Fourth Quarter 2015 Market Commentary
Doug Ramsey, CFA, CMT
Chief Investment Officer
Investors spent much of 2015 wringing their hands over the likely timing of the Federal Reserve’s
first interest rate hike since the 2008 financial crisis. We contended that a new Fed tightening cycle
was already underway (and has been for two years now), having kicked off in January 2014 when the
Federal Reserve initially began to “taper” its monthly level of bond purchases under its Quantitative
Easing program. (Although so-called “Fed watching” does not play a prominent role in our investment
disciplines.)
Following the January 2014 initial taper, there were six additional tapering moves over the next 10
months, and financial markets didn’t even wait until the end of that program to signal that the underlying
investment environment had taken a turn for the worse. High Yield U.S. bonds turned south in June
2014, the MSCI World Ex USA Index peaked a month later, and Emerging Market equities topped in
September 2014. The weakness in these assets correctly foreshadowed what would be a difficult year for
U.S. stocks in 2015.
Whether Fed tightening “caused” the last 18 months’ difficulties in global stocks can’t be proven
nor disproved. What’s inarguable, though, is that market valuations (especially in the U.S.) had moved to
such heights by 2014 that any negative change in the monetary environment was likely to prove difficult
for stocks. These concerns, combined with deteriorating market action throughout the first several
months of 2015, drove our Major Trend Index into bear territory last August, which in turn triggered a
defensive stance in our tactical portfolios (where they remain today). Both the Leuthold Core and Global
Funds currently target net equity exposure of 37%, near the low end of our 30%-70% range.
Small Caps and foreign stocks are usually the first to succumb during a bear market, and this cycle
fit that pattern. Over the last seven months, Small Caps fell more than 23% into their January market
low, while MSCI EAFE and the MSCI Emerging Markets Index—both of which peaked in the second
half of 2014—were down 22% and 36%, respectively, at their January lows. The silver lining behind these
steep losses, of course, is that they’ve helped re-establish better value. Emerging Market equities trade at
around 9x our 5-Year Normalized EPS estimate, a valuation just barely above the level reached at the final
trough of the Great Recession. Europe has also gotten statistically cheap, at 13.6x Normalized EPS.
While the market setback has “refreshed” valuations among Mid Caps, Small Caps, industrial
cyclicals, and foreign stocks, it has yet to inflict much damage upon U.S. blue chips. Again, this pattern
is typical for cyclical bear markets and severe corrections: the Dow Jones Industrial Average and S&P 500
generally hold up better than all other stock market measures until the very end, masking the extent of
the underlying losses in most portfolios and keeping equity investors hopeful. In fact, by the time the
Dow and S&P 500 finally reach the common bear market threshold (a loss of 20%), the typical cyclical
bear market is almost over. We still believe this “capitulation” phase in blue chip U.S. indexes is ahead of
us. Obviously, though, if our market disciplines take a turn for the better, we’ll adjust our expectations
(and our portfolios) rapidly.
(Continued)
Leuthold Weeden
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Capital Management
Fourth Quarter 2015 Market Commentary
(continued)
After a couple of tough months in the third quarter, equity markets rebounded in October.
The strongest fourth quarter gains were extremely concentrated, however, led by U.S. Large Caps,
while Small/Mid Cap stocks continued to lag. Our equity strategies had a hard time keeping pace with
a market increasingly driven by mega-cap stocks, and fourth quarter results essentially neutralized what
was otherwise an exceptional year for our group selection models. Minor changes to both our industry
selection model and stock selection disciplines have paid off; we just weren’t prepared for the extreme
flight-to-quality into the largest and “safest” U.S. stocks that occurred in late 2015. The economically
defensive Large Caps now look very overvalued in our work, and we expect them to suffer during both
the balance of the market decline and the subsequent rebound.
Since the spring of 2013, we’ve avoided exposure to alternative holdings like REITs, MLPs, precious metals and commodities. This decision has proven mostly on the mark; only REITs generated
significant additional gains over that period. If the bear market progresses as we expect, new opportunities in one or more of these areas should emerge.
Our conservative fixed income positioning paid off in 2015. The models drove us into longer
maturity government debt and away from low-grade Corporates and Emerging Market debt. High Yield
bonds haven’t yet fallen to levels we consider compelling, but we expect that to change in the months
ahead. Chaos creates opportunity.
Please feel free to contact us with any questions or comments. Thank you for your support, and
best wishes in 2016!
Doug Ramsey, CFA, CMT
Chief Investment Officer
Leuthold Weeden
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Capital Management
Other Market Notes
Foreign Stocks: The Value Trap Persists
It’s probably age, but we’ve come to appreciate the
predictability of the commencement of the new year—the extra eight pounds from holiday feasts, another Big Ten embarrassment in the Rose Bowl, and the booking of yet another
year’s underperformance by foreign equities. One’s darts
had to be extremely accurate to have cashed in on the eight
MSCI country indexes that produced gains in 2015 (versus
41 countries with losses). The small capitalization weighting
of many of these country indexes minimized the damage, as
it usually does late in bull markets and early in bear markets.
While the MSCI AC World Index declined 4.3%, the median
loss among the 49 country indexes was a much larger –10.6%.
Foreign stocks’ perpetual underperformance has
opened up a valuation gap that should look extremely appealing to anyone with a horizon of more than two years.
But from a tactical point of view, we’ve cautioned that Value
stocks will likely lag as long as the bull market remained intact (not merely at the country level, but among industries
and stocks as well). If the bear unfolds as we expect, look for
signs of a leadership change favoring cheapness—in stocks,
sectors, and countries.
Ratio,
MSCI AC World Ex USA
(in USD) to
S&P 500
40
35
40
P/E Ratios On 5-Yr. Normalized EPS U.S. Vs. Rest Of World
40
30
25
35
35
30
30
20
15
Plunging t o new lows...
© 2016 T he L euthold Group
1990
2000
25
MSCI USA I ndex
25
2010
21.1x
20
15.3x
(World
Ex
USA)
15
10
9.9x
(Emerging Markets)
© 2016 The Leuthold Group
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Leuthold Weeden
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20 1 0
Capital Management
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15
10
Other Market Notes
Deciphering The Transports’ Message
The Dow Jones Transports was the first U.S. index to top in this cycle (December 31, 2014), and it
closed January 7, 2016 down 24.1% from that historic high. That development, in and of itself, sharply increases the odds that a new cyclical bear market is underway. Since 1940, there have been 29 declines of 20%
or more in the DJ Transports; of those, only seven were not associated with a bear market in the S&P 500.
(But, the most recent of those 20%+ “stand-alone” declines occurred during the last gasp of the Technology
bubble and was followed by a memorable market top just two weeks later).
For the bulls among our audience, the two most encouraging precedents would have to be the DJ
Transports’ mid-cycle declines of –28% in 1984, and –26% in 1994. Neither of those episodes was followed
by any serious economic weakness and, of course, there were huge additional stock market gains to be
reaped into the bull market tops of August 1987 and March 2000.
Keep in mind, though, the 1984 and 1994 episodes are outliers. We’ll side with the preponderance
of this study’s historical evidence, which is that a cyclical bear market is underway.
33 S. 6th Street, Suite 4600
Minneapolis MN 55402
612.332.9141
info@LWCM.com
www.LWCM.com
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/or 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: 1.30.16
Leuthold Weeden Capital Management is the adviser to Leuthold Funds. Distributor: Rafferty Capital Markets, LLC, Garden City, NY, 11530; Copyright © 2016 by The Leuthold Group. All Rights
Reserved.
Leuthold Weeden
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Capital Management