2/14/2015 The Bear Market That You Never Noticed

Sector Model	XLU	-2.99%
Full Model	Date	Return	Days
ESI	8/4/2014	-47.03%	194
EDU	10/27/2014	-15.93%	110
UVV	12/2/2014	16.88%	74
JOY	12/8/2014	-14.09%	68
RS	12/11/2014	-9.92%	65
JNPR	1/5/2015	6.19%	40
GNW	1/20/2015	18.77%	25
AGCO	1/23/2015	12.45%	22
DNR	2/4/2015	0.46%	10
ALB	2/10/2015	4.70%	4
(Since 5/31/2011)
S&P	Annualized	12.71%
Sector Model	Annualized	23.83%
Full Model	Annualized	20.97%
S&P	Total	55.89%
Sector Model	Total	120.99%
Full Model	Total	102.61%
Sector Model	Advantage	11.12%
Full Model	Advantage	8.25%
	Previous	2015
S&P	53.06%	1.85%
Sector Model	122.60%	-0.72%
Full Model	101.13%	0.73%

 

The Full Model is ahead of the Sector for the year, after an annoying week in utilities:

 

The Sector Model remains well ahead of the benchmark, but the sector tracking is behaving in a very strange way, similar to how the model behaved just before the Lehman Brothers collapse: the sectors are rotating in reverse order.

Behind the scenes the money-flow has moved backwards since I last posted them the first weekend of December.

At that point we were looking at the possibility of a blow off top in materials and energy.  But energy never hit the buy zone and the model started unwinding from the end of a bull, to the beginning of a bull and even further back to a late bear configuration.

This is similar to the behavior in the summer of 2008 when the model moved from a late bear back to a market top.

In 2008 the action warned of a bear drop just beginning instead of one nearing its end.

This year the action is pointing to the possibility of a rather aggressive rise – even perhaps a dose of irrational exuberance.

We’ll have to wait and see.  I don’t time the market, but I do share the same fascination with timing that other investors have.  We’ve all watched in wonder at a market that outperformed a stagnant economy.  It could be that we are getting close to an actual recovery that doesn’t need to be faked by the Fed.

On a more granular level, let’s take a look at the specific industries being favored by the Full Model:

EDUC	Bottom
INSLIFE	Bottom
THRIFT	Bottom
CHEMDIV	Bull
COAL	Bull
HEAVYTRK	Bull
OILPROD	Bull
PUBLISH	Bull
STEEL	Bull
TOBACCO	Bear
UTILCENT	Bear

 

In the first column I have the industries in the buy zone for the model.  In the second column I have an estimate of the most typical market placement for that industry on the model.

Other than Tobacco and Utilities, the industries are heavily bullish.  Granted, Insurance-Life and Thrift are typical of the tag end of a bear going into a bottom, but that’s close enough to a bottom to call it one in light of the other stocks.

The puzzle for most folks is, “how can we have a bottom after such a long bull market?”

Shiller’s Cyclically Adjusted Price to Earnings ratio is showing a nosebleed reading against CPI of 27.60!  That’s even higher than it was before the 2007-2009 market collapse.

First a chart of Shiller’s real price:

Well above trendline.

Now Shiller’s CAPE ratio:

 

Well into pre-crash territory.

I’ve noted this in the past, and will note again: Shiller’s CAPE ratio only deals with real return expectations – not nominal return expectations.  Over the next decade Shiller’s chart indicates an expectation of about 1-2% real returns, with a likely crash during that decade (according to analysts like John Hussman).

But that’s neglecting to take into account Quantitative Easing.

You don’t need a market crash to pull down real returns.  Inflation will do that too.  This market does not resemble 1929, 1999, or 2007 when you take QE into account.  The nearest monetary parallel is 1972, after Nixon had bought his re-election by coercing the Fed to be too easy with monetary policy.

Quantitative Easing has been no secret, but the effects are not taken into account in Shiller’s data.  If we adjust prices by M1 instead of CPI, we see that there has been no bull market at all, but rather a long stagnation along a secular bottom:

In terms of CAPE we still have an inflated value, but not a pre-crash level – of 18.36:

 

If there has been no bull market, there is nothing to crash.

Again, bull and bear markets cannot be predicted with any certainty.  But claims of an aging bull market fail to acknowledge that in terms of money supply there has been no 2009-2015 bull market.  Instead there was a tiny bull from 2009-2011, followed by a tiny bear from 2011-2013, followed by another tiny bull from 2013 to today.

Let’s zoom in a bit to see it:

 

That, ladies and gentlemen, is what happens when the Fed pulls a rabbit out of a hat.  It’s just a bit of sleight of hand in terms of market levels.  When you filter out Quantitative Easing, the peak from 2009 through 2015 was actually in December of 2011.  We had a diluted bear market, followed by a slow recovery that has not yet reached 2011 valuations.

So, to all of those screaming about being overdue for a bear, I have this to say: we already had that bear in 2012 and you didn’t see it because of smoke and mirrors.

Tim