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.
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.
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Dave Anthony, CFP®, RMA®