The very big picture:
In the “decades” timeframe, the question of whether we are in a continuing Secular Bear Market that began in 2000 or in a new Secular Bull Market has been the subject of hot debate among economists and market watchers since 2013, when the Dow and S&P 500 exceeded their 2000 and 2007 highs. The Bear proponents point out that the long-term PE ratio (called “CAPE”, for Cyclically-Adjusted Price to Earnings ratio), which has done a historically great job of marking tops and bottoms of Secular Bulls and Secular Bears, did not get down to the single-digit range that has marked the end of Bear Markets for a hundred years, but the Bull proponents say that significantly higher new highs are de-facto evidence of a Secular Bull, regardless of the CAPE. Further confusing the question, the CAPE now has risen to levels that have marked the end of Bull Markets except for times of full-blown market manias. See Fig. 1 for the 100-year view of Secular Bulls and Bears.
Even if we are in a new Secular Bull Market, market history says future returns are likely to be modest at best. The CAPE is at 26.22, little changed from the prior week’s 26.28, after having earlier reached the level also reached at the pre-crash high in October, 2007. Since 1881, the average annual return for all ten year periods that began with a CAPE around this level have been just 3%/yr (see Fig. 2).
This further means that above-average returns will be much more likely to come from the active management of portfolios than from passive buy-and-hold. Although a mania could come along and cause the CAPE to shoot upward from current levels (such as happened in the late 1920’s and the late 1990’s), in the absence of such a mania, buy-and-hold investors will likely have a long wait until the arrival of returns more typical of a rip-snorting Secular Bull Market.
In the big picture:
The “big picture” is the months-to-years timeframe – the timeframe in which Cyclical Bulls and Bears operate. The U.S. Bull-Bear Indicator (see Fig. 3) turned negative on January 15th, and remains in Cyclical Bear territory at 53.59, up from the prior week’s 51.23.
In the intermediate picture:
The intermediate (weeks to months) indicator (see Fig. 4) turned negative on May 12th. The indicator ended the week at 30, up 2 from the prior week’s 28. Separately, the quarter-by-quarter indicator – based on domestic and international stock trend status at the start of each quarter – gave a positive indication on the first day of April for the prospects for the second quarter of 2016.
In the Secular (years to decades) timeframe (Figs. 1 & 2), whether we are in a new Secular Bull or still in the Secular Bear, the long-term valuation of the market is simply too high to sustain rip-roaring multi-year returns. The Bull-Bear Indicator (months to years) is negative (Fig. 3), indicating a new Cyclical Bear may have arrived. The Quarterly Trend Indicator (months to quarters) is positive for Q2, and the Intermediate (weeks to months) timeframe (Fig. 4) is negative. Therefore, with two of the three indicators negative, the U.S. equity markets are rated as Mostly Negative.
In the markets:
The major U.S. benchmarks were mixed for the holiday-shortened week. Repeating the pattern that dominated the entire month of May, the SmallCap and MidCap indexes and technology-heavy NASDAQ Composite outperformed the LargeCap S&P 500 Index, which ended basically unchanged for the week. For the week, the Dow Jones Industrial Average fell -66 points to 17,807, down -0.37%. The LargeCap S&P 500 finished just shy of 2100, essentially unchanged for the week. The MidCap S&P 400 rose +0.59%, and the SmallCap Russell 2000 gained ‑1.19%.
In international markets, Canada’s TSX rose for a fourth consecutive week, finishing higher +0.86%. In Europe, markets were mostly negative. The United Kingdom’s FTSE fell -0.98%, Germany’s DAX declined -1.78%, and France’s CAC 40 ended down over -2%. Asian markets were mixed. China’s Shanghai Stock Exchange rallied +4.17% and Hong Kong’s Hang Seng rose +1.8%, but Japan’s Nikkei gave up -1.14%.
In commodities, precious metals recovered after a multi-week sell-off. Gold rallied $31.20 an ounce to close at $1,246.50 an ounce, up +2.57%. Likewise, Silver rallied +1.17% to $16.44 an ounce. The industrial metal copper was up a second week, rising +0.43%. Crude oil had its first down week in four, giving up -1.33% to end the week at $48.90 for a barrel of West Texas Intermediate.
The month of May was positive for U.S. market indices, and not so much elsewhere. In the U.S., the SmallCap and MidCap indices both gained more than +2% for May, while the S&P 500 rose +1.53%. The big winner for May was the Nasdaq Composite, rising +3.62%. International indices were less fortunate in May. The Developed International markets lost a modest -0.09% (EFA), while the Emerging International markets lost a more significant ‑3.69% (EEM). Gold and Oil went in opposite directions in May: gold lost -5.66% while oil gained +6.93%.
In U.S. economic news, analysts, investors and politicians alike were shocked Friday morning when the Labor Department’s official tally of job gains, the Non-Farm Payrolls report (NFP) showed the smallest increase in monthly payrolls since November of 2010, a gain of only +38,000. The talking heads were (momentarily) speechless. Forecasts had been for a reading of +162,000. The report adds to evidence that job growth is slowing. Shockingly to those who read the fine print (no one even commented on this, to our knowledge), the gains came entirely from part-time jobs – full-time jobs actually shrank in the month of May, for the second month in a row according to the “household survey” portion of the monthly NFP report.
A limited supply of homes on the market supported rising home prices, according to the latest S&P/Case-Shiller Index. The 20-metropolitan area report showed a +5.4% increase in prices from a year ago.
The Institute for Supply Management (ISM) U.S. manufacturing index rose half a point last month to 51.3, the 3rd consecutive reading above 50, beating forecasts of a dip to 50.3. In the report, however, the production and new orders gauges pointed to slightly weaker growth and the order backlog component turned negative. However, the Chicago-specific manufacturing index fell 1.1 points to 49.3 in May, indicating that manufacturing activity in the Midwest is contracting.
ISM’s services index fell to 52.9 in May, down from 55.7. It was the lowest reading since February 2014, but remained in expansion territory (above 50). Services reported slower growth in production and new orders. Services account for more than 70% of U.S. jobs, and the weak reading added to the bad news from the weak May jobs report.
Consumer spending rose last month to its highest level in almost 7 years, a hint that consumers may be back again after a very difficult first quarter. The Commerce Department reported that consumer purchases rose +1% in April, beating forecasts by 0.3%. The month-over-month increase was the largest since August of 2009. Strong consumption also lifted inflation last month, the Personal Consumption Expenditures (PCE) core price index (which excludes food and energy) rose +0.2% following a +0.1% increase in March. The year-over-year core PCE rate is at 1.6%, still substantially below the Federal Reserve’s 2% target. However, on a negative note, the Conference Board’s consumer confidence index fell -2.1 points to 92.6, saying that households had a less favorable view of the labor market. Economists had expected the index to rise to 96. The share of respondents saying jobs were plentiful remained unchanged at 24.3, while those reporting that jobs were “hard to get” increased to 24.4% from 22.8% – which may help explain why more than 400,000 workers simply dropped out of the workforce in May.
The Federal Reserve’s “Beige Book”, a compilation of anecdotal evidence from Federal Reserve Districts around the country, reports that the U.S. economy seems to be expanding at a modest pace across most of the country since mid-April. The reported noted that “tight labor markets were widely noted in most districts.” Employment and wage growth were described as modest, with pay raises “concentrated in areas of labor tightness.” Energy sectors continued to report “soft labor markets” across the oil patch. Generally, the Beige Book reported modest to moderate economic growth in the majority of its 12 districts stating that “several districts noted that contacts had generally optimistic outlooks, with firms expecting growth either to continue at its current pace or to increase.”
The Bank of Canada estimated that Alberta’s wildfires trimmed 1.25 percentage points from second-quarter GDP growth due to lost crude oil production. Bank of Canada Governor Stephen Poloz said that once that production returns, Canada’s real GDP growth should rebound that much. The Bank of Canada has held interest rates steady at 0.5% so far this year.
In the United Kingdom, the Organization for Economic Cooperation and Development (OECD) came out with an intentionally-alarming report that claimed a “Brexit” or British exit from the Eurozone would cost each worker in the UK $4,644.80 (US) by 2030 and send economic shockwaves around the world. International institutions have been ramping up their warnings to British citizens who will vote June 23rd whether to stay in or leave the European Union. The question is whether such warnings will be seen by the British electorate as outsider meddling, or as helpful input.
Eurozone Central Bank (ECB) President Mario Draghi released a forecast that showed inflation largely unchanged and called on governments to play a bigger role in spurring economic growth. Its inflation forecasts include a +1.6% prediction for 2018—still shy of its price-stability goal of just under +2%. He re-iterated that the ECB will continue to buy 80 billion euros ($90 billion) worth of assets each month under its QE program until at least March 2017. Ultimately, he stated that the ECB will take whatever action is needed to revive the euro-area economy, “using all instruments available within our mandate.”
French economic growth accelerated faster than initially estimated in the first quarter. Sharp rises in consumer spending and investment contributed to the gain. The Eurozone’s second largest economy expanded +0.6% in the first quarter, up +0.1% from the initial estimate according to France’s national statistics agency Insee. It marked the third straight quarter of growth in France, however puny, but further evidence that France’s economy is expanding modestly after years of being moribund.
In China, stocks surged as investors anticipated that the popular Morgan Stanley Capital International (MSCI) emerging-market index will soon include many stocks in the Shanghai Composite. This inclusion would channel billions of passively managed dollars into the Chinese equity markets. MSCI will announce its decision on June 14.
Finally, the Non-Farm Payrolls report issued on Friday contained a shocking headline, with just 38,000 jobs added, but also included an even bigger shocker (mostly ignored) in the “Household Survey” section: for the second consecutive month, full-time jobs were actually lost, not gained – and that the reported jobs gains came from part-time jobs. Any reasonable observer would agree that full-time jobs are the proper yardstick by which to measure jobs growth, so the shock in the market at the feeble supposed 38,000 jobs should have been even more severe had any attention been paid to the full-time vs part-time numbers.
(sources: all index return data from Yahoo Finance; Reuters, Barron’s, Wall St Journal, Bloomberg.com, ft.com, guggenheimpartners.com, ritholtz.com, markit.com, financialpost.com, Eurostat, Statistics Canada, Yahoo! Finance, stocksandnews.com, marketwatch.com, wantchinatimes.com, BBC, 361capital.com, pensionpartners.com, cnbc.com, FactSet; Figs 1-5 source W E Sherman & Co, LLC)
The ranking relationship (shown in Fig. 5) between the defensive SHUT sectors (“S”=Staples [a.k.a. consumer non-cyclical], “H”=Healthcare, “U”=Utilities and “T”=Telecom) and the offensive DIME sectors (“D”=Discretionary [a.k.a. Consumer Cyclical], “I”=Industrial, “M”=Materials, “E”=Energy), is one way to gauge institutional investor sentiment in the market. The average ranking of Defensive SHUT sectors rose slightly to 16.5, up from the prior week’s 16.8, while the average ranking of Offensive DIME sectors fell to 11.8 from the prior week’s 9.8. The Offensive DIME sectors continue to lead the Defensive SHUT sectors. Note: these are “ranks”, not “scores”, so smaller numbers are higher ranks and larger numbers are lower ranks.