Bear Markets Ahead?

Bear Markets Ahead?

The third quarter ended with all the major indices in the red for 2015, with small cap stocks as well as the industrials delivering the weakest performances… so the big question is are bear markets ahead?

2015-09-30 Mkt Indices

Every sector also ended the quarter in the red for the year, with the one exception of Consumer Discretionary, which barely eked out a wee little positive return, (technical term there) while the Energy sector and Materials took a major pounding.

2015-09-30 Sectors

So let’s take a bigger step back and see where the markets are from a longer-term perspective. The chart below shows the inflation-adjusted S&P 500 index in constant August 2015 dollars. We believe it is rather telling to see that prior to the current bull run, the S&P 500 peaked in 2000.  The 2007 peak did not quite reach as high as the 2000 peak and had a lower trough.  The most recent bull run reached just slightly higher than the 2000 peak, but has broken its longer-term upward trend and now appears to be on a downtrend.


The big question is are we now in an interim dip, that will provide a great buying opportunity along a continued upward trend, or are we facing the beginnings of a beat market? Hate to say it, but the data is giving me a serious craving for some honey!

  • The typical bear pattern is first a loss of breadth, which we’ve experienced for about 18 months. Check…
  • Next comes loss of leadership. We’ve seen Walt Disney (DIS), which has been on a tear since late 2011 break significantly out of its long-term trend. Sectors like biotech, as illustrated by iShares NASDAQ Biotechnology ETF (IBB) and media, such as Global X Social Media Index ETF (SOCL) have also experienced major directional shifts. Check, check.
  • During the first stage of a bear market, we often see rallies that simply cannot hold. We experienced a painful plunge down to a bottom on August 24th with the following rally unable to bring us back up to the previous highs, followed by another collapse on September 16th. Check, check, check!
  • Finally, after having the markets trade in the tightest trading band in history for the first half of the year, we now have triple digit drops in the Dow Jones Industrial average becoming more frequent. Check, check, check, check!


That’s the market movement, but what about fundamentals? Over the last six months, only about 37% of publicly traded companies have increased their revenue forecasts, which is the smallest percentage since 2009 and almost as bad as during the 2001 bust. Median sales growth estimates for the next 12 months are about 4% versus the longer-term norm of 7%. Meanwhile earnings revisions are back down at historically low levels not seen since the financial crisis.


With weaker earnings moving forward, a continued bull market will need investors that are comfortable with expanding P/E ratios, but that would require that investors be risk-seeking and there isn’t much evidence of that when we look at how much money has been pulled out of emerging market stocks and bonds.  Only time will tell if that bear is coming out of hibernation to stay a while, but for now, I’m getting increasingly defensive as I perceive the potential risks for most equities as being disproportionately nail-biting versus rewards.

What the Fed Did Not Say

What the Fed Did Not Say

The annoying truth that very few economists want to admit is that the field is more art than science – much like investing. If investing were as easy as simply looking at the past and extrapolating it forward, you’d not need us. When it comes to econElephant face downomics, the best we can do is to develop an idea of general future probabilities based on how events unfolded in the past.

The headlines have been heralding all kinds of economic triumphs lately, which has been giving yours truly much brow furrowing consternation; talk about heads in the sand! Let me walk you through what no one seems else seems to be talking about.


One: Q1 GDP has been revised into a contraction, falling 0.7%. It is important to note that this is the first time in recorded US economic data that the economy has contracted three times during a recovery. That seems like a noteworthy lack of strength, particularly given all the support the Federal Reserve has been supplying coupled with the mindboggling level of federal spending; recall that during the last seven years US debt has doubled, meaning the government overspent as much in the past 7 years as it did in the entire 230 years prior combined!


Two: June 15th we learned that Capacity Utilization for total industry in the United States fell for the sixth month in a row. This is measured by the Federal Reserve and represents, “the percentage of resources used by corporations and factories to produce goods in manufacturing, mining, and electric and gas utilities for all facilities located in the United States (excluding those in U.S. territories). This measure has fallen six months in a row ten times previously since 1967, the earliest recorded data. Every single time it has fallen in the past six times in a row, the economy has been in a recession. In fact, the economy has never been in a recession when the metric did not fall for at least six consecutive months. Think of it this way, the US economy has thrown a big old production party, but hardly anyone’s on the dance floor and everyone’s wondering when the crowd is finally going to arrive.

Total Capacity Utilization

Three: Industrial Production has now come in below expectations six months in a row, and has shown a rather concerning downward trend since January. Keep in mind that a contraction in GDP for two quarters in a row, i.e. six months, is the definition of a recession. Industrial Production used to be the metric for the economy before GDP started being measured after WWII. May’s number is also a bit of a blow to the hopes for a turnaround to GDP in Q2, as the level of production so far in Q2 is down 2.4% at an annual rate relative to the average for Q1, which was itself down 0.3% from Q4 2014. This means we are likely to see the first back-to-back quarterly contraction in production since Q1 and Q2 of 2009. Were this pre-WWII, this data mean an official declaration of a recession.


Four: The three month moving average for US retail sales is at a level that is never seen outside of a recession, hat tip to Raoul Pal of Real Vision Television, (which I highly recommend for on-demand interviews with the best and brightest in the markets) for pointing out this one to me. While May retail sales were up from April, they were still 25% below March with an overall trend downward trend that is clear in the chart. So much for the return of the American consumer… not just yet.

US Retail Sales

Five: The talking heads on TV claimed that the contraction in Q1 was due to extreme weather conditions and the port closures/slowdowns due to the labor union kerfuffle on the west coast. First quarter earnings releases and analyst calls where abuzz with retail executive bemoaning the lost sales thanks to goods getting stuck at the west coast ports. Alrighty then… we were willing to give them some wiggle room here. However, the port situation was resolved some months ago, which should have led to a big jump up in transportation needs within the US to get goods to and from those congested ports. Errrh….. May… not looking so good. That phrase is starting to sound like Wall Street speak for, “The dog ate my homework.”


Not exactly inspirational; not only has rail traffic in 2015 been materially lower overall than in 2014, but May saw a sizeable decline both relative to April and to May 2014. This data is reinforced by the Cass Freight Shipping data, which was released on June 15th, showing that while shipments and expenditures rose in May from April, they are still below 2014 levels, which was the strongest year so far since the Great Recession. Both car-loadings and intermodal-loadings were declining by month’s end as well, indicating that June is likely to also be weak.



To emphasize the point with transports, earlier this week Federal Express delivered quarterly earnings and revenue that fell short of expectations, citing pension costs, the impact of the strong dollar and lower fuel surcharges. All reasonable claims except they are nothing new, thus the company’s guidance should have already taken those factors into account. To us this just gives further reason for concern.


Six: For all the talk about how the labor markets are heating up, getting tighter… whatever lovely catch phrase you like, June 18th the Labor of Bureau Statistics announced that real average hourly earnings decreased by 0.1% in May, seasonally adjusted. Real average weekly earnings also decreased by 0.1%. So much for all the talk about tightening labor markets inducing inflation, I keep scratching my head wondering what the heck the talking heads are looking at! On top of that, a recent report from Glassdoor Inc. revealed that job seekers had to wait about 22.9 days for an offer or rejection in 2014, up from 12.6 days in 2010 – again not an indicator of a tight job market.


To drive the point home, the chart below shows just how much of the incoming data has surprised to the downside. Does this mean that expectations are entirely out of whack with reality or does it mean that the economy is weakening? Well, putting it all together…

Surprise Index

Bottom Line: As I said earlier, economics and investing involve looking at the new data coming in, comparing it to earlier data and looking for correlations in an attempt to identify trends or causation. In other words, we seek to understand what’s going on now, what’s causing it and where are we going? The current recovery has stumbled an unprecedented three times into contraction, which gives concrete data on how week this recovery actually has been. Capacity utilization, Industrial Production and Retail Sales data all point to a recession. Transportation of goods is well below last year and not showing signs of improvement and if one looks under the covers of the labor market – it is much weaker than the headlines indicate. One of our primary jobs is to manage risk and when we put all that data together, it gives us cause for concern as to the direction of the economy. The chart below indicates that we aren’t the only ones noticing just how weak the economy has become, as executives increasingly decide to return money to shareholders directly rather than invest it in elusive future growth.

Cash Uses


March Market and Economic Update

March Market and Economic Update

The U.S. stock market has given investors a bumpy ride so far this year, but it has been more than 500 days since the S&P500 experienced a correction of 20% of more, a run which has occurred only 10 times in the past 100 years so we really ought not complain despite the increased Pepto on Wall Street. January gave the market jitters as the S&P500 closed down 3.6% from its December 21st close. Cupid brought some respite in February, recovering some of those losses with the S&P closing down only 0.6% from the Dec 31st close. As of March 14th, the S&P was essentially flat from last year’s close, making the broader indexes in 2014 so far Shakespearean much-ado-about-nothing. In comparison, the Dow and the S&P 500 were up around 10% at this point last year.


The CNN Money’s Fear and Greed Index shown above illustrates that in the past week, the markets have experienced a shift from “Extreme Greed” to entering “Fear” territory. This index looks at seven indicators, shown below. Stock price strength indicates that the number of stocks hitting their 52-week highs is at the upper end of its range. The yield demanded on junk bonds is higher than what has been typical for the last two years, while the S&P 500 has typically been further above the 125-day average than it is now, indicating that investors are committing capital to the market at a slower rate than they had been previously. We are also seeing puts at among the highest level seen in the last two years, indicating significant concerns that the market’s direction is likely to change for the worse. Overall, the market today is a lot like a sophomore headed to his first dance, sitting on her father’s couch as he waits for his date to emerge; understandably nervous, but still holding onto hope that the night could be a success.









While the U.S. markets have been pushing higher and higher, other markets around the world have been even more ambitious.






From June 2012 to December 30th the Nikkei rose over 90%, (up 52% in 2013 alone) but has since stumbled from its Dec 30th high and is now up around 70%, having briefly entered into a bear market (20%) contraction by last month. The index as of March 14th sits down 12.21% from its year-end high, falling 3.3% last Friday. I’ll bet there’s a bit more sake being consumed this quarter in the after-hours!






The Euro Stoxx 50 Index, the leading blue-chip index for the Eurozone, has gained over 50% since June 2012, outperforming the S&P, despite the region’s sluggish economy. The chart at right illustrates the growth rates, (or lack thereof) for the Eurozone and its major economies through 2012. Estimates for 2013 aren’t much better, with the region as a whole contracting 0.4%, Germany up just 0.5%, while Spain and Italy are estimated to have contracted as well by, falling 1.2% and 1.8% respectively.

Unemployment in the region started 2012 at 10.2%, but has frustratingly worsened to 12.1% today and is anything but consistent across member nations. Unemployment in Spain, Italy and Greece are 26.7%, 12.7% and 28% respectively with youth unemployment shockingly high at 57.7%, 41.6% and 61.4% respectively! In contrast, German unemployment is just 5.2% with youth unemployment an enviable 7.5%. The impact of these employment levels for the young in the southern European nations will be a drag on those economies for decades to come as studies show the early years are critical for developing skills which impact an individual’s income generating potential over their entire career. I imagine many parents in these nations would be happy to be able to complain about not seeing their kids enough as they start their careers and build their young lives!

Meanwhile over in Japan, despite the massive run up in its stock market and levels of monetary stimulus that could make Bernanke blush, things are also not rosy either. Japan’s economy grew even more slowly than initially calculated in the final three months of 2013 and posted another record current-account deficit in January, increasing the likelihood that an economy already struggling with ugly demographics is in for yet more near-term angst. According to government figures, the overall economy grew just 0.7% on an annualized basis in the final three months of 2013, a downward revision from the initially projected 1% growth. The slight silver lining is business investment, which grew by an annualized 3% in the fourth quarter, compared with a preliminary reading of a 5.3% increase. Consumer spending was up an annualized 1.6%, revised lower from a preliminary 2% rise.

China too is showing signs of slowing. Forecasts for China’s GDP growth were cut by many in the investment banking world on Thursday after Beijing reported the biggest slowdown in investment for more than a decade coupled with the slowest retail sales expansion in nine years. Confidence was further undermined by news that a well-known steel mill has failed to repay loans that came due last week, the first default on corporate debt that the government has allowed.

European growth in aggregate just isn’t happening and the reforms needed to induce it are politically challenging to say the least. Japan continues to try and get out of its decades long funk. The Chinese engine which fueled much growth post-financial collapse is sputtering. In the US, as we predicted in last month’s newsletter, GDP growth for Q4 2013 was revised downward from an initial estimate of 3.2% to 2.4% versus Q3 2013 growth which is estimated to have been 4.1%. GDP growth for the full year of 2013 is estimated to be about 1.9% falling from 2.8% in 2012. Even with the downgrade, growth for the second half of 2013 is now estimated to be 3.3% versus 1.8% in the first half, showing an improvement, but not exactly a robust economy.

On the global front, keep in mind that for almost 30 years, the U.S. ran growing trade deficits, which effectively provided a lot of stimulus for foreign exporters; in other words we bought a lot of stuff from other countries, (funded in part by increasing debt levels) which helped their economies grow in a global form of seller-financing. We’ll buy your stuff if you lend us the money by buying our Treasuries. The chart above shows the magnitude of this trade deficit over time. Notice that since 2006 the deficit has been shrinking which may please those who prefer “made in America”, but is bad news for the countries from which we used to buy!









I’ll leave this review with one of my favorite sayings, hat tip to Warren Buffet for refreshing my memory in his most recent letter to shareholders, “A bull market is like sex. It feels best just before it ends.” Something to always keep in mind when one is tempted to chase returns.

Bottom Line: The economies of the largest nations and regions around the world continue to struggle to grow in line with historical norms, while their respective stock markets have experienced a wild run up in recent quarters. This makes continued across-the-board-increases in broad indexes increasingly unlikely, thus having a broadly diversified portfolio, with exposure to various markets and asset classes is even more important. The reduction in correlations between investments provides opportunities for those who are patient and pay attention.