FBIAS™ for the week ending 9/16/2016
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 graph below 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 26.56, up modestly from the prior week’s 26.42, 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 graph below).
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 graph below) is in Cyclical Bull territory at 62.05, down from the prior week’s 63.88.
In the intermediate picture:
The Intermediate (weeks to months) Indicator (see graph below) turned positive on June 29th. The indicator ended the week at 31, down from the prior week’s 33. 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 above), 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 above), 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 above) is also positive. Therefore, with all three indicators positive, the U.S. equity markets are rated as Very Positive.
In the markets:
Stocks ended the week modestly higher despite elevated volatility. The Dow Jones Industrial Average ended the week up +38 points to close at 18,123. The tech-heavy NASDAQ surged +2.3%, up +118 points to 5,244 (mainly on the back of a big winning week for Apple, which is the most-heavily weighted stock in the NASDAQ index). Most other major indexes were up with LargeCaps showing relative strength over their smaller peers. The S&P 500 LargeCap index rose +0.5%, while the S&P 400 MidCap index fell -0.48%, and the SmallCap Russell 2000 ended the week up +0.46%.
In international markets, Canada’s TSX was off -0.6%, while in Europe major markets were red across the board. The United Kingdom’s FTSE declined -0.98%. On Europe’s mainland France’s CAC 40 dropped sharply, down 3.5%, Germany’s DAX fell -2.8%, and Italy’s Milan FTSE plunged -5.6% as worries over Italy’s financial sector continued. Markets in Asia were also red: Hong Kong’s Hang Seng index fell -3.2%, Japan’s Nikkei dropped -2.6%, and China’s Shanghai Composite was off -2.8%. In broader terms, developed markets as tracked by the ETF ‘EFA’ were down -1.78%, while emerging markets as tracked by ‘EEM’ were down -0.54%.
In commodities, strength in the U.S. dollar weighed on precious metals and energy. Gold fell $24.30 an ounce to $1310.20, down -1.8%. Silver, likewise, was off down -2.6% to $18.86 an ounce. Oil plunged -4.9% to $43.62 a barrel for West Texas Intermediate crude oil after statements from the International Energy Agency and OPEC indicated that elevated inventories are likely to keep the price of oil near current levels until 2018. The industrial metal copper had a strong week, up +3.2%.
In U.S. economic news, the number of people who applied for unemployment benefits last week rose slightly to 260,000. The number remains below the key threshold of 300,000, and is still near the lowest level in decades. Economists had expected a rise to 265,000. As the labor market continues to tighten, companies are increasingly complaining that they cannot find enough skilled workers. The smoothed four week average of new jobless claims rose +500 to 260,750, according to the Labor Department. Continuing jobless claims, those already receiving unemployment benefits rose by 1,000 to 2.1 million in the first week of September. All figures are seasonally adjusted.
A measure of sentiment of small business owners declined in August as owners became more cautious leading up to the election. The National Federation of Independent Business (NFIB) small business optimism index fell 0.2 points to 94.4. The most dramatic change was in the outlook for business conditions in the next six months, which declined -7 points. In addition, 38% of business owners in the NFIB survey cited the political climate as a reason not to expand – an all-time high for the survey.
Consumer sentiment remained flat at 89.5, according to the University of Michigan’s consumer sentiment index. Economists had forecast a slight improvement to 90.5. Consumer’s assessment of the present weakened slightly while future expectations rose. Richard Curtin, the survey’s chief economist stated “Small and offsetting changes have taken place in the third quarter 2016 surveys: modest gains in the outlook for the national economy have been offset by small declines in income prospects as well as buying plans.” Curtin stated the reason expectations improved was to be found in the decline in stated inflation expectations for the future.
U.S. retail sales fell in August for the first time in five months as most stores reported a drop in traffic. The decline of -0.3% missed estimates of a -0.1% decline. Lately the report has been mixed as online retailers have had solid performance, while more traditional sellers such as department stores have fared poorly. However, August’s report showed that sales for Internet sellers and mail order companies fell for the first time since the beginning of 2015. Only restaurants and apparel stores showed much strength, up +0.9% and +0.7%, respectively. Despite the relatively weak report, economists continue to predict that improved finances of American households will help increase spending in the last quarter of 2016.
Higher rent and surging medical costs are putting a dent in the wallets of Americans, according to the latest Consumer Price Index (CPI) data. The CPI rose +0.2% last month due to the rising costs of housing and medical care. Medical care costs rose +1%, the fastest rate since 1984, while prescription drugs soared +1.3% according to the Labor Department. Excluding the volatile food and energy categories, the so-called core consumer prices rose +0.3%. The rising costs of housing and healthcare has been at least somewhat offset by lower prices for food and energy.
Two closely watched U.S. regional manufacturing gauges both improved in September. The Empire State manufacturing index, which measures conditions in the New York area, remained in contraction but improved to 2 from -4.2. Factories in New York reported fewer new orders, lower shipments and reduced staffing levels, consistent with a contraction reading. In the city of brotherly love, the Philadelphia Fed Business Index jumped to 12.8, up 10.8 points from a month earlier. New orders improved, rising from -7.2 to +1.4 and the percentage of firms reporting increases in new orders edged up to 30%, up +3% from last month.
But the Federal Reserve reported that industrial output weakened in August, declining -0.4%. The decline was worse than the -0.2% drop expected. On an annual basis, industrial production fell -1.1% in the 12 months through August. Over the year, manufacturing output was down -0.4% and mining output plunged -9.3%. The mining sector includes oil and gas extraction, which has been hurt by the low price of oil.
The federal government ran a budget deficit of $107 billion last month according to the Treasury Department $43 billion more than the same time last year. The government spent $338 billion last month, up 23% from August 2015. Increase spending for veterans’ programs and Medicare contributed to the rise. Total receipts for August were up 10% to $231 billion and up 1% for the fiscal year to date. Steve Blitz, chief economist at M Science LLC in New York notes, “This deficit has effectively been on a widening trend since the beginning of this year. We know that the current recovery has failed to create the same growth in nominal incomes as the prior ones, and it is becoming evident in the inability of the primary deficit to get to zero even during this expansion.”
In Canada, the Royal Bank of Canada said the economy will snap back as rising energy prices, low interest rates, and federal stimulus will help economic growth. The bank said it is looking for real annualized growth in GDP of +3.7% in the 3rd quarter as rebuilding takes place in Alberta following the devastating wildfire. The bank is anticipating a +1.9% rise in the 4th quarter. Hurt by the fire and weak exports, the Canadian economy shrank 1.6% on an annualized basis in the second quarter—the largest quarterly decline since 2009.
In the United Kingdom, the Bank of England held interest rates steady in the wake of recent upbeat economic activity. The move, or lack thereof, was widely expected. The Bank’s Monetary Policy Committee lowered the UK base rate to a record low 0.25% in August to help cushion the effects of Brexit on the economy. This month, the bank voted unanimously to leave interest rates on hold and also voted to continue with its monthly bond buying purchases of 435 billion pounds of UK government bonds and 10 billion pounds of corporate bonds.
German Vice Chancellor and Economic Affairs Minister Sigmar Gabriel will visit Russia next week to hold talks with Russian officials about the state of bilateral trade relations. The Ministry for Economic Affairs and Energy stated Gabriel was making his visit at a time when trade between Russia and Germany was declining because of weakness in the Russian economy and the low buying power of the ruble. Trade between the two countries fell 13.7% in the first half of the year compared to a year earlier and German exports to Russia were also down.
China’s economy strengthened last month following government infrastructure spending and property sales. A slew of data from factory output to retail sales showed activity rebounding in August following a difficult summer. China’s National Bureau of Statistics reported that industrial output rose +6.3% last month from a year earlier, and up +0.3% from July – both beating expectations. Investment in buildings and other fixed assets outside rural households climbed a better-than-expected +8.1% from the previous year in the first 8 months of 2016.
The Bank of Japan is preparing to expand its monetary stimulus even further as the economy remains mired in lackluster economic growth. Of concern is that the yen is considered a ‘safe haven’ currency that attracts foreign capital, which in turn drives up the price of Japanese exports. The central bank has repeatedly tried the help Japan’s international trade-reliant economy with “liquidity injections”; however, improvements in the economy perversely drive up the prices of Japanese goods overseas. But if the BOJ attempts to put downward pressure on the yen by lowering interest rates, it lowers borrowing costs making the economy more attractive to foreign investors, raising the yen and the cycle continues. This persistent catch-22 has remained a thorn in the side of BOJ officials attempting to spur the Japanese economy to steady growth. Despite nearly $800 billion of bonds being purchased annually, plus billions of dollars’ worth of exchange trade funds, economic growth remains stagnant while the yen has been on a tear—the opposite of the desired effect. Japan’s stock market is down 12.7% so far this year.
Finally, there is evidence that 6 years into the economic recovery from the financial crisis, ordinary Americans are finally seeing an improvement in their household incomes.
Data from the Census Department show that middle-class household incomes are growing at the fastest rate since the Great Recession. Even better, the strongest gains were noted among the lower-income groups, as can be seen on the chart below which illustrates the greatest percentage increase in real household income growth came in the lowest two income percentile groups.
Larry Mishel, President of the Economic Policy Institute, stated the data was “superb in almost every dimension.” Income data had been “submerged” for many years he noted. “This one year almost single-handedly got us out of the hole. That’s worth celebrating.”
(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)
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 to 22.3 from 23.3, while the average ranking of Offensive DIME sectors fell to 18.3 from the prior week’s 15.8. The Offensive DIME sectors remain higher in rank than the Defensive SHUT sectors, but by a much-reduced margin. 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®, RMA®