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 27.07, little changed from the prior week’s 27.08, and only a little lower than the level 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 69.62, up from the prior week’s 67.41.
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, unchanged from 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:
Trading was mixed in U.S. markets last week as most segments were little changed to slightly lower. Trading volumes were also lackluster despite the Federal Reserve releasing the minutes from its July policy meeting. The Dow Jones Industrial Average barely moved, down -23 points to 18,552. The tech heavy NASDAQ composite rose only slightly, +5 points to 5,238. Transports moved the strongest on the continued strength in oil, rising +1.58%. This seems counterintuitive, since transport companies are oil consumers, but the rise in oil prices implies more rail traffic hauling oil as production comes back following price improvement. The Utilities sector gave up -1.29%. The LargeCap S&P 500 was essentially flat (-0.01%), while MidCaps and SmallCaps showed strength with the S&P 400 MidCap index rising +0.32% and the Russell 2000 SmallCap index adding +0.57%.
In international markets, Canada’s TSX fell -0.41%. Weakness was also fairly wide-spread in Europe where the United Kingdom’s FTSE fell -0.83%. On mainland Europe, Germany’s DAX ended down -1.58%, France’s CAC 40, declined -2.21%, and Italy’s Milan FTSE plunged -4.05%. In Asia markets were mixed. Japan’s Nikkei gave up ‑2.21%, but Hong Kong’s Hang Seng index rose +0.75% and China’s Shanghai stock exchange added +1.88%. Developed International markets as a group declined -0.03% (EFA), while Emerging International markets as a group rose +0.32% (EEM).
In commodities, precious metals were mixed with gold rising +0.22% or $3 to $1346.20 an ounce, while silver fell ‑1.96% to $19.32 an ounce. The industrial metal copper was up +1.26%. The big news was in oil, which surged +$4.62, or +10.38%, to $49.11 a barrel for West Texas Intermediate crude oil.
In U.S. economic news, first time filings for unemployment benefits remained below the 300,000 benchmark for a 76th straight week. Jobless claims fell 4,000 to 262,000, a one month low, and a sign that the labor market remains healthy. Economists had forecasted 265,000. The smoothed 4-week average of claims rose 2,500 to 265,250 according to the Labor Department. Continuing claims, those already receiving benefits, rose 15,000 to 2.18 million.
The National Association of Home Builders reported that builder confidence in the market for new single-family homes rose more than expected in August. The Home Builders Index rose +2 points to 60, beating economists’ expectations of 59. In the details of the report, the sub-index for current sales conditions rose +2 points to 65 and the index of expected conditions over the coming six months increased +1 to 67. However, the index that tracks buyer traffic dropped -1 point to 44. Readings over 50 indicate expansion. The NAHB stated “New construction and new-home sales are on the rise in most areas of the country, and this is helping to boost builder sentiment.” A rebound in multifamily units lifted housing starts to the second highest rate since the recession began. Home builders broke ground on more units than expected in July on strong demand for housing and confidence in the economy. Housing starts ran at a seasonally adjusted 1.2 million annual rate, according to the Commerce Department, up +2.1% over June. Starts for single-family homes edged up only a slight +0.5% to a 770,000 annual pace. The big increase was in multifamily starts which surged +8.3% to a 433,000 annual rate. Overall, housing starts are up +5.6% compared to year ago. Giving an indication of future activity, building permits were at a 1.15 million annual rate last month, matching June’s reading.
U.S. manufacturing reports were mixed this week as two different Fed manufacturing reports were released. Manufacturing conditions in the New York region weakened in August as the Empire State Index reverted back to negative territory, according to the New York Fed. The index for August fell to -4.2 from 0.6 in July, missing forecasts. On a positive note, in the details of the report new orders were positive and shipments improved. Ian Shepherdson, chief economist at Pantheon Macroeconomics stated “Overall, we think manufacturing is now expanding slowly, but no boom is in prospect.” In the second report, the Philadelphia Fed reported that its manufacturing index returned to positive territory to 2.0 from -2.9. However, that positive number was influenced mostly on hope of a better future as the gauge for future general activity rose +12 points to 45.8, rather than actual current conditions. The new orders index plunged to -7.2 from 11.8 in July, and the employment index collapsed -18 points to -20. The Philly Fed report stated “The survey’s future indicators suggest that firms expect the current weakness to be temporary.”
The cost of consumer goods was unchanged in July, as inflation remained tame for almost everything Americans purchase. The Labor Department reported that the consumer price index (CPI) was unchanged in July, and up only +0.8% compared to a year ago. The index is at a five month low. Core CPI, which excludes food and energy increased +2.2% on an annualized basis down -0.1% from last month. This missed analyst forecasts, which forecasted a +0.2% increase. The cost of food was unchanged in July and has risen only +0.2% over the past year. Energy prices declined -1.6%, and are down over -10.9% for the year. Real hourly wages (wages adjusted for inflation) increased +0.4% in July and are now up +2.0% annualized. However, that lags the increases Americans are seeing in some nondiscretionary costs. For example, rent is up over +3.8% compared to a year ago, and medical care prices have risen over +4.1%.
This week, minutes from the Federal Reserve meeting in July revealed that Fed officials expressed relief that concerns over “Brexit” were overblown and that the job market remained healthy. However, there was division over the timeline to raise rates. Two Fed officials pushed for a rate hike at the July meeting, however the majority voted to wait for more information. Fed officials voted 9-1 to hold rates at their current levels. As usual, the minutes do not elaborate on the timing of a Fed move, using the keywords “open” and “flexible” to describe when they will act. Sal Guatieri, senior economist at BMO Capital Markets stated “The Fed is inching closer to a rate hike, but it likely isn’t there yet…It will take further evidence that the economy is picking up, including another strong jobs report in August, to spur a move as early as September.”
In Canada, the manufacturing sector received some much-needed good news as Statistics Canada reported that June’s factory sales came in at an unexpectedly strong +0.8%. Analysts had forecasted a rise of +0.7%. The gain followed a -1% drop the previous month. The difference amounts to about a $50.2 billion gain to the Canadian economy. Ontario was the main province driving the gains, which were led by machinery and transportation equipment. Overall, sales were up in 15 of the 21 industries tracked by the Canadian federal data agency.
In the United Kingdom, British retail sales last month smashed expectations and jumped +1.4% compared to the previous month. The result provided further evidence that mainstream economists from world-renowned institutions were (so far) completely wrong on the effect of the UK’s “Brexit” vote. Economists had expected only a paltry +0.1% rise. Trevor Charsley, senior markets adviser at London-based money transfer frim AFEX said: “The retail sales figures, coming hot on the heels of inflation and unemployment data, complete a hat-trick of U.K. data releases this week that paint a healthier-than-expected picture of the U.K. economy.”
In contrast, Germany’s ZEW think-tank reported economic sentiment missed expectations. The actual reading improved slightly in August, but remained below its long-term average. ZEW President Achim Wambach said that their indicator has “partly recovered from its Brexit shock.” The indicator rose to 0.5 from -6.8, while the long-term average stands at 24.2. Germany’s economy weakened in the second quarter after a very strong first quarter. The Federal Statistics Office reported that quarterly growth eased to 0.4% from 0.7% in the first quarter.
The French unemployment rate fell below 10% for the first time since 2012. French statistics agency Insee reported that unemployment on mainland France and its overseas territories fell to 9.9% last quarter, down from 10.2%. French President Francis Hollande has said that he would not stand for re-election in 2017 unless there was a sustained fall in unemployment this year. Unemployment was down in all age categories, with youth unemployment falling the most, down -0.4% to 24.3% – the lowest since 2014.
In Asia, Moody’s Investor Services raised its forecasts for China’s economic growth in the wake of “significant” fiscal and monetary stimulus policies. Moody’s raised its economic growth forecasts for the mainland to 6.6% for this year, from 6.3% previously. Madhavi Bokil, senior analyst at Moody’s stated “The slowdown and rebalancing of China’s economy is likely to be gradual, thus we do not expect China to exert a significant drag on global growth prospects over the rest of 2016 and 2017.” Analysts also expect that this slowing would likely spur additional stimulus measures from the People’s Bank of China.
Japanese manufacturing took a hit as the mood of manufacturers’ soured to its lowest level in 3 years, according to a Reuters poll. The Reuters economic survey (known in Japan as the Tankan) followed data that showed exports had tumbled in July the most since 2009 and that economic growth had stalled in the second quarter. Yuichiro Nagai, economist at Barclays Securities, laid out the fundamental problem: “The recent indicators confirm that external and domestic demand are both weak. With the yen’s rise and consumers tightening their belts, companies find it harder to justify raising prices. As such, a complete end of deflation remains out of sight.”
Finally, while the economic news of late has focused on the strong housing market and rising real estate prices there is a significant downside to the good news. According to a new study by Zillow, an amazing 86% of Americans who are renters no longer have a sufficient credit score or income to afford to buy a home in their local market.
Home ownership rates have been on a steady decline and are now near a 48-year low (see the chart below). Adding to the difficult situation is that real household incomes have dropped 9% while rents have increased 7% over the last 13 years. The poor home ownership situation will likely persist, since nearly half of today’s renters spend more than 30% of their pre-tax income on housing.
(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 again to 23.0, down from the prior week’s 19.8, while the average ranking of Offensive DIME sectors rose to 14.3 from the prior week’s 17.3. The Offensive DIME sectors are now much higher in rank 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®