FBIAS™ for the week ending 10/28/2016

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 26.33, down from the prior week’s 26.51, 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 55.20, down from the prior week’s 57.82.

In the intermediate picture:

The Intermediate (weeks to months) Indicator (see graph below) turned negative on October 14th.  The indicator ended the week at 19, down from the prior week’s 23.  Separately, the Quarterly Trend Indicator – based on domestic and international stock trend status at the start of each quarter – was positive entering October, indicating positive prospects for equities in the fourth quarter of 2016.

Timeframe summary:

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 Q4, and the Intermediate (weeks to months) timeframe (Fig. 4 above) is negative.  Therefore, with two of three indicators positive, the U.S. equity markets are rated as Mostly Positive.

In the markets:

Most of the U.S. major indexes were down for the week as third quarter earnings reports continued to stream in.  The Dow Jones Industrial Average had a second week of little movement, rising only +0.09% or +15 points to close at 18,161.  The Nasdaq Composite was decisively negative after less-than-stellar earnings reports from tech-bellwethers Apple and Amazon: the NASDAQ fell -1.28% to end the week at 5,190.  Once again, smaller cap indexes took it on the chin as the SmallCap Russell 2000 declined -2.5% and the MidCap S&P 400 ended down 1.7%, while the LargeCap S&P 500 gave up “only” -0.7%.

In international markets, Canada’s TSX retraced some of last week’s gain, ending down -1%.  Across the Atlantic the United Kingdom’s FTSE fell -0.34%.  Europe’s mainland major bourses were mixed: France’s CAC 40 rose +0.28%, while Germany’s DAX fell -0.14%, and Italy’s Milan FTSE had its 6th week of gains by rising +0.9%.  Asian major markets were mixed as well.  China’s Shanghai composite rose for a 3rd straight week, gaining +0.4%.  Japan’s Nikkei had a second week of gains, adding +1.5%, but Hong Kong’s Hang Seng Index fell -1.8%.  Developed international markets as a group, as measured by the MSCI EAFE Index, fell -1.8% while emerging markets as a group, as measured by the MSCI Emerging Markets Index, fell -0.7%.

In commodities, precious metals were bid up as Gold rose +$9.10 to end the week at $1,276.80 an ounce, and Silver rebounded +1.73% to close at $17.80 an ounce.  The industrial metal copper retraced almost 3 weeks of losses, rebounding more than +5%.  Oil went the other way, having its first negative week in 6, falling over 4.2% to close at $48.70 for a barrel of West Texas Intermediate crude oil. 

In U.S. economic news, the number of people who applied for new unemployment benefits fell by 3,000 to 258,000 according to the Labor Department.  Initial jobless claims have remained below the key 300,000 threshold watched by economists for 86 straight weeks, a feat last seen in 1970.  Economists had forecast claims would total a seasonally adjusted 255,000.  Analysts note that the labor market for skilled workers remains tight, and firms have been reluctant to fire workers since they might not be able to find suitable replacements.  The less-volatile 4-week moving average of claims rose by 1,000 to 253,000.  Continuing claims, the number of people already receiving unemployment benefits, declined by 15,000 to 2.04 million.  Continuing claims are released with a 1 week delay.

In housing, U.S. home prices continued to rise according to the closely-watched S&P CoreLogic Case-Shiller 20-City Index.  Home prices rose +0.4% in August, and were up +5.1% compared to the year-ago period.  Economists had forecast a +0.2% gain.  In the three months ending in August, 10 cities in the index recorded higher yearly gains than in July.  Denver, Portland, and Seattle saw the greatest price gains.  Case-Shiller’s national index is now just 0.1% below its peak recorded in 2006, although the 20-city sub-index remains 7.2% below its peak.  Echoing the Case-Shiller report, the Federal Housing Finance Agency’s (FHFA) House Price Index was also up +0.7% in August, gaining +0.2% over July.  FHFA’s index is made up of prices on properties guaranteed by Fannie Mae and Freddie Mac.  The index is up +6.4% from August of last year.

New home sales reached the second-highest level of the recovery running at a seasonally-adjusted annualized rate of 593,000 last month.  The Commerce Department reported that new home sales for September were +3.1% higher than in August and +29.8% higher than a year ago.  The median sales price of a new home sold last month was $313,500, up +6.7% over August, while the average price was $377,700.  At the current sales pace, there is a 4.8 month supply of homes available on the market (a 6 month supply is desirable).  Despite the demand, builders have been reluctant to ramp up construction of new homes, with many continuing to report difficulties finding affordable labor and lots.  So far this year, new home sales have averaged an annualized sales rate of 564,000—a substantial increase of +13% over the same period last year.

The government reported that the nation’s Gross Domestic Product (GDP) grew at an annualized +2.9% rate in the 3rd quarter, the fastest pace in 2 years.  The advance was substantially driven by a huge spike in soybean exports following a poor harvest in South America and elsewhere (accounting for +0.9% of the +2.9% all by itself), and a rebound in business inventories.  The improvement in GDP was significant compared to the first half of the year, when the U.S. grew just barely over +1% annualized.  The details of the report reveal that consumers increased spending by +2.1%, exports increased the most in almost 3 years, and businesses restocked shelves following a decline in inventories in the spring.  On the negative side, higher imports, a second consecutive quarterly decline in spending on new construction, and less investment in business equipment weighed on the final result.  Sam Bullard, senior economist at Well Fargo Securities summarized the report aptly, “Bottom line, the U.S. economic expansion remains resilient, yet unremarkable.”

The Chicago Fed’s National Activity Index improved from a -0.72 in August to a slightly negative -0.14 last month as factory production, housing, consumer spending and business orders all showed improvement.  The index itself improved but the less-volatile 3-month moving average, a measure watched more closely by analysts, continued to weaken to a -0.21 from -0.14 in August.  The September reading shows that economic growth continues to run below its potential.  Bernard Yaros, economist at Moody’s remarked that the reading “dovetails with incoming U.S. economic data that have been mixed but supportive enough to keep a December rate hike on the table for Federal Reserve policymakers.”  The Chicago Fed index is a weighted average of 85 different economic indicators, designed so that zero represents trend growth and a three-month average below negative 0.70 suggests a recession has begun.

In U.S. manufacturing, Markit said its flash Purchasing Managers Index (PMI) rose to 53.2 this month, up +1.7 points from September, rebounding from a 3-month low.  In the report, new orders and goods produced grew by the fastest increase in a year.  Production has risen for 5 consecutive months.  Markit said that the October PMI report “signaled that U.S. manufacturers started the fourth quarter in a strong fashion.”  Markit noted they recorded improvement in manufacturing conditions in most of the world’s other major economies as well.

In contrast, the Commerce Department’s durable-goods orders weakened slightly last month, predominantly due to lower demand for military hardware and computers.  Durable goods, goods expected to last longer than 3 years, fell -0.1%, missing expectations of a +0.1% increase.  However, stripping out the volatile defense category, new orders actually rose +0.7%.  Customers ordered more heavy machinery, new autos, and commercial planes the Commerce Department noted.  Although overall demand remained resilient, orders for core capital goods (a key measure of business investment) fell by -1.2% last month, and are down  -4.1% over the past year. 

Consumer confidence took a hit in October as uncertainty surrounded the presidential election and more consumers reported that jobs were a bit harder to find.  The confidence of Americans in the U.S. economy fell to a 3-month low of 98.6, down from 103.5 in September, the Conference Board said.  The decline was worse than expected.  Despite the drop, consumer confidence is still near a post-recession peak.  The present situation index fell -7.3 points to 120.6 as fewer Americans reported that jobs were “plentiful”.  Lynn Franko, director of economic indicators at the Conference Board said, “Overall, sentiment is that the economy will continue to expand in the near-term, but at a moderate pace.”

The University of Michigan’s Consumer Sentiment index fell to 87.2, a loss of -4 points, to the lowest level since 2014.  In the report, Americans were less upbeat about both current and future conditions.  The drop in sentiment suggests that consumer spending may continue to moderate.  When asked about the year-ahead for the economy, only 35% of respondents expected good times, the lowest reading since fall of 2013. 

In international economic news, a group of prominent Canadians known as the Century Initiative has proposed that Canada reach a bold target of 100 million citizens by the end of the century.  The Canadian federal government’s Advisory Council on Economic Growth has also recommended that immigration be increased by 50% from roughly 300,000 a year to 450,000.  With a current population of about 36 million, Canada has a long way to go to reach the group’s target of 100 million.  At a population of 100 million, Canada would be second only to the United States among the G-7 countries!

In the United Kingdom, GDP growth slowed to +0.5% following the Brexit vote, down -0.2% from the 2nd quarter.  The Office of National Statistics reported that despite the slowdown, growth was still stronger than the +0.3% expected by economists.  Britain has now grown for 15 quarters in a row, and is now a robust 8.2% higher than the GDP peak set in 2008.  The number also beat the latest forecast from the Bank of England, which had predicted growth of only +0.1%.  Joe Grice, head of the Office of National Statistics, said the figure shows “little evidence” of a significant effect in the immediate aftermath of the Brexit vote.

In France, the economy grew less than expected, rising only +0.2% in the 3rd quarter.  The French economy was weighed down by prolonged weakness in consumer spending, declining business investment, and a drop in tourism following terrorist attacks.  French consumers, a main pillar of economic growth for the country, were subdued in the 3rd quarter according to the French National Institute of Statistics and Economic Studies.  The Economy and Finance Minister Michel Sapin acknowledged that it will be “difficult” to achieve the official target of +1.5 percent growth this year on which France has based its budget projections, inevitably leading to further deficits.

In Germany, German Economy Minister Sigmar Gabriel said that China is strategically buying up key technologies in Germany while protecting its own companies against foreign takeovers with “discriminatory requirements.”  In a guest column in Die Welt newspaper, Gabriel urged the EU to adopt a tougher approach to China to ensure a level playing field.  “Nobody can expect Europe to accept such foul play of trade partners,” Gabriel wrote, adding that Germany was one of the most open economies for foreign direct investments.  In China, on the contrary, foreign direct investments by European companies are being hampered and takeovers are only approved under discriminatory requirements, he said.

In Asia, China’s currency sank to its lowest level against the U.S. dollar in 6 years – good news for the country’s economy, but raising concerns that Chinese policymakers were becoming more tolerant of their currency’s ongoing weakness.  The yuan is on track for a loss of -1.6% for October, the largest monthly decline since China’s shock devaluation in August 2015.  China officially states that it wants its currency to be more market-driven, but traders note that in reality it maintains tight control over the yuan’s daily exchange rate – and down seems to be the direction the government has chosen.

Japanese core consumer prices fell for the 7th month in a row, down -0.5% last month from a year earlier.  A separate index from the Bank of Japan that strips out the volatile food and energy prices, showed inflation hit a 3-year low of +0.2% in September, down -0.2% from August.  The data supports the BOJ’s view that it will take quite some time for inflation to reach its target of 2%, and that it must therefore maintain its aggressive stimulus program.

Finally, what do you consider to be “fast shipping?”  The definition appears to be rapidly changing.  The chief cause of this change is Amazon, according to a study by accounting and consulting firm Deloitte.  As Amazon Prime subscribers grow more and more accustomed to getting their orders in 2 days, deliveries that take any longer are now viewed with frustration. 

In Deloitte’s study, just 42% of consumers surveyed now view 3-4 day shipping as “fast”, whereas almost two thirds of consumers considered 3-4 days to be “fast” just last year!  Amazon is now upping the pressure on traditional outlets even more, as it begins rolling out same-day delivery to more markets.

(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 slightly to 23.0 from 23.5, while the average ranking of Offensive DIME sectors rose to 14.25 from the prior week’s 16.5.  The Offensive DIME sectors continue to lead Defensive SHUT sectors.  Note: these are “ranks”, not “scores”, so smaller numbers are higher ranks and larger numbers are lower ranks.

FBIAS™ for the week ending 10/21/2016

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 26.51, barely changed from the prior week’s 26.46, 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 57.82, down from the prior week’s 58.95.

In the intermediate picture:

The Intermediate (weeks to months) Indicator (see graph below) turned negative on October 14th.  The indicator ended the week at 23, down from the prior week’s 27.  Separately, the Quarterly Trend Indicator – based on domestic and international stock trend status at the start of each quarter – was positive entering October, indicating positive prospects for equities in the fourth quarter of 2016.

Timeframe summary:

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 Q4, and the Intermediate (weeks to months) timeframe (Fig. 4 above) is negative.  Therefore, with two of three indicators positive, the U.S. equity markets are rated as Mostly Positive.

In the markets:

Stocks were green across the board as all major U.S. indexes recorded gains for the week.  Of note, roughly a quarter of the market capitalization of the S&P 500 index reported third-quarter results during the week.  For the week, the Dow Jones Industrial Average added just +7 points to end the week at 18,145, up +0.04%.  The tech-heavy NASDAQ Composite gained +43 points to 5,257, up +0.83%, helped by strong earnings reports from Netflix and Microsoft.  Smaller cap indexes modestly outperformed larger as the MidCap S&P 400 rose +0.46% and the SmallCap Russell 2000 gained +0.47%, while the LargeCap S&P 500 added +0.38%. 

In international markets, Canada’s TSX rose a strong +2.43%.  In Europe, the United Kingdom’s FTSE ended relatively flat, rising only +0.1%.  On Europe’s mainland, major markets were strong across the board.  France’s CAC 40 was up +1.46% for a 3rd week of gains.  Germany’s DAX rose +1.23%, and Italy’s Milan FTSE surged +3.47% for a 5th week of gains.  In Asia, China’s Shanghai Composite tacked on a second week of gains, rising +0.89%.  Japan’s Nikkei reversed last week’s loss, gaining +1.95%.  Hong Kong’s Hang Seng rose a slight +0.6%.  Developed international markets as a group, as measured by the MSCI EAFE Index, rose +0.9% while emerging markets as a group, as measured by the MSCI Emerging Markets Index, rose +1.95%.

In commodities, oil had a 5th week of gains, up +0.2% to $50.85 for a barrel of West Texas Intermediate crude.  Precious metals regained some of their shine as an ounce of Gold rose +$12.20 to $1267.70 (+.  Silver, likewise, added a nickel to $17.49 an ounce, up +0.3%.  The industrial metal copper, viewed by many as an indicator of the health of the global economy, fell for a 3rd straight week, down -1.04%.

In U.S. economic news, the number of people who applied for new unemployment benefits last week rose 13,000 to 260,000—a 6-week high, according to the Labor Department.  Economists had expected 248,000 new claims.  The biggest increases in claims occurred in California, Pennsylvania, Texas, and New York.  Nonetheless, initial claims have remained below the key 300,000 level for 85 straight weeks.  The less volatile 4-week moving average of claims rose slightly to 251,750.  Although the economy has added millions of jobs over the last 6 years, companies continue to complain that they cannot find enough skilled workers to fill open positions.  Continuing claims, the number of those already receiving benefits, rose by 7,000 to 2.06 million, but remained near a 16-year low.

Home builders broke ground on the fewest number of new homes in over a year and a half last month, according to the Commerce Department.  Housing starts were at an annual 1.047 million pace last month, 9% lower than in August and 11.9% lower than this time last year.  It was the slowest pace of starts since spring of 2015.  Economists had expected a 1.18 million annual pace.  Digging deeper into the numbers, the damage seems to have been confined to new construction of apartment buildings, which plunged -39%.  In contrast, single-family housing starts surged +8.1% to an annual pace of 783,000—the highest in 7 months.  The U.S. now has the most single-family homes under construction since the fall of 2008.  On a positive note, building permits rose +6.3% to a 1.23 million annual rate in August.  Permits are taken as an indication of future building activity.  The Commerce Department’s figures are traditionally very volatile and are often revised, to the point that upon receiving the numbers Amherst Pierpont Securities Chief Economist Stephen Stanley wrote in a note, “Nothing to see here, move along.”

The National Association of Home Builders’ (NAHB) index retreated slightly to 63 after reaching its highest level in 10 years in August.  Current sales conditions fell -2 points to 69, while the measure of sales expectations for the next 6 months gained a point to 72.  Buyer traffic fell a point to 46.  Buyer traffic has remained below the neutral 50 mark since the height of the housing bubble.  In the NAHB report, builders note that demand is still being supported by a strong job market and low mortgage rates, but shortages of skilled labor and buildable lots continue to weigh on their ability to meet that demand.

Existing home sales snapped a two month losing streak and rebounded last month according to the National Association of Realtors (NAR).  Existing-home sales ran at a seasonally-adjusted 5.47 million annual rate, a +3.2% increase from August and a +0.6% increase year-over-year.  The median sales price of $234,200 was +5.6% higher than a year ago—the 55th straight month of annual price gains.  The 2 month losing streak of sales has been attributed to shrinking inventory and surging prices, says NAR.  Sales rose in all four regions, ranging from a +5.8% rise in the Northeast to a +0.9% increase in the South.  First-time buyers were responsible for 34% of all transactions, the most in 4 years.  At the current sales pace, there were just 4 ½ months of inventory on the market, well below the usual 6 months that has historically marked a balanced housing market.

Manufacturing in the New York area took a turn for the worse as the Empire State Manufacturing index plunged to a -6.8 reading, from a previous reading of -2.  Analysts had been expecting a reading of positive 1.  Any reading below zero indicates shrinking activity.  The index for new orders improved slightly, but still remained negative at 5.6.  Orders for shipments, unfilled orders, inventories, number of employees and average employees work week were also all negative vs the prior month.

In the city of brotherly love, the Philadelphia Federal Reserve’s manufacturing index also pulled back, but the details of the report painted a brighter picture than in the New York report.  Overall, the Philadelphia Fed’s monthly index on regional manufacturing fell to 9.7, down -3.1 points from September, which had been the highest reading in over a year and a half.  Economists had expected a reading of only 7.  In the details, new orders surged to 16.3, up from 1.4 in September and shipments rose +24 points to a positive 15.3.

Industrial production rose slightly last month, up a bare +0.1% according to the Federal Reserve.  American producers are struggling with the twin headwinds of slow global growth and a stronger U.S. dollar which raises the relative price of U.S. goods overseas.  In addition, business profits have been declining and lower oil prices have forced domestic drillers and energy producers to curtail investment.  Capacity utilization, used by analysts to forecast future industrial production numbers, rose a tick to 75.4%, but remained below its long-term average of 80%.  In other words, plants are operating at only ¾ capacity. 

The Federal Reserve’s latest Beige Book, a collection of anecdotal information on current economic conditions from each Federal Reserve Bank, reported that the economy in most areas of the country grew at a “modest to moderate pace”.  The area surveyed by the New York Fed saw no growth.  Of concern, the Fed’s survey reported that the stronger dollar is weighing on exports.  On a positive note, the report highlighted increases in retail spending, heightened demand for services, a robust real-estate market, and a firming energy sector.   

The Conference Board’s index of Leading Economic Indicators (LEI) rebounded +0.2% last month, signaling modest economic growth.  The LEI index is a weighted gauge of 10 indicators designed to signal business-cycle peaks and troughs.  Of the 10 indicators, 5 expanded last month.  Ataman Ozyildirim, director of business cycle research at the Conference Board said that the increase last month, along “with the pickup in the six-month growth rate, suggests that the economy should continue expanding at a moderate pace through early 2017.”

Gas and housing prices rose the most in 5 months, pushing the Consumer Price Index (CPI) up by +0.3% in September, according to the Federal Reserve.  The CPI increase was at the fastest pace since May of this year.  On an annualized basis, consumer prices have increased +1.5% – the greatest annual gain since late 2014.  Significant gains in CPI may force the Federal Reserve to raise interest rates, regardless of other factors.   Economists are predicting that inflation will continue to creep higher as oil prices stabilize and wages continue to rise.  However, on a positive note, Americans continue to see relief at the grocery store as food remained unchanged for the third straight month.  Over the past year, food prices have fallen -2.2% – the biggest drop since 2009.  Without the volatile food and energy categories, consumer prices were up only +0.1% last month.

In international news, the Bank of Canada left its key interest rate unchanged at 0.5%, but cut its GDP outlook for 2016 to just +1.1%.  The central bank is predicting a slower housing market and stated that the export sector is not rebounding as strongly as it anticipated.  The Canadian central bank had forecast 2016 GDP to be +1.3% at July’s meeting.  The bank doesn’t expect the Canadian economy to return to full capacity until mid-2018 – 6 months later than previously expected.  CIBC economist Nick Exarhos stated “The Bank didn’t cut rates today, but it is warning markets that it is only operating with a thin margin of error when it comes to what might prompt another ease in policy.”

In the United Kingdom, concerns are rising of the possibility of a “hard Brexit”—a severing of most trade ties between the UK and the European Union in a swift, some say brutal, manner.  That would require further support from the Bank of England in the form of lower interest rates and an extension of the current quantitative easing program.  Dean Tenerelli, portfolio manager for European equities at T. Rowe Price, believes that the possibility of a hard Brexit has darkened the outlook for the UK and European economies, which have otherwise shown resilience since the UK referendum in June.  He added that the “divorce process” would be “lengthy and complex”.

On Europe’s mainland, ratings firm Standard & Poor’s raised its outlook on France’s long-term sovereign credit rating to “stable” from “negative”.  The U.S. ratings agency left its rating on French debt unchanged at AA—it’s 3rd highest rating.  The improvement in the country’s outlook is due to the “gradual introduction of growth-enhancing reforms amid ongoing fiscal consolidation,” S&P said in its report.  French Prime Minister Manuel Calls welcomed the news calling it a “sign of confidence”.  S&P had downgraded France’s AAA rating in 2012.

German Chancellor Angela Merkel is taking a hard line against Britain in the coming Brexit talks, instructing officials to avoid any back-door contacts that could hand the U.K. any advantage.  Merkel’s chancellery is refusing to grant the U.K any favors in advance of the official negotiations, instructing officials to not have contact with their U.K. counterparts that might reveal negotiating positions, Bloomberg reports.  In short, the German message in private is that same as in public – discussions can’t start until Britain presents its opening positions in regard to leaving the European Union.

In Italy, ratings agency Fitch cut its outlook due to political uncertainty, weak growth, and high debt.  Italians will be voting on a referendum which could decide the future of Prime Minister Matteo Renzi’s future.  Polls are currently suggesting that the vote is too close to call.  The referendum vote planned for December 4, 2016 asks voters whether they approve of amending the Italian constitution to reform the appointment and powers of the Italian Parliament, as well as partitioning the powers of state, regional, and national administrative entities.  The agency left Italy’s BBB+ rating unchanged, but said downside risks have increased.   

China’s economy grew at an annual rate of +6.7% in the 3rd quarter—a sign that growth is stabilizing.  The figure matched forecasts and was in line with first and second quarter growth.  The reading is expected to reassure investors after China’s market and currency volatility earlier this year sparked fears of a slowdown.  The National Bureau of Statistics said “The general performance was better than expected”, and the figure is in line with Beijing’s growth target of +6.5% to +7% for the year.

In Japan, Bank of Japan Governor Haruhiko Kuroda said the economy is expected to “expand moderately as a trend”.  In addition, he reported core consumer prices remain slightly negative to flat and that the central bank stands ready to take further action to boost growth if needed.  Specifically, he stated, “The BOJ will continue expanding the monetary base until the year-on-year rate of increase in the observed CPI exceeds the price stability target of 2% and stays above the target in a stable manner.”  Just last month, the Bank of Japan said it would target the yield curve and move its activities away from expanding the monetary base. 

Finally, could 2016 be the best year to buy a home since 2012?  With median home prices rising month after month one would be forgiven for answering a resounding “No!”  But real-estate research firm Trulia came to a different conclusion.  Trulia compared the costs to rent with the costs of buying a home and found that it is now 37.7% cheaper to buy a home rather than rent in the top 100 cities in America (the cheapest it’s been since 2012).  Trulia’s analysis compared the monthly cost of owning—mortgage payments, maintenance, insurance, and taxes, to the cost of renting comparable properties.  The range is from more than 50% cheaper in Miami and Fort Lauderdale, Florida to under 20% in Honolulu and San Francisco.  Although home prices have greatly appreciated in the last 4 years, in many cases rents have been rising just as – or more – quickly.

(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 slightly to 23.5 from 23.25, while the average ranking of Offensive DIME sectors rose slightly to 16.5 from the prior week’s 17.0.  The Offensive DIME sectors continue to lead Defensive SHUT sectors.  Note: these are “ranks”, not “scores”, so smaller numbers are higher ranks and larger numbers are lower ranks.

FBIAS™ for the week ending 10/14/2016

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 26.46, down from the prior week’s 26.72, 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 58.95, down from the prior week’s 61.97.

In the intermediate picture:

The Intermediate (weeks to months) Indicator (see graph below) turned negative on October 14th.  The indicator ended the week at 27, down from the prior week’s 30.  Separately, the Quarterly Trend Indicator – based on domestic and international stock trend status at the start of each quarter – was positive entering October, indicating positive prospects for equities in the fourth quarter of 2016.

Timeframe summary:

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 Q4, and the Intermediate (weeks to months) timeframe (Fig. 4 above) is also positive.  Therefore, with two of three indicators positive, the U.S. equity markets are rated as Mostly Positive.

In the markets:

Stocks were in the red for a second week as earnings season began with mixed results, and poor economic data from China sparked renewed concerns about slowing global growth.  The Dow Jones Industrial Average fell 102 points (-0.56%) to end the week at 18,138.  The tech-heavy NASDAQ Composite gave up -78 points to close at 5,214, down -1.48%.  All other major U.S. indexes were also down with the LargeCap S&P 500 losing -0.96%, the MidCap S&P 400 ending down -0.92%, and the SmallCap Russell 2000 faring the worst, dropping -1.95%.

International markets were broadly mixed.  Canada’s TSX rose +0.13%, while the United Kingdom’s FTSE fell 0.44%.  European mainland markets were mostly positive:  Italy’s FTSE MIB rose +1.13%, followed by Germany’s DAX, gaining +0.85%, and France’s CAC 40, adding +0.47%.  Asian markets were more mixed.  China’s Shanghai Composite rallied +1.97%, while Hong Kong’s Hang Seng fell -2.13%.  Japan’s Nikkei ended basically flat, down 0.02.  Developed international markets as a group, as measured by the MSCI EAFE Index, ended down -1.55% while emerging markets as a group, as measured by the MSCI Emerging Markets Index, fell -2.15%.

In commodities, oil had a 4th week of gains as a barrel of West Texas Intermediate crude oil rallied +1.89% to $50.75.  The Baker Hughes oil rig count rose for a 7th straight week to 432 rigs in production, the most since February.  Gold managed a slight gain, up +0.29% to $1,255.50 an ounce following 2 weeks of sharp losses.  Similarly, silver rebounded +0.35%, to $17.44 an ounce.  The industrial metal copper, though, had a second week of losses, giving up -2.45%.

In U.S. economic news, the number of people who applied for unemployment benefits remained flat at 246,000 for the first week of October—a 42-year low, according to the Labor Department.  Economists had forecast claims to total 252,000.  Initial jobless claims have been under 270,000 for 15 straight weeks, an event that hasn’t occurred since 1973.  The less-volatile f our week moving average of initial claims dropped -3,500 to 249,250.  Continuing jobless claims, a count of those already receiving benefits, declined by -16,000 to 2.05 million for the week ended October 1.

The number of job openings fell in August to the lowest level in 8 months, a sign that job gains will most likely remain modest in the coming months analysts say.  The Labor Department said job openings dropped almost 7% to 5.4 million, down from a record 5.8 million in July.  The biggest declines occurred in professional and business services.  The number of people who quit their jobs remained mostly unchanged at almost 3 million.  That number is up +4.4% over the past year.  Economists view the low level of “quits” as a sign that Americans are more optimistic about the job market and their chances of finding new work.

In the latest National Federation of Independent Business (NFIB) survey, small businesses say finding qualified workers now ranks as their second biggest problem.  The NFIB’s index of small business optimism fell slightly last month, the second consecutive drop.  Although the economy has improved steadily since the end of the Great Recession, small businesses still aren’t doing as well as they did before.  In the past, a complicated tax code and excessive regulation were generally the top 2 complaints.  But now, a shortage of skilled job applicants ranks near the top.  In the survey, 60% of firms had anticipated hiring in September, but almost half reported “few or no qualified applicants for the positions they were trying to fill,” the NFIB said.

Retail sales bounced back last month further evidence that U.S. consumers remain confident, according to the Commerce Department.  Sales at retail stores, online retailers, and restaurants rose a seasonally-adjusted +0.6% in September, following August’s 0.2% decline.  Sales at auto dealers and gas stations led the rebound, with auto dealers seeing a +1.1% increase in receipts and gas station sales rising at a seasonally-adjusted +2.4%.  Analysts note that auto dealers have relied on sharply higher discounts to lure buyers as demand appears to be leveling off after a multi-year long boom in sales.  Auto purchases account for roughly 20% of all retail spending.  Ex-autos and gasoline, retail sales rose a more moderate +0.3%.

Prices of foreign goods shipped to the U.S. increased last month as a modest rebound in oil markets is slowly lifting inflation, according to the Labor Department.  The import-price index, which measures the cost of goods ranging from Colombian coffee beans to Japanese cars rose +0.1% from a month earlier.  Import prices have risen 6 out of the past 7 months.  Even so, import prices were -1.1% lower last month versus a year earlier.  The index is one of several measures the Federal Reserve uses to gauge how quickly prices for goods and services are rising in the U.S. and to determine economic health.  That, in turn, influences Fed policy makers as they decide when to adjust interest rates, and by how much.  Prices for U.S. exports rose +0.3% last month, the fifth increase in six months.  From a year earlier, export prices were down -1.5%. 

Producer prices rose slightly last month, a sign that inflation could be firming.  The producer-price index for final demand, which measures changes in the prices that U.S. companies receive for their goods and services, increased +0.3% on a seasonally-adjusted basis in September compared with the prior month, according to the Labor Department.  Ex-food and energy, which are often quite volatile, the index still rose +0.2%.  Both gains were slightly stronger than analysts had expected.  Stephen Stanley, economist at Amherst Pierpont Securities noted that the latest figures are “consistent with the notion that price pressures are beginning to accumulate and suggest that the consumer-price readings may continue to be firm going forward.”  The overall index is up +0.7% from a year earlier, the largest year-over-year increase since December 2014.

A measure of consumer sentiment fell to a one-year low, a potential sign of growing anxiety among middle- and lower-income households prior to the U.S. presidential election.  The University of Michigan’s Index of Consumer Sentiment fell to 87.9, its lowest level since September 2015, down -1.9 points from August.  Economists had expected a rise to 92.  The loss was concentrated among households with incomes less than $75,000, whose index                                                                                                                                                                                                                                                                                                                                                                                                                        fell to the lowest level since August 2014.  Richard Curtin, the survey’s chief economist wrote, “”Prospects for renewed market gains, other than an immediately relief rally following the election results, would require somewhat larger wage increases and continued job growth as well as the maintenance of low inflation.”

In international economic news, Canadian Prime Minister Justin Trudeau’s Liberal government believes in taking a little bit of economic pain now to prevent much more later.  Finance Minister Bill Morneau introduced new real estate measures that will likely cool the housing market, reducing its impact on the already tepid gross domestic product.  The measures apply a stricter standard to borrowers and close an existing loophole widely taken advantage of by foreign buyers.  Minister Morneau is hoping that the measures will lessen the odds of a real-estate crash in Canada’s hottest real estate markets of Toronto and Vancouver.

The United Kingdom Foreign Secretary Boris Johnson is intent on pursuing closer economic ties with the Arab world.  Speaking to a delegation of Arab ambassadors, Johnson said the Middle East region is a region of “huge opportunity” for Britain.  “We believe, and I certainly believe, after Brexit in particular, and after our decision to have a new position in the world, that we need to be more outward looking than ever before, more engaged than ever before with the Arab world,” Johnson said.  Johnson also acknowledged the importance of solving the Israeli-Palestinian conflict, but emphasized to his Arab audience that it was “not the only problem in the region.”  “It is absolutely vital that we do not allow the Middle East, the Arab world in the eyes of the British public to be defined by these problems,” he said.

In Germany, economic sentiment improved more than expected in October according to the ZEW Centre for Economic Research.  The report said that its index of German economic sentiment rose sharply to 6.2 this month, up from September’s reading of 0.5.  Analysts were anticipating an increase of only 4.3.  The Current Conditions Index rose to 59.5 this month, up +4.4 points from last month.  In addition, the index of Eurozone economic sentiment increased to 12.3, up +6.9 points from September.  ZEW President Achim Wambach acknowledged the concern regarding the German banking sector brought on by troubles at Deutsche Bank, stating “In particular, the risks concerning the German banking sector are currently a burden to the economic outlook.”

China’s Premier says the Chinese economy exceeded expectations in the 3rd quarter and the country’s debt risks are now under control.  In a speech in Macau, Premier Li Keqiang said, “China‘s economy in the third quarter not only extended growth momentum in the first half but showed many positive changes.”  He reported that key economic indicators such as factory output, profits, and investment have all rebounded.  China will be able to achieve its main economic targets this year and maintain medium to high growth, he said. 

In Japan, in his latest address to business leaders in Nagano, Bank of Japan Board member Yutaka Harada noted the positive effects of the central bank’s qualitative and quantitative easing program over the last few years.  Harada believes that the current monetary policies have not yet reached the limits of their effectiveness.  In his assessment, the positives for Japan’s economy outweigh the negatives, and the economy can achieve its 2% inflation/price stability target through the use of its yield curve control initiative – the BoJ’s strategy of managing its yield curve to keep Japanese government bond yields near 0% while simultaneously benefiting the higher yielding corporate bond market.

Finally, the last time stocks were as “expensive” as they are right now was 15 years ago, right before the first bear market of the 21st century – the so called “dotcom” bust.  So says Savita Subramanian, equity and quantitative strategist at Bank of America Merrill Lynch, writing that the current market valuation is near levels seen during the tech-bubble era.  She writes, “The S&P 500 median P/E [price-to-earnings ratio] is currently at its highest level since 2001 and that the average stock trades a full multiple point higher than the oft-quoted aggregate P/E. This puts it in the 91st percentile of its own history and just 14% from its tech-bubble peak.”  The key is the median (or middle point in a range) P/E ratio, which some analysts feel is a more reliable measure of total-market valuation than the aggregate P/E more commonly referenced.  The chart below is from her report.

(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 slightly to 23.25 from 23.75, while the average ranking of Offensive DIME sectors fell to 17.0 from the prior week’s 14.0.  The Offensive DIME sectors still lead Defensive sectors, but by a slightly narrower margin.  Note: these are “ranks”, not “scores”, so smaller numbers are higher ranks and larger numbers are lower ranks.

FBIAS™ for the week ending 10/07/2016

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 26.72, down from the prior week’s 26.90, 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 61.97, down from the prior week’s 63.77.

In the intermediate picture:

The Intermediate (weeks to months) Indicator (see graph below) turned positive on June 29th.  The indicator ended the week at 30, down from the prior week’s 31.  Separately, the Quarterly Trend Indicator – based on domestic and international stock trend status at the start of each quarter – was positive entering October, indicating positive prospects for equities in the fourth quarter of 2016.

Timeframe summary:

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 Q4, 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:

U.S. stocks fell modestly for the week as investors awaited the start of the 3rd quarter earnings season.  All major indexes finished in the red, with the typically more volatile smaller cap indexes declining the most.  The Dow Jones Industrial Average fell -68 points to 18,240, a loss of -0.37%.  The NASDAQ Composite fell -19 points to 5,292, also down -0.37%.  The LargCap S&P 500 declined -0.67%, while the S&P 400 MidCap index lost -1.18%, and the SmallCap Russell 2000 brought up the rear, ending the week down -1.21%. 

In international markets, Canada’s TSX reversed from recent gains, falling -1.08%.  The United Kingdom’s FTSE 100 had a strong week rallying +2.1%, while on the mainland of Europe France’s CAC 40 was basically flat, up just +0.04%, and Germany’s DAX fell slightly, down -0.19%.  In Asia, Japan’s Nikkei was up a strong +2.49%, along with Hong Kong’s Hang Seng which rallied +2.38%, although China’s Shanghai Composite Index pulled back by -0.96%.  Developed international markets as a group, as measured by the MSCI EAFE Index, ended down -0.93% while emerging markets as a group, as measured by the MSCI Emerging Markets Index, rose +0.64%.

In commodities, precious metals had another difficult week, this time led by a -9.5% plunge in Silver and a -4.95% drop in Gold.  The industrial metal copper, viewed by many as a proxy for the economic health of the global economy, also ended down -2.13%.  On the positive side, crude oil rallied for a 3rd straight week, rising +3.25% to $49.81 for a barrel of West Texas Intermediate crude oil.

In U.S. economic news, the economy added +156,000 new jobs last month, a gain “good enough” that some analysts suggest will give the Federal Reserve the green light to raise interest rates.  Job creation in some industries such as energy and manufacturing has slowed since last year, but most segments of the economy are adding workers.  Professional services, high-tech employers, health care companies, and restaurants led the hiring in September.  Jim Baird, chief investment officer in Plante Moran Financial Advisors said “the jobs market remains a relative bright spot in an environment that continues to be characterized by moderate growth overall.”  The unemployment rate rose slightly to 5%, the first uptick since April, mostly due to the fact that an additional 444,000 people entered the labor force.

The number of people who applied for new unemployment benefits fell by 5000 to 249,000 last week, the second lowest level since the end of the Great Recession.  Economists had been expecting a reading of 256,000.  Initial jobless claims have been under 270,000 for 14 straight weeks, an achievement not seen since the early 70s.  The low level of layoffs helps explain how the unemployment rate was able to fall below 5% this year for the first time since 2008.  The less-volatile smoothed four week average of initial claims dropped -2,500 to 253,500.  Continuing jobless claims, those people already receiving unemployment checks, declined -6,000 to 2.06 million in the week ended September 24 – the lowest level since late summer of 2000.

Private-sector employers added 154,000 private sector jobs in September, lower than the 175,000 reported by payroll processor ADP.  The increase was the smallest since April and missed expectations of 170,000.  In the report, small private-sector businesses added 34,000 jobs, medium businesses added 56,000, and large businesses added 64,000.  Most of those gains were in the service sector with 151,000 jobs added, while goods producers added 3,000, and manufacturers actually lost 6,000.  Mark Zandi, chief economist at Moody’s Analytics, said job growth should be expected to slow as the U.S. nears full employment.

The Institute for Supply Management (ISM) services index accelerated last month to an 11 month high of 57.1, beating expectations by 4 points.  Growth in the services sector has now reached 80 straight months.  In the ISM report, business activity surged +8.5 points to 60.3, while the index for new orders was up +8.6 points to 60.  Employment in services was also strong, up +6.5 points to 57.2. Numbers above 50 indicate expansion. 

Breaking recent trends, manufacturers reported improved business conditions last month, according to the Institute for Supply Management (ISM) manufacturing index.  The index rose back into expansion to 51.5, after dipping into contraction (sub-50) territory in August.  Forecasts had been for a reading of 50.6.  The survey of executives reported that new orders rose, but the industry is still experiencing soft demand in the United States and weak exports.  Richard Moody, chief economist at Regions Financial stated “All in all, we’d rather have the headline index above 50.0 than below it, but the bottom line is that the manufacturing sector still faces challenging conditions.”  On a positive note, the measure of new orders jumped to 55.1 from 49.1 and a gauge of production increased +3.2 points to 52.8.

Research firm IHS Markit’s Purchasing Managers Index (PMI) manufacturing index report was considerably less enthusiastic than the ISM report.  The PMI report indicated that production declined in September and that orders are the weakest of the year.  Chris Williamson, chief business economist at IHS Markit stated “Manufacturing growth slowed to a crawl in September, suggesting the economy is stuck in a soft-patch amid widespread uncertainty in the lead-up to the presidential election.”

Auto sales in the United States began to slow in September with the largest automakers reporting declines.  General Motors reported sales slipped -0.6% and Ford’s sales fell -8.1% despite efforts to keep dealer lots full and offers of sweetened incentives for buyers.  But Toyota reported that its sales rose +1.5%, along with Nissan that reported an overall +4.9% gain.  Industrywide, U.S. light vehicle sales are expected to have fallen -1% compared with the same time last year, according to JD Power.  In addition, retail sales, which strip out sales to fleet buyers are seeing by JD Power as falling -1.4%, the fifth decline in the past seven months.

U.S. construction spending weakened, according to the Commerce Department, dropping -0.7% in August.  Year over year, the spending in August of $1.14 trillion was -0.3% lower than a year ago.  The decline was led by steep cuts in spending on public projects, down -8.8% from a year ago and the lowest level since March 2014.  Spending on private projects fell -0.3% in August.  Within that category, residential spending fell -0.2% and nonresidential spending dropped -1.1%.

In Canada, for the first time in two years the economy managed two consecutive monthly employment gains, adding +67,200 jobs last month.  Statistics Canada reported that the gain was driven by the biggest increase in self-employment in seven years.  “If you can’t find work, you create your own work,” said Vincent Ferrao, at the Labour Division of Statistics Canada.  “It makes sense, given fewer people were working for companies and more people were working on their own.”  Most of the job gains came in Quebec, Alberta and New Brunswick, Statistics Canada said, while employment in other provinces was basically steady — most notably in Ontario and British Columbia, which had previously been showing labor gains.  The unemployment rate remained unchanged at 7% as more Canadians reported they were actively looking for work.

Across the Atlantic in the United Kingdom, the International Monetary Fund (IMF) stated that Britain will be the fastest-growing G-7 economy this year.  The IMF also accepted the fact that its prediction of a post-Brexit financial crash was overly pessimistic.  The Washington-based IMF said Britain would have a “soft landing” in 2016, with growth of +1.8%.  However, it is sticking with its prediction of sub-par expansion in 2017, sticking to its view that the economy would eventually suffer from its break with the EU.

On Europe’s mainland, French President Francois Hollande gave a speech demanding that the United Kingdom pay a heavy price for deciding to leave the EU.  The French President called the Brexit referendum the biggest crisis in the EU’s history and said its future depended on a determination to be tough during exit talks.  President Hollande stated: “There must be a threat, there must be a risk, there must be a price.  Otherwise we will be in a negotiation that cannot end well.”  The comments followed similar tough talk from German Chancellor Angela Merkel, none of which seemed to deter UK Prime Minister May.

In Germany, politicians have accused the US of waging economic war as concern continues to rise among that country’s political and corporate leaders over the financial health of Deutsche Bank, its largest financial institution.  Some of Germany’s top corporate leaders have come to the support of the bank, stressing its importance to the economy and confidence in the leadership of the bank’s CEO John Cryan.  Deutsche has been under intense pressure since the United States Department of Justice requested the bank pay a $14 billion settlement to settle claims of its mis-selling of mortgage securities.  Shares fell to their lowest level since 1983 last week before a rebound following rumors that the settlement was closer to being a much smaller $5.4 billion.

The IMF has lowered its global economic growth forecast for China by -0.1%, to -3.1% based on China’s efforts to switch its economic engine away from investment and towards consumption and services.  According to its forecasts, the change would reduce China’s GDP growth down to 6.6% this year, and 6.2% for next year.  Frederic Neumann, co-head of Asian Economic Research at HSBC stated, “We are a little bit cautious because we think the restructuring in China has barely begun.  We would expect the Chinese economy to slow down next year, and that could put headwinds for emerging markets going into 2017.”

In Japan, Prime Minister Shinzo Abe is working on a ¥1 trillion ($9.6 billion) economic cooperation deal with Russia.  The envisioned cooperation covers 41 items chiefly concerning infrastructure construction, resource development and improvement in the quality of life in the Russian Far East and Siberia.  Among the items are improvement of three Far Eastern ports — Vladivostok, Zarubino, and Vostochny — as well as a ¥600 billion ($5.8 billion) project to construct a petrochemical plant near Vladivostok. 

Finally, as the U.S. economy continues to create jobs there still appears to be no shortage of people looking for work.  The U.S. economy has added over 11.5 million jobs since the bottom of the Great Recession, but that growth has slowed over the past 6 months.  The slowdown is leading some to speculate that we are nearing full employment.  One number in the monthly jobs report that doesn’t get a lot of attention is the available labor supply—the number of people who aren’t working, but would like to.  Over the past year, this “available” work force has actually grown despite the creation of 2.4 million jobs.  It appears that as more jobs are created, even more people are being pulled off the sidelines looking for work.  Even as headlines abound that the U.S. has achieved “full employment”, there are nonetheless more than 14 million people out there who’d like to start earning a paycheck, the most in more than a year.

(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 fell to 23.75 from 21.5, while the average ranking of Offensive DIME sectors rose to 14.0 from the prior week’s 19.5.  The Offensive DIME sectors have widened their lead over the Defensive SHUT sectors.  Note: these are “ranks”, not “scores”, so smaller numbers are higher ranks and larger numbers are lower ranks.

FBIAS™ for the week ending 9/30/2016

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 26.90, nearly unchanged from the prior week’s 26.86, 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 63.77, up from the prior week’s 62.85.

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, unchanged from the prior week.  Separately, the Quarterly Trend Indicator – based on domestic and international stock trend status at the start of each quarter – was positive entering October, indicating positive prospects for equities in the fourth quarter of 2016.

Timeframe summary:

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 Q4, 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 finished the week modestly higher for the most part, but the tepid numbers masked the high day-to-day volatility.  The Dow Jones Industrial Average experienced triple digit moves every day of the week, ending with a +164 point rally on Friday to close at 18,308, but ended up just +0.26% for the week.  The NASDAQ Composite was likewise modestly higher for the week, adding just +0.12%.  The LargeCap S&P 500 index gained +0.17%, the S&P 400 MidCap index rose only +0.09% and the SmallCap Russell 2000 index fell -0.24%.

In international markets, Canada’s TSX rose +0.19% but elsewhere markets were mostly in the red.  The United Kingdom’s FTSE was off slightly, down -0.15%.  On the mainland, France’s CAC 40 was off -0.9%, Germany’s DAX fell -1.09%, and Italy’s Milan FTSE was down -0.32%.  In Asia, China’s Shanghai Composite fell -0.96%, along with Japan’s Nikkei which ended down -1.8%, and Hong Kong’s Hang Seng index lost -1.64%.  Broadly speaking, developed countries were down -0.22% while emerging markets were down -0.48%, as measured by the ETFs EFA and EEM.

Commodities were mixed for the week.  Precious metals lost some of their shine, as gold ended the week down 1.8% to $1,317.10 an ounce, and silver fell -3% to $19.21 an ounce.  Oil had a strong week, with the price of a barrel of West Texas Intermediate crude oil surging +8.45% to $48.24.  The industrial metal copper was also positive, up +0.43%.

The month of September saw modest moves among U.S. stock indexes.  The Dow Industrials, the LargeCap S&P 500, and the MidCap S&P 400 were all down less than -1% for the month (-0.50%, -0,12%, and -0.80% respectively) , while the SmallCap Russell 2000 and the NASDAQ Composite were both positive for the month (+0.95% and +1.89%, respectively).  International markets outstripped U.S. markets for September.  Developed International, represented by the ETF EFA, gained +1.34% and the best performance came from Emerging Markets, represented by the ETF EEM, rising +2.52%.

The third quarter saw gains in stock markets around the world.  The Dow Jones Industrial Average gained +2.1%.  That gain was eclipsed by a +9.7% surge in the NASDAQ composite.  The LargeCap S&P 500 index added +3.3%, while the S&P 400 MidCap index rose +3.7%, and the SmallCap Russell 2000 vaulted +8.7%.  Canada’s TSX rose +4.7%.  Developed International, represented by the ETF EFA, added +5.93%, and Emerging Markets, represented by the ETF EEM, added a handsome +8.99% for the quarter.

In U.S. economic news, applications for unemployment benefits rose slightly to 254,000 last week, according to the Labor Department.  The number remains below the 300,000 threshold that economists use to indicate a healthy labor market.  Initial claims first fell below 300,000 last year and have remained there for 82 straight weeks.  In addition, new claims have numbered less than 270,000 for 3 months, an event not seen since 1973.  The economy has added an average of 182,000 new jobs per month this year and the unemployment rate is at 4.9% – an 8-year low.

Sales of new homes fell in August, but the reading was the second-highest since the end of the Great Recession.  According to the Commerce Department, sales of newly constructed homes ran at a seasonally-adjusted 609,000 annual rate exceeding economist forecasts of 600,000.  At the current sales pace, there is a 4.6 month supply of homes available.  The median sales price last month fell to $284,000, the lowest since September 2014 and -5.4% below year-ago levels.  The lower median sales price is welcome news to a market short on affordable housing, and indicates more sales in the lower half of home prices.  In August, Richard Moody, chief economist at Regions Financial noted that homes priced in the upper half ($300,000 or above) made up 44% of all sales—the lowest since February of 2014. 

Pending home sales, which tracks real estate transactions in which a contract has been signed but the deal has not closed, fell -2.4% to 108.5 last month.  It was the lowest reading in 7 months.  The National Association of Realtors stated that without more inventory, the housing recovery ‘could stall’.    Economists had forecasted a gain of +0.5%.  Of all the regions, only the Northeast saw an increase, up +1.3%.  It was also the only region in which the index reading was higher than its level this time last year. 

Home prices in the Pacific Northwest saw the biggest gains according to the latest numbers from the S&P CoreLogic Case-Shiller home price index.  Overall, house prices were up +0.6% in July and +5.0% from this time last year.  Portland and Seattle led the 20-city index with the greatest annual price increases of +12.4% and +11.2%, respectively.  One notable change was the formerly white-hot market of San Francisco, which was essentially flat for the month.  San Francisco has had double-digit annual price increases for quite some time, but that appears to be moderating.  Overall, the Case-Shiller National Index is near its high previously set in 2006.

In U.S. manufacturing, orders for durable goods (items expected to last at least 3 years) stagnated following a strong July reading.  Orders fell -22% for large commercial aircraft, a volatile category that frequently exhibits large swings in orders received.  Stripping out transportation, orders were down just -0.4%, according to the Commerce Department.  Demand for heavy machinery, electrical equipment, and computers all declined.  Shipments of core capital goods, a category used in the calculation of GDP, fell -0.4%, which was its fourth straight decline.  However, on a more positive note, orders for core capital goods rose +0.6%, its third straight increase.  Orders for core capital goods are frequently considered a proxy for business investment.

In Chicago, the Chicago regional Purchasing Managers Index (PMI) rose +2.7 points to 54.2 in September.  The gains were led by an improvement in production, which was up +7.3 points to the highest level since the beginning of the year.  PMI readings above 50 indicate improving conditions.

Consumer sentiment improved in September according to the University of Michigan’s index which showed a gain in September to 91.2, up +1.4 points.  Households with incomes over $75,000 were responsible for the gain.  On an annual basis, however, the trend has been basically flat as September’s number was the same as September 2015’s number.

Americans were the most optimistic about the economy since the summer of 2007 according to the Conference Board’s Consumer Confidence index.  The index climbed to 104.1 this month, up +2.3 from August.  Consumers were more upbeat about the strong labor market, in which the unemployment rate has held below 5% and millions of people have been added to payrolls.  In addition, a shortage of skilled labor has forced companies to raise wages.  Lynn Franco, director of economic indicators at the Conference Board stated, “Consumers’ assessment of present-day conditions improved, primarily the result of a more positive view of the labor market.”  The present situation index, which measures current conditions, climbed to 128.5, up +3.2 points.  That measure is also at its highest level since August of 2007.  Analysts note that the rise in confidence could benefit the incumbent Democratic Party in the upcoming presidential election.

However, American’s rising confidence in the economy wasn’t reflected in consumer spending, which was barely changed in August according to the Commerce Department.  A decline in sales of cars and trucks failed to offset an increase in services such as education and health care.  The flat reading for August was the weakest since March and missed estimates of a +0.2% gain.  Factoring in inflation, spending actually fell slightly in August.  Incomes rose only +0.2% in August, the smallest increase in 7 months.  The slower spending and modest growth in income did appear to have a positive impact on personal savings, however, which rose +0.1% to 5.7% for the typical consumer, a 3-month high. 

Inflation as measured by the Personal Consumption Expenditure Index (PCE) rose +0.1% in August, according to the Commerce Department.  The so-called “core” rate of inflation that strips out the volatile categories of food and energy increased +0.2%.  The PCE index, the preferred Federal Reserve inflation barometer, rose 1% over the last 12 months as of the end of August.  It rose +0.2% from July.  Annualized core inflation was up +1.7%.  At this point, inflation remains below the 2% target desired by the Federal Reserve—one reason that the Federal Reserve has been reluctant to raise interest rates.

Second quarter GDP rose +0.3% from earlier estimates to 1.4% as business investment in the second quarter was actually much better than had been previously reported.  The improvement in GDP reflected stronger investment by companies than earlier government estimates showed.  Investment excluding housing actually rose +1% instead of falling -0.9%, as previously reported.  Excluding mining and drilling, investment was up a solid +10% in the second quarter.  The all-important American consumer continues to be the growth engine of the economy.  Consumer spending accounts for about 2/3’s of the economy and consumer spending increased +4.3% in the second quarter.  Loretta Mester, president of the Cleveland Federal Reserve, stated “Based on incoming data, growth is poised to rebound in the second half of the year.”

The Canadian economy grew +0.5% in July, according to Statistics Canada, predominantly due to a rebound in oil and gas production.  Activity in the oil and gas extraction and mining sectors was up +3.9% from June.  The goods-producing sector of the economy rose +1% while the services side increased +0.3%.  Economists had expected a gain of only +0.3%.  Toronto Dominion (TD) bank economist Brian DePratto said “Today’s report points to a healthy, if somewhat artificially boosted, economic momentum for the third quarter. We are currently tracking economic growth of roughly 3.0 per cent for the third quarter.” 

According to the UK Office for National Statistics (ONS), Britain’s economy was stronger than previously thought leading up to the EU referendum. The ONS figures suggested that the economy had a decent start in the third quarter, with the services sector (which accounts for almost 80% of the UK economy) growing by +0.4% in July.  According to the ONS there was no sign that Britain leaving the EU triggered any immediate shock to the economy.  Economists largely agree that Britain will almost definitely avoid a recession this year, but that in 2017 the economy could slow down due to uncertainty.

In France, the Labor Ministry said the number of jobless people registered as out of work rose 50,200 to 3.5 million, an increase of +1.4% from July.  The increase was the steepest since late 2013 and brought the total closer to the record 3.59 million set in February.  Labor Minister Myriam El Khomri said the tourism sector suffered after a terrorist attack in the city of Nice that killed 86 people.  French President Francois Hollande has given hints that he intends to run for re-election, but only if unemployment could be brought down.  The latest increase is another blow to Hollande’s bid for re-election amid a term marred by low growth and high unemployment.

In Germany, all eyes have been on Deutsche Bank as questions have arisen regarding its liquidity position following multi-billion dollar judgements against the company in the United States and its derivatives exposure.  Deutsche Bank is the region’s biggest investment bank.   In addition, German car-manufacturer Volkswagen also faces multi-billion dollar fines in the United States related to an emissions issue.  Together the two companies employ more than 700,000 and further weakening of these two major companies would impact growth in Germany and around the world.  Horst Loechel, economics professor at the Frankfurt School of Finance and Management stated, “With two heavy-weights shaking, that could lead to a setback in consumption and investment.”  Deutsche Bank (symbol DB) shares hit a record low Thursday.

The World Trade Organization cut its forecast for global trade growth this year by more than a third, prompting China’s Commerce Ministry to declare that China’s economic fundamentals are sound and it remains a contributor to global growth.  China’s growth target for this year is 6.5-7%.  Last quarter, the world’s second largest economy grew 6.7% from a year earlier, according to official data.  Imports and exports both showed improvement last month.  Imports were boosted by demand for coal and other commodities, and exports fell less than expected, down -2.8%, as demand in the United States, Europe and Japan was firmer than predicted.

Japanese Prime Minister Shinzo Abe pledged Monday to accelerate his policies to support Japan’s economic recovery and to speed up approval of the Trans-Pacific Partnership trade pact.  In his policy statement, Abe outlined stimulus measures to help the recovery and spur more consumer and corporate spending.  His proposal tacked on an additional 28 trillion yen ($2.8 billion) to the group of economic stimulatory measures that have become commonly known as ‘Abenomics’.

Finally, when asked to name the most unaffordable place to live in the United States, you would be forgiven for declaring locations like Maui, San Francisco, or the Napa Valley.  But the answer is…..Brooklyn, NY.  A person earning the average salary in Brooklyn cannot come close to affording to buy the average home there, according to a study by real estate data company ATTOM Data Solutions.  The study looked at home sales price data in 414 of the most populous counties in the U.S. and corresponding wage data from the Bureau of Labor Statistics. 

Home sale prices were compared to average wages in each locale to create a scale of “Home Prices as % of Average Local Wages”.  For comparison, the U.S. Department of Housing and Urban Development recommends a maximum of 30% of household income should be spent on housing or one runs the risk of having “difficulty affording necessities such as food, clothing, transportation, and medical care.”  The chart below lists the 10 most unaffordable places to live in America, and by that Department of Housing and Urban Development yardstick, homebuyers there must be going without food, clothing, transportation and medical care!

(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 fell to 21.5 from 19.3, while the average ranking of Offensive DIME sectors rose to 22.5 from the prior week’s 22.5.  The Offensive DIME sectors recaptured the advantage over the Defensive SHUT sectors.  Note: these are “ranks”, not “scores”, so smaller numbers are higher ranks and larger numbers are lower ranks.