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 26.42, 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 63.88, down from the prior week’s 67.21.
In the intermediate picture:
The Intermediate (weeks to months) Indicator (see Fig. 4) turned positive on June 29th. The indicator ended the week at 33, down from the prior week’s 34. 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 suffered their largest weekly decline since the start of a year, due almost entirely to a sharp sell-off on Friday. Friday’s plunge marked the end of an extended period of light trading activity and relatively stable stock prices. For the week, the Dow Jones Industrial Average fell -406 points to 18,085 down -2.2%. The NASDAQ Composite declined more than -123 points to 5,125, down -2.36%. LargeCaps did better than SmallCaps and MidCaps for the first time in a while: the S&P 500 LargeCap index ended down -2.39%, while the S&P 400 MidCap index lost ‑3.19%, and the SmallCap Russell 2000 lost over -2.61%.
Most international markets were also lower, but not to the extent of the U.S. Canada’s TSX fell -1.73%, the United Kingdom’s FTSE declined -1.71%, Germany’s DAX lost -1%, France’s CAC 40 ended down -1.1%, and Italy’s Milan FTSE remained nearly flat, down just -0.16%. But major markets in Asia bucked the trend by ending the week on a positive note. China’s Shanghai Composite was up for the week, rising +0.37%, Japan’s Nikkei rose +0.37%, and Hong Kong’s Hang Seng index surged a very strong +3.58%. As a group, international developed markets fell ‑1.51% (EFA), while as a group international emerging markets fell -1.87% (EEM).
Commodities demonstrated their uncorrelated-ness with equities. Gold added +$7.80 to $1,334.50 an ounce, up +0.59% and Silver ended the week flat at $19.37 an ounce. Oil rebounded from the previous 2 weeks decline, rising +3.24% to $45.88 a barrel.
In U.S. economic news, the number of Americans who applied for new unemployment benefits fell by 4000 last week to 259,000, remaining near the lowest level since the early 1970’s. Economists had forecast a reading of 265,000. The less-volatile four week moving average of claims fell 1,750 to 261,250. New claims have remained below the key 300,000 threshold for 79 straight weeks, the longest stretch since 1970. Continuing jobless claims were also positive, dropping 7,000 to 2.14 million in last week of August. These claims reflect people already receiving unemployment benefits. All figures are seasonally adjusted.
Unfilled job openings reached an all-time high of 5.9 million in July, according to the Labor Department’s Job Openings and Labor Turnover Survey (JOLTS). In the report, hires increased to 5.23 million from 5.17 million in June. The number of people quitting jobs voluntarily remained flat at 2.98 million, but that number remains up substantially from recessionary levels, interpreted to mean that departing workers are confident about finding another job. The JOLTS report follows the monthly nonfarm payrolls data, but provides greater detail in labor market conditions, particularly how fluid or stagnant it is.
The Institute for Supply Management’s (ISM) services gauge missed expectations, dropping abruptly to a six year low in the latest string of unexpectedly weak economic data. The ISM services index dropped to 51.4 last month from 55.5 as new orders plunged. Consensus expectations had been for a reading of 55. While readings over 50 still indicate expansion, companies in the US that offer services such as healthcare, transportation services, and financial services grew at their slowest pace since 2010. The report is of particular concern because services make up roughly 80% of the U.S. economy. ISM’s manufacturing survey turned negative last month. Jennifer Lee, a senior economist at BMO Capital Markets stated “much like its manufacturing cousin, the nonmanufacturing services ISM could pour cold water on expectations for a Fed rate hike later this month and also called into question the strength of the economy heading into the fall.” In the details of the report, the ISM manufacturer new orders index plunged almost 9% to the lowest level since the end of 2013. The production index had a similar large decline, and the employment gauge remained barely in expansion at 50.7%.
The Federal Reserve’s Labor Market Conditions Index (LMCI) slipped back into negative territory last month, the seventh negative reading in the last eight months, falling to -0.7 from 1.3 in July. The LMCI combines 19 labor market indicators and is designed to give a broad view of jobs market momentum. The index confirms the Conference Board’s employment trends index, which also slowed in August. Gad Levanon, chief economist for North America at the Conference Board remarked “The employment trends index is consistent with moderating job growth in the second half of 2016.”
The Federal Reserve’s Beige Book, a summary of current economic conditions from 12 Fed districts, reported that the U.S. continues to experience “modest” economic growth in most districts. However, key regions like New York and Kansas City showed no growth, and Philadelphia and Richmond reported slower economic growth. The report showed rising wages, but inflation remains tame. Most districts reported that labor markets remained tight, but price increases were described as “slight overall”. Overall consumer spending was little changed in most districts, and auto sales declined slightly but remained at high levels. Respondents indicated that they expected growth to continue at a “moderate” pace in coming months.
Consumer credit jumped to $17.7 billion in July as borrowing accelerated in July, supporting expectations that consumer spending will remain a key factor in economic growth. Economists had expected an increase of “only” $16 billion. In the second quarter, real consumer spending rose at an annualized 4.4% rate. Non-revolving credit, such as student and auto loans, drove borrowing in July with a 6.7% annual gain in July, compared to a 2.4% annual gain the previous month. Revolving credit, representing mostly credit card debt, rose at a 3.5% annual pace in July, down from June’s 11.5% spike.
The Canadian job market rebounded last month, creating 26,200 net new jobs In August and partially offsetting the loss of 31,200 jobs in July, according to Statistics Canada. However, even with the improved jobs number, the unemployment rate crept up to 7% from 6.9% in July as more people entered the labor force. Economists were expecting a gain of only 15,000 jobs. TD Bank economist Brian DePratto wrote in a note to clients that “Job growth came from full-time employment, and the unemployment rate rose for the ‘right’ reason as more Canadians were engaged with job markets in August, reversing a four month trend.”
In the United Kingdom, the Organization for Economic Cooperation and Development (OECD) ate some crow regarding its earlier doom and gloom forecasts, admitting that Brexit will not have a major impact on the UK economy after all. In addition, it stated that the global outlook now remains unchanged following the vote. It was a major retreat from its forecast ahead of the referendum, when it warned that a Brexit vote would have a ‘large negative shock’ on the economy – rightly described as “scare tactics” by Brexit proponents.
German exports plunged in July, the latest in a string of weak economic data from Europe’s leading industrial economy. The Federal Statistical Office, Destatis, reported that exports dropped -2.6% from June. Even worse, exports were down -10% from July last year– the steepest twelve-month decline since the fall of 2009. Industrial orders barely rose in July and output was down the most in nearly 2 years. Demand for goods in countries outside of the EU, such as China, Russia, Japan, and the U.S. was down the most – more than -13% compared to July of last year.
The Italian statistics agency and Eurostat (the EU’s statistical arm) agree that Europe’s third-largest economy experienced no growth in the second quarter of 2016. The data comes as another blow to Prime Minister Matteo Renzi as he prepares for a major referendum on constitutional reform. The referendum aims to streamline Italy’s political system by giving more power to the prime minister. There have been 63 Italian governments since the end of World War 2—many lasting just a few months – and governmental chaos is more the rule than the exception.
This week China hosted the G20 summit where world leaders gathered to discuss the shared challenges of encouraging global economic growth and avoid protectionist policies. The fact that China hosted the event is further evidence of China’s ascension among the world’s economies. China’s economic transformation has been one of the most dramatic in modern history. Per capita incomes have risen six-fold in just over a decade, and the country holds the world’s largest amount of foreign exchange reserves. According to the International Monetary Fund (IMF), China now accounts for more than 12% of world exports – more than any other single country.
In Japan, the economy expanded at an annualized pace of +0.7% from the previous quarter, beating expectations of a +0.2% rise. Improved capital expenditure figures, higher inventories, and strong public investment all contributed to the modest rise. But business investment declined -0.1%, better than the expected fall of -0.4%, but still negative and down a second consecutive quarter.
Finally, the housing market continues to power ahead month after month as we note prices rising and inventory continuing to shrink. However, real estate consultant John Burns has dug deeper into the numbers and noted that while the housing market continues to move ahead (mostly on limited supply), a generation of home buyers is being left behind. His research notes that home ownership rates have fallen across all age groups since the housing collapse in 2009, but the biggest drop has occurred in the millennial generation. Burns predicts that the homeownership rates will continue to fall through 2025, meaning that millennials will be renting or living with their parents a lot longer than their own parents did.
(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 was unchanged at 23.3, while the average ranking of Offensive DIME sectors fell to 15.8 from the prior week’s 15.3. The Offensive DIME sectors remain 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®