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.
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.
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Dave Anthony, CFP®, RMA®