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 27.06, up from the prior week’s 26.95, 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) is in Cyclical Bull territory at 65.11, up from the prior week’s 62.72.
In the intermediate picture:
The Intermediate (weeks to months) Indicator (see Fig. 4) turned positive on June 29th. The indicator ended the week at 35, down 1from the prior week. Separately, the Quarterly Trend Indicator – based on domestic and international stock trend status at the start of each quarter – gave a positive indication on the first day of July for the prospects for the third 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 positive (Fig. 3), indicating a potential uptrend in the longer timeframe. The Quarterly Trend Indicator (months to quarters) is positive for Q3, and the Intermediate (weeks to months) timeframe (Fig. 4) is also positive. Therefore, with all three indicators positive, the U.S. equity markets are rated as Very Positive.
In the markets:
A 1% rally on Friday rescued a theretofore losing week, pushing U.S. markets into positive territory for the week. The gains pushed the Nasdaq Composite into record territory, joining the Dow Jones Industrial Average, the LargeCap S&P 500, and the MidCap S&P 400 index. The SmallCap Russell 2000 reached a new high for 2016, but remains below a peak set in the middle of 2015. The Dow Jones Industrial Average added 111 points last week to end at 18,543, up +0.6%. All other indices were positive, with the LargeCap S&P 500 rising +0.43%, the MidCap S&P 400 index adding +0.2%, while the SmallCap Russell 2000 and the NASDAQ Composite pulled away from the others, gaining +0.93% and +1.14% respectively.
In international markets, Canada’s TSX added an additional +0.45% last week supported by a modest rebound in the price of oil. In Europe, the United Kingdom’s FTSE gained over +1%, France’s CAC40 fell -0.66%, while Germany’s DAX added +0.29%. Italy’s MIB fell -1.3% as concern remains among analysts about the financial stability of several of Italy’s largest banks. Asian markets were also mixed as Japan’s Nikkei gave up more than ‑1.9%, but Hong Kong’s Hang Seng rose +1.1%. China’s Shanghai Stock exchange was basically flat, down -0.09%.
In commodities, defensive investments like precious metals had a difficult week, with Gold settling down -$13.50 to $1,344.40 an ounce, down -0.99%. Silver likewise fell below the $20 handle, ending at $19.82 an ounce down ‑2.6%. Oil rebounded slightly, as West Texas Intermediate crude oil closed at $41.80/bbl, up +0.48%. Copper continued its volatile up and down swings of late, losing over -3%.
In U.S. economic news, the labor department reported that the U.S. economy added 255,000 jobs in July, well above the expected 180,000. The unemployment rate remained unchanged at 4.9 percent. “The jobs report was incredibly impressive,” said JJ Kinahan, chief strategist at TD Ameritrade. “What I think it did, is it took the May report and made it into an anomaly.” May’s jobs report, you may recall, was a shockingly low 38,000.
Payroll processor ADP reported that private-sector hiring remained robust as employers added 179,000 jobs last month. Economists had expected a gain of only a 165,000. ADP’s reports have shown steady job growth while the Labor Department’s employment report has been more volatile. Mark Zandi, chief economist at Moody’s Analytics, stated that with underlying job growth of about 150,000 to 200,000, the labor market remains strong.
Growth in manufacturing slowed slightly in July but still remained in expansion according to the Institute for Supply Management’s (ISM) latest survey. The ISM manufacturing index declined 0.6 point to 52.6. Readings over 50 indicate more companies are expanding rather than shrinking. The index has been positive for the fifth straight month following negative readings from last fall into February. Most executives reported that business remains solid and felt little to no impact from the Brexit vote. ISM’s new orders index remained strong at 56.9, production also gained coming in at 55.4. On a negative note, the employment sub-index fell back into negative territory, losing a point to 49.4. Manufacturers have cut roughly 30,000 jobs in the past year, according to both ADP and the Labor Department.
Confirming the ISM survey was Markit’s manufacturing Purchasing Managers Index (PMI), which also came in at an 8-month high of 52.9. The PMI report showed that manufacturing had a strong start to the 3rd quarter. Foreign markets were the source of increased demand that helped push export sales to the fastest pace since September 2014. Chris Williamson, Markit chief economist, noted that the stronger PMI in July “suggests that manufacturers and exporters have helped lift the economy at the start of the third quarter.”
Switching to services, ISM’s service index reports most U.S. companies are growing. Companies that offer services such as healthcare, retail goods and entertainment continued to grow, but at a slightly slower pace, according to a survey of senior executives. The ISM’s nonmanufacturing index fell to 55.5 last month, still firmly in expansion territory (above 50). A healthy 15 of the 18 service sectors tracked by the ISM report showed growth. The new orders index rose to a very strong 60.3, a positive sign for the broader economy. The only soft spot in an otherwise great report was the employment sub-index, which fell ‑1.3 to 51.4.
Backing up the services report, the government reported that consumer spending rose +0.4% in June, the third consecutive month of solid increases. On a quarterly basis, spending in the second quarter of this year marked the biggest quarterly gain since the recovery began in 2009. Most of the increase in spending was on services such as housing, healthcare, entertainment and utilities. Income growth, however, did not match the increase in spending. Incomes rose only +0.2% in June, slightly less than expected.
In International economic news, the Canadian economy is now growing at the slowest pace in 60 years and the housing market is about the only thing keeping it in expansion, according to economists. Friday’s GDP report revealed that in the two years since oil prices began their decline, Canada’s economy has become almost completely reliant on bank lending and the hot housing markets of Vancouver and Toronto. Real estate and financial services now account for approximately 20% of the Canadian economy, levels not seen since the early 1960’s. Since May of 2014, Canada’s economy has expanded just 1.2% – the slowest 2-year pace outside of recession in the last 6 decades, according to Statistics Canada.
Markit’s European manufacturing PMI for July was revised up to 52, slightly better than the original print, but containing very mixed results. Markit said that most of the growth was seen in Germany, but growth had almost stalled in both Italy and Spain, and France and Greece were both in contraction.
In the United Kingdom, the Bank of England dropped its key benchmark interest rate a quarter point to 0.25%, the lowest level ever, and telegraphed that the rate could go even lower in the months ahead. The bank also started a new funding program that offers lenders cheap 4-year loans in order to lend to households and businesses. Overall the measures were much larger than markets anticipated, driving the British pound down and the 10-year UK government bond yield down to a record low.
Despite being the bright spot in the European PMI report (above), Germany, Europe’s largest exporter of manufactured goods, reported that its factory orders fell -0.4% in June, widely missing estimates that they would rise +0.5%. The sharp drop was due to a lack of orders from within the Eurozone. On a positive note, domestic orders rose +0.7% and orders from non-Eurozone states rose +3.8%.
Japanese Prime Minister Shinzo Abe approved an economic stimulus package totaling 28.1 trillion yen (approximately $275 billion) in a further effort to stimulate the Japanese economy and spur inflation. The measures include substantial infrastructure spending and enhancements to welfare services. According to Kyodo news, Abe told party leaders, “We want to not only stimulate immediate demand, we aim to pursue sustainable economic growth…and ensure the creation of a society in which all people can play active roles.” The effects on Japan’s already-staggering debt load were not discussed.
China’s National Development and Reform Commission (NDRC), the research arm of China’s top economic planning agency, called for a cut in interest rates and the reserve requirement for banks. The NDRC’s comments were noted by analysts as important since the commission does not generally comment on monetary policy, which officially falls under the domain of the People’s Bank of China. Some analysts feel the statement signals a possible rift among Chinese policymakers, especially since it follows a front-page article in the government run People’s Daily newspaper quoting an “authoritative person” who warned of the dangers of too much stimulus to the economy.
Finally, “jobs” are a constant topic on the campaign trail this year. The Republicans decry what they view as Obama’s dismal job-creation record, while Democrats counter with claims that jobs created during Obama’s term are actually stellar. Here (below) is a chart of jobs created since the start of each recent President’s term, going back to Jimmy Carter. Both sides can take some comfort: Obama comes in well below Clinton and Reagan, but better than George W. Bush (who was saddled with both the 2000-2002 recession and the 2007 employment turndown).
One thing missing in this (and most) analyses is a good scale of comparison. Since the population was much lower 20 and 30 years ago, it is reasonable to conjecture each million new jobs would have a larger economic impact in prior years with lower populations. Dividing the total jobs created by the starting population for each President reveals a slightly different scale of results than shown by the chart. Jobs created per million of population were 69,726, 87,098, and 33,713 for Reagan, Clinton and Obama, respectively. By that measurement, jobs created during Obama’s term have been less than half per million of population than his predecessors Reagan and Clinton, but much better than the 8,731 jobs created per million of population under George W. Bush.
(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 fell to 14.8, down from the prior week’s 13.5, while the average ranking of Offensive DIME sectors fell to 18.3 from the prior week’s 16.8. The Offensive DIME sectors remained lower in ranking than the Defensive SHUT sectors. Note: these are “ranks”, not “scores”, so smaller numbers are higher ranks and larger numbers are lower ranks.
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Dave Anthony, CFP®