First Quarter 2015 Market Commentary
Doug Ramsey, CFA, CMT
Chief Investment Officer
The cyclical bull market entered its seventh year in March, making it the fourth longest
U.S. bull market of the past 100 years. While we were quite vocal in recognizing the attractive
valuations that existed near the 2008-2009 market lows, we certainly did not foresee the length
and extent of the upswing that was to follow. Fortunately, our asset allocation disciplines trump
our opinions and forecasts. Thanks to those quantitative tools, our tactical portfolios have maintained fairly high allocations to equities throughout most of the bull market, despite misgivings
over the high level of stock market valuations (particularly in the U.S.) during the past couple of
years.
As we enter the second quarter, our Major Trend Index is still in moderately bullish territory, and our tactical accounts are positioned with net equity exposure of 58%. After spending
time in the “neutral” zone late last year and part of the first quarter of 2015, we expected the next
major move in the Major Trend Index would be into bear territory. But the bull has surprised us
with its longevity time and again, and most indications are that the market is not ready to roll over
just yet. For example, the month of April saw new bull market highs in the S&P 500, MSCI All
Country World Index, Russell 2000, NASDAQ Composite, Value Line Arithmetic and Geometric
(equal-weighted) Averages, and—perhaps most significantly, from the perspective of historical
probabilities—the NYSE Daily Advance/Decline Line. These market highs are so broad in nature
that it’s difficult to argue a final bull market topping process has even begun (as we had been tentatively doing just a few months ago). Our latest concerns, in terms of market and sector behavior,
include the relative weakness of the Transportation and Bank stocks and the poor performance
of equity-like High Yield bonds. But, historically, the stock market tends to put up a few more
warning flags before it’s ready to roll over on a cyclical basis.
For more than three years, we have noted that foreign stocks have been priced significantly more cheaply than their U.S. counterparts… and for three years, that valuation gap did
nothing but widen. Valuations are the most important investment variable in the long run, but
sometimes appear irrelevant in the short run. Now, after years of irrelevance, those cheaper
foreign valuations suddenly seem to matter; year-to-date, foreign stocks have decisively outperformed U.S. stocks, even in the face of continued dollar strength. Despite this improved action,
the valuation gap in favor of foreign shares remains sizeable: non-U.S. Developed Markets trade
at 17.0x our 5-year Normalized EPS estimate, and Emerging Markets trade at just 12.2x Normalized EPS, compared to a U.S. Normalized P/E ratio of 22.0x.
(Continued)
Leuthold Weeden
1
Capital Management
First Quarter 2015 Market Commentary
(continued)
The strong 2014 performance of our quantitative equity strategies carried over into the first
quarter of 2015, with our positions in leading sectors (Health Care, Consumer Discretionary, and
Information Technology) continuing to perform better than their respective benchmarks. Over
the last year this work has also kept us a safe distance from the underperforming commodityoriented stocks, although a future buying opportunity now appears to be developing in the Energy
sector, which, at a P/E ratio of just 12.0x, is the cheapest market sector by about 30%.
With little to excite us from a long-term return perspective, our tactical portfolios’ Fixed Income holdings remain at a low 20% allocation. We think inflation has reached a low (0% in the U.S.
currently), which should put a floor under long-term bond yields. The U.S. dollar looks vulnerable
to a setback after the last twelve months' powerful surge, so we’ve therefore tilted a bit more toward
foreign bond holdings.
If you have any questions please feel free to contact us. We appreciate your support.
Sincerely,
Doug Ramsey, CFA, CMT
Chief Investment Officer
Leuthold Weeden
2
Capital Management
Other Market Notes
Confidence & Stock Prices
Chart 1
Consumer Confidence shot to new cycle highs in March,
closing within 6-7 points of the peak made shortly before the
Great Recession (Chart 1). Many contrarians view this breakout
as a contrarian SELL signal for stocks, but we’d caution against
interpreting confidence in such a simplistic way.
Consumer Confidence is nothing more than a sentiment
indicator, and we’ve long cautioned investors to recognize that
the predominant driver behind any sentiment measure is the
past price performance of the asset in question. Show us the past
several weeks’ action in stock prices, and we’d venture we could
give you a fairly accurate estimate of the VIX, put/call ratios, and
sentiment survey responses. In the case of a long-term sentiment
measure like Consumer Confidence, the response to past price
movements is long-tailed—with the stock market’s trailing oneyear, three-year, and 10-year performance all highly correlated to
today’s level of confidence. Chart 2 shows that a weighted summation of these three rates-of-change bears an uncanny resemblance
to the monthly Consumer Confidence survey itself.
The key takeaway is that today’s inflated confidence levels
are more a reflection of the stock market’s recent gains than a
guide to future ones.
Chart 2
Leuthold Weeden
3
Capital Management
Other Market Notes
Commodity Washout?
Oil’s 60% decline in the last nine months has been the headline-grabber, but the remaining components of
the Continuous Commodity Index (CCI) deserve some love, too. Most of them are down sharply over the same span:
from its spring 2011 peak, the CCI’s cumulative loss is a massive –41%. Thus, during a period of: (A) sluggish but
stable growth in the world’s largest economy; and, (B) lengthy programs of quantitative easing by two major central
banks (recently joined by a third), the CCI has suffered a decline approaching the magnitude of that seen during the
worst global recession and financial panic in 75 years.
We were early to identify the supply-side issues that would eventually trigger the 2011-2015 commodity rout
(Chart 1). This “supply glut” thesis has now become consensus thought, however, making bearish commodity bets
(either outright or via commodity-oriented equities) a higher risk proposition than at any other time during the current slide. For example, our composite sentiment reading on 21 commodities just undercut its fall 2008 panic low. A
sentiment washout alone doesn’t make a distressed asset buyable (see Emerging Markets equities in 2012, 2013, and
2014). But it’s certainly enough to get us to re-evaluate major bets against the despised asset in question.
Ideally, we’d like to see the washout in investor sentiment matched by a commensurate washout in valuations,
but that’s not yet the case in the Materials sector—which trades at a multiple of cash flow comparable to last cycle’s
peak (Chart 2). Avoid.
Chart 1
Chart 2
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Disclaimer: The views expressed are those of Doug Ramsey and The Leuthold Group, and are subject to change at any time based on market and other conditions. References to specific securities and issuers are not intended to be, and should not be interpreted as, recommendations to purchase or sell such securities. DOFU: 4.29.15
Leuthold Weeden Capital Management is the adviser to Leuthold Funds. Distributor: Rafferty Capital Markets, LLC, Garden City, NY, 11530; Copyright © 2015 by The Leuthold Group. All Rights
Reserved.
Leuthold Weeden
4
Capital Management