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Leuthold: a cyclical bear has commenced

Hi, guys.

Just finished reading the lead section of Leuthold's Perception for the Professional, their monthly report for paying research client (and us). It's pretty current, with data through September 8th.

The bottom line is that a cyclical bear began in August and it's got a ways to go. Their bear market targets for the S&P 500 - based on a variety of different bear patterns - are in the range of 1500-1600; it closed Friday, 9/11, at 1961. The cluster of the Russell 2000 is around 1000; the Friday close was 1158.

They address some of the self-justificatory blatter ("it's the most hated bull market in history," to which they reply that sales of leveraged bull market funds and equity exposure by market-timing newsletters were at records for 2014 and much of 2015 which some might think of as showin' some lovin'), then make two arguments. (1) Market internals have been breaking down all summer. (2) After the August declines, the market's forward P/E ratio was still higher than it was at the peaks of the last three bull markets. In their tactical portfolios, they've dropped their equity exposure to 35%.

They are torn on the emerging markets. They argue that "there must be serious fundamental problems with any asset class that commands a Normalized P/E of only 13x at the peak (in May 2015) of one of the greatest liquidity-driven bull markets in history. We now expect EM valuations will undercut their 2008 lows before the current market decline has run its course. That washout might also serve up the best stock market bargains in many years..." (emphasis in original) Valuations are already so low that they've discussed overriding their own models but will not abandon their discipline in favor of their guts.

Current asset allocation:

52% long equities
21% equity hedge a/k/a short for a net long of 31%
4% EM equities, which are in addition to the long position above
20% fixed income, with both EM and TIPS eliminated in August. The rest is relatively short and higher quality.
3% cash

All of which is, I know, a pretty poor synopsis of 50 pages of analysis but I think I captured the gist of it.

For what that's worth,

David

Comments

  • Thanks David.

    Always good to keep up with the thinking of the Leuthold Group
  • Hi @David_Snowball
    Thank you for the overview.
    You would not have taken the time, IMO; to note the above if you did not feel there is value to Leuthold's opinion.
    Might this also be, to some extent; your near term market view, too.

    Regards,
    Catch
  • edited September 2015
    Thanks David....that first 10% did seem a bit too compact and painless....relatively. The Vulcan Value Partners recent communication was equally sobering though less specific in terms of index valuations.

    The next 6 weeks or so will be very interesting.

    press
  • Have LCORX in my IRA. Leuthold of the fund people no longer there, but hopefully these guys know what they are doing. Low EM allocation actually is also my ANALysis. I asked elsewhere - if Dollar continues to strengthen, methinks Emerging Markets will have a lull.

    Grandeur Peak...timing is everything, waiting to buy...
  • David, thanks for the report on Leuthod. Can u tell us what they are short - which indexes or is it individuul issues? Are they more constructive on other developed markets
  • Nice to see a concrete, testable prediction, especially on that hardest of all concepts, market timing. We will soon see if they're right. I doubt it, but I'm not a pro and I don't claim to be able to time the markets.
  • Hi, guys.

    The bottom line is that a cyclical bear began in August and it's got a ways to go. Their bear market targets for the S&P 500 - based on a variety of different bear patterns - are in the range of 1500-1600; it closed Friday, 9/11, at 1961. The cluster of the Russell 2000 is around 1000; the Friday close was 1158.


    Did they discuss a long secular bear market?

    What is a bit surprising is that from the numbers above the S&P is falling much more then the Russell - I would think the small caps would get hit harder.

    Any indication why the S&P would get hit harder?

    1961
    1500
    461
    0.235084141


    1158
    1000
    158
    0.136442142


  • Hi, guys.

    Kind of a busy day at the college - two meetings over recruiting new faculty (14 searches are beginning, about usual), one on helping transfer students retain and prosper, then my News Literacy class - so I'll be quick.

    Not sure why the S&P needs to fall more. The S&P target was a composite drawn from the levels necessary to achieve:
    1. a reversion to 1957-present median valuations
    2. 50% retracement of gains from the October 2011 low
    3. the October 2007 peak
    4. the median decline in a postwar bear
    5. the March 2000 secular bull market peak
    6. 50% retracement of the gain from the March 2009 low
    7. April 2011 market peak

    Each of those represents what some technicians see as a "support level" in a typical cyclical bear. Since Leuthold recognizes that it's not possible to be both precise and meaningful, they look for clustered values. Most of the ones about lie between 1525 and 1615, so ....

    They seem to meaningfully overweight only two sectors. Their "select industries" portfolio, which is the core equity exposure in Leuthold Core, is 25% consumer discretionary (versus 13% in the S&P) and 25% health care (versus 15%). Tiny overweight in industrials (13 vs 10). Zero exposure to telecom, utilities, or materials.

    They seem to meaningfully over-short only one sectors. Their "AdvantHedge" portfolio, which generates Core's short positions, is 18% energy (versus 7% in the S&P 500). They also over-short materials, utilities and telecos. They have double-digit short positions in energy, industrials and consumer discretionary but those are pretty much in-line with the size of those sectors in the S&P 500. They treat health care, financials and consumer staples with respect. Finally, there's a 5% short on indexes.

    Leuthold focuses on global industries, not on individual countries. With the exception of the emerging markets, exposure to which they gain separately, the equity exposure in the Global fund comes from their global industries portfolio. Things get tricky because they invest in industries within sectors (you think "financials," they think "reinsurance (increased)" or "life & health insurance and brokers (decreased)." For any number of reasons, not least the fact that industries are increasingly borderless, Leuthold tends to buy exposure across borders. Globally, they're meaningfully overweight consumer discretionary (21% versus 13% in the MSCI World), health care (19 vs 13), and industrials (14 vs 10). Financials is the largest sector and they're a little overweight (23 vs 21).

    For what all that's worth,

    David
  • Negative Momentum Weighs On All The Major Asset Classes
    By James Picerno | Sep 14, 2015 at 06:37 am EDT The Capital Spectator
    Emerging-market stocks have been getting hammered this year, but last week offered some relief. The Vanguard FTSE Emerging Markets ETF (VWO) jumped 3.9% for the week through Sep 11, delivering the best weekly performance for our standard set of proxies for monitoring the major asset classes.
    Is it time to jump back into this battered-and-bruised corner of global equities? Probably not.
    The negative momentum that’s currently weighing on all the major asset classes remains a potent force and there are few signs that the bearish tide has run its course. Although last week’s gains in some markets suggest otherwise, it’s not yet obvious that the latest uptick marks a bullish turning point that’s worthy of a full-throated risk-on allocation.
    image
    One reason for remaining cautious: for first time since the 2008-2009 financial crisis and Great Recession we have the following worrisome trend hobbling all the ETF proxies for the major asset classes: negative year-over-year returns. That’s a formidable force. Beyond nibbling on the edges for speculative purposes, strategic-minded investors may want to wait for more encouraging signs before redeploying capital into risky assets in a meaningful way.
    image

    http://www.capitalspectator.com/negative-momentum-weighs-on-all-the-major-asset-classes/
  • The ETF returns above are price only and don't reflect dividends. It' still not a pretty situation but not as dire as portrayed, at least for the bond related ETFs.
  • Thanks much for the L details on sectors, David; that's especially "meaningful" (both long & short) to this kid.
  • @VintageFreak

    That core fund LCORX has sure done well recently, since the new kids took over. And that with lots of cash/bonds. I am not seeing the appeal so much compared with GLRBX and all the others, nor with my goal of 40-40 DSENX and PONDX, but pretty good work recently in this awful slump.
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