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.
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.
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Dave Anthony, CFP®, RMA®