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 Fig. 1 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 Fig. 2).
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 Fig. 3) 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 Fig. 4) 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.
In the Secular (years to decades) timeframe (Figs. 1 & 2), 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), 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) 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, FactSet; Figs 1-5 source W E Sherman & Co, LLC)
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.
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Dave Anthony, CFP®