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 26.93, down from the prior week’s 27.07, 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 66.70, down from the prior week’s 69.62.
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:
Stocks ended mostly lower for the week after worries of an upcoming Federal Reserve rate hike erased earlier gains. The Dow Jones Industrial Average fell -157 points to 18,395, down -0.85%. The tech heavy NASDAQ composite fared slightly better, down -0.37% to 5,218. The LargeCap S&P 500 index fared the worst of the major indexes, falling -0.68%, while the S&P MidCap 400 index fell -0.2% and the SmallCap Russell 2000 managed to eke out a small gain of +0.1%. Utilities continued their recent bad stretch, down -2.36% for the week and down more than -5% for August, driven by the twin forces of a risk-on shift and rekindled fears of rising interest rates.
International markets were mixed for the week, with the majority down. Canada’s TSX fell -0.32%. In Europe, the United Kingdom’s FTSE, likewise was down -0.3%, but on Europe’s mainland most markets gained. Germany’s DAX rose +0.4%, France’s CAC 40 gained +0.94%, and Italy’s Milan FTSE surged +3.27% (retracing most of last week’s plunge). In Asia, major markets were all in the red. China’s Shanghai stock exchange was down -1.22%, Hong Kong’s Hang Seng was off a fractional -0.12%, and Japan’s Nikkei fell -1.12%. Overall, the developed world ETF EFA was off -0.71%, while the emerging market ETF EEM lost over -2.2%.
Precious metals continued to lose their shine with Gold down $20.30 to $1,325.90 an ounce, a loss of -1.5%. Silver, likewise, was down over -2.9% to $18.75 an ounce. The industrial metal copper, sometimes used as a leading indicator of overall global economic activity, fell over -3.8%. Oil had its first weekly loss in the last 4, declining -2.99% to $47.64 per barrel of West Texas Intermediate crude.
In U.S. economic news, the number of Americans who applied for unemployment benefits last week fell by 1000 to 261,000 and remained near post-recession lows. The data indicates a healthy labor market with relatively few people losing their jobs. The less volatile four-week average of new jobless claims fell by 1,250 to 264,000, according to the Labor Department. Claims have remained below the 300,000 threshold for 77 straight weeks, the longest streak since 1970. Continuing jobless claims, those already receiving benefits, fell by 30,000 to 2.15 million. All figures are seasonally adjusted.
In housing, new-home sales surged to the highest level in nearly 8 years on strong demand from buyers and an increase in building activity. On Tuesday, the Commerce Department reported that new home sales rose +12.4%, to a seasonally adjusted annual rate of 654,000 units last month. The rate was +31.3% higher than this time last year, and easily beat economists’ forecasts of 581,000. The median sales price of a new home last month stood at $294,600. At the current sales pace, there is a 4.3 month supply of homes on the market. As a caveat, the government’s new-home sales data can be quite volatile and comes with a large margin of error. However, Trulia Chief Economist Ralph McLaughlin released a note stating that last month’s figures “are a rare case where the year-over-year change is statistically significant, indicating the surge in sales can be taken with more than just a grain of salt.”
In contrast to the surge in new-home sales, sales of previously owned homes fell last month as tight inventory weighed on the market and pushed prices higher. Existing home sales declined -3.2% to a seasonally adjusted annual rate of 5.39 million, according to the National Association of Realtors (NAR). The rate was -1.6% lower than this time last year and missed economists’ forecasts of 5.48 million. NAR Chief Economist Lawrence Yun attributed the decline to leaner inventory and higher prices. Inventory was -5.8% lower than this time last year and the 14 consecutive month of year-over-year declines. The median home price was $244,100, +5.3% higher than a year ago. As housing prices rise at a faster rate than wages, it is much harder for renters to become owners, Yun stated.
U.S. durable goods orders posted their biggest gain since last fall, up +4.4% last month, according to the Commerce Department. Orders for commercial planes surged +90% last month after plunging -60% in June. Defense orders also contributed to the gain. After stripping out the volatile transportation sector, orders rose a smaller +1.5% (but still the biggest increase of the year). Another positive sign was the first rise in inventories in over six months. Orders for core capital goods had their second straight gain and their biggest increase since January, rising +1.6%. Core capital goods orders (durable goods minus aircraft and defense orders), are viewed as a proxy for future business investment.
Markit’s flash manufacturing Purchasing Managers Index (PMI) fell -0.8 to 52.1 in August after reaching a 9-month high in July. Chris Williamson, chief business economist at Markit stated “taking the July and August readings together suggests that manufacturing is enjoying its best growth so far this year in the third-quarter, and should help drive stronger GDP growth.” Output showed a solid increase this month, while slower growth in total new work and employment, and inventories weighed on the overall headline number. While remaining above 50 (indicating improving conditions), August’s reading was weaker than the post crisis average of the index.
Consumer sentiment slipped slightly in August as Americans views of their personal finances dimmed a bit. The University of Michigan’s consumer sentiment survey declined -0.2 point to 89.8 last month, -2.3% lower than year ago. Economists had expected a reading of 91. The current economic conditions sub-gauge fell -2 points to 107, while the index of consumer expectations rose +0.9 to 78.7.
On Friday, Federal Reserve Chairwoman Janet Yellen said that the case for another interest rate hike “is strengthening”, sending a signal that the US central bank could raise rates as soon as next month. “In light of the continued solid performance of the labor market and our outlook for economic activity and inflation, I believe the case for an increase in the federal funds rate has strengthened in recent months,” Yellen remarked in a speech in Jackson Hole, Wyoming. Yellen reaffirmed that the Fed policy committee “continues to anticipate” that gradual increases in the fed-funds rate will be appropriate.
The U.S. economy grew at a rather weak +1.1% annualized rate in the second quarter on the heels of weaker business investment and government spending. The original estimate had been for a +1.2% gain. Personal consumption expenditures increased at an annual rate of +4.4% for the quarter with strong growth in durable goods purchases of 9.9% and solid growth in services, up 3.1%. In the details of the report, corporate profits decreased -$24.1 billion in the second quarter, following an increase of +$66 billion in the first. Adjusted pretax corporate earnings dropped -1.2% to mark the fifth earnings decline in the last six quarters. Unless profits turn up again, the economy is unlikely to grow much faster.
In Canada, the financial impact of wildfires in May that reduced total Canadian oil production and subsequent lower revenues are taking a toll, a provincial leader said. The provincial government of Alberta said it experienced a net fiscal impact of about $387 million from the wildfires. Alberta’s finance minister said the provincial economy is expected to run an $8.3 billion deficit, $400 million greater than previously estimated. “Our government continues to take a prudent approach, controlling spending, protecting critical public services, and taking action to create jobs and diversify our economy,” Finance Minister Joe Ceci said in a statement.
In the United Kingdom, economic growth during the second quarter remained relatively robust. The revised second-quarter GDP data registered +0.6% growth in the three month leading up to the Brexit vote, according to data released by the Office for National Statistics. Household expenditures increased +0.9% for the quarter, the strongest reading since fall of 2014. The strong readings indicate that the uncertainty over the outcome of the Brexit referendum did not have a major negative impact on second quarter investment.
Confidence has plunged in the German economy since Britain voted to leave the European Union. Business morale in Europe’s biggest economy tumbled in August at its fastest rate since the height of the Eurozone debt crisis in 2012, according to the economic institute IFO survey. The survey’s reading of 106.2 is now sitting at its lowest level since February. At the same time, another index measuring corporate expectations in the country fell to the lowest level since October 2014. IFO head Clemens Faust remarked “business confidence in Germany has clearly worsened.”
In France, new data suggests that the G-7 economy continues to struggle to find growth. The data shows that even before the recent wave of terror attacks, French GDP growth was nil in the second quarter, according to the national statistics agency. That is a sharp slowdown from the +0.7% rise in the first quarter.
Japanese manufacturing got a boost as Markit’s flash PMI reading for August came in at 49.6, versus 49.3 in July. The output sub-index rose into expansion at 50.6, a positive development for a sector that has been stuck in negative territory all year. IHS economist Annabel Fiddes stated “ Japan’s manufacturing sector edged closer to stabilization in August, but the latest batch of PMI data gave a mixed picture overall.” Japanese policymakers are reevaluating their stimulus efforts as the economy continues to struggle. Analysts are expecting a new stimulus drive the latter part of this year, based on a pre-election promise by Prime Minister Shinzo Abe.
Finally, last Sunday’s closing ceremony signaled the end of the 2016 Summer Olympics. Now that the party is over, the hangover has set in as organizers calculated the final cost of hosting the event. Online statistics portal Statista reported “The organizers have put in a huge amount of work and invested an impressive amount of cash to get to this point…Costs ran 51% over budget in Rio, ending up at $4.58 billion. Even though that may seem like a huge amount of money, it pales in comparison to the Winter Olympics in Sochi in 2014. Costs there quickly snowballed with many venues coming in catastrophically over budget…Hosting the Olympics is expensive with the people of Hamburg (Germany) voting to withdraw their city’s bid for the 2024 games in late 2015, primarily on funding grounds.”
The following graphic shows the costs of hosting each of the Olympics since 1992, and their staggering overruns. Note that not a single one came in at or under budget.
(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 23.5, down from the prior week’s 23.0, while the average ranking of Offensive DIME sectors was unchanged from the prior week at 14.3. 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®