the world. Alone among global equities, the US has reclaimed the highs of 2011 whereas most other world indices are still well below those levels.
In the intermediate picture:
The intermediate (weeks to months) indicator (see Fig. 4) decreased by 2 to 33, still in the upper range of 30-36. The market is susceptible to pullbacks from these levels, although the current rally has shown itself to be resistant to all but the shallowest declines.
In the markets:
A one-day pullback occurred on Tuesday of this week, but by the end of the week, the US had regained Tuesday’s losses and all US indices except the Dow Jones Industrials finished up for the week – again.
The final piece of economic data for the week – the February employment report that was released on Friday – revealed that a pleasing +227,000 jobs had been added, and the US markets then finished the task of regaining the week’s earlier losses.
International markets suffered more on the Tuesday pullback, since it was triggered by European fears of a failure in Greek debt talks, and International markets did not benefit as much as the US from Friday’s employment report. International markets finished the week down -0.5% to -1.0%.
The ranking relationship (shown in Fig. 5) between the defensive SHUT sectors ("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 20.3 from 22.3, while the average ranking of Offensive DIME sectors also rose, to 13.8 from 14.3. The Defensive SHUT sectors continue to be ranked lower than the Offensive DIME sectors by a wide margin.
Note: these are “ranks”, not “scores”, so smaller numbers are higher and larger numbers are lower.
The US has led the recovery from last year’s travails, and is currently the strongest among all global markets. However, the over-arching Secular Bear Market remains in place.
Because we are in a Secular Bear, we have no expectations of runs of multiple double-digit consecutive years, and we expect poor market conditions such as have been experienced recently 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.