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 27.40, up from the prior week’s 27.01, 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 57.72, up from the prior week’s 55.40.
In the intermediate picture:
The Intermediate (weeks to months) Indicator (see Fig. 4) turned positive on November 10th. The indicator ended the week at 29, up 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), 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 positive. Therefore, with all three indicators positive, the U.S. equity markets are rated as Very Positive.
In the markets:
This week, the Dow Jones Industrial Average, NASDAQ, and Russell 2000 all hit all-time highs together for the first time since 1999. Major indexes were strong both at home and around the world. The Dow Jones Industrial Average gained +284 points to close at 19,152, up +1.5%. The tech-heavy NASDAQ Composite rose +77 points to end the week at 5398, up +1.45%. Smaller market caps outperformed large caps for the third consecutive week, as the MidCap S&P 400 index rose +2.17% and the SmallCap Russell 2000 added +2.4%, while the LargeCap S&P 500 gained +1.44%. Of note, both the Dow Jones Transports and Utilities indexes had strong weeks. The defensive Utilities sector joined the fun after having been beaten down since the election, gaining +2%.
Canada’s TSX rose a third straight week, up +1.4%. Across the Atlantic, the United Kingdom’s FTSE also had its third week of gains, up +0.96%. On Europe’s mainland, France’s CAC 40 rose +1%, while Germany’s DAX gained a third of a percent. Italy’s Milan FTSE added +1.5%. Major Asian markets were strong across the board. China’s Shanghai Composite rose +2.16%, Japan’s Nikkei surged +2.3%, and Hong Kong’s Hang Seng index gained +1.7%. Overall, emerging markets as a group (as measured by the MSCI Emerging Markets Index) edged developed markets as a group (as measured by the MSCI Developed Markets Index), with emerging markets rising +1.9%, while developed gained +1.1%.
In commodities, oil plunged almost -4% on Friday, but for the week managed to end down only -0.65%. Precious metals had a third consecutive down week as Gold fell -2.5% to close at $1,178.40 an ounce while Silver dropped ‑0.93% to $16.47. The industrial metal copper, an indicator of global economic activity, had a big week by surging over +8%
In U.S. economic news, the number of Americans who applied for new unemployment benefits rose by 18,000 to 251,000, according to the Labor Department. The increase comes one week after initial claims fell to a 43-year low. Economists had forecast initial claims to rise to a seasonally adjusted 248,000. Most of the increase appears to have come from Illinois and California. Initial claims have remained below the key 300,000 threshold for 90 straight weeks, the longest streak since 1970. The economy has been adding about 180,000 new jobs a month this year, and the unemployment rate remains at a low 4.9%.
Existing home sales soared to almost a 10-year high last month, further evidence of the strong demand supporting the housing market. According to the National Association of Realtors, existing home sales ran at a seasonally adjusted annual rate of 5.6 million, an increase of +2% from September and +5.9% higher than a year ago. Forecasts had been for only a gain of 5.4 million. It was the fastest rate of sales since February of 2007. All four regions of the country recorded gains. In addition, it was the 17th straight month of yearly inventory declines with 4.3% fewer homes on the market than in October of last year. With inventory shrinking, it’s no surprise that the median sale price ratcheted up to $232,200, +6% higher than last year.
In contrast to existing home sales, new single-family home sales actually fell -1.9% to 563,000 in October according to the Commerce Department. The number missed economists’ expectations of 595,000. Nevertheless, October’s sales were +17.8% higher than October of 2015, and year to date sales in 2016 are +12.6% higher than this time last year. The median sales price last month was $304,500, versus $298,700 a year ago. At the current sales rate, it would take 5.2 months to exhaust the supply of homes on the market. Strong demand for housing with the corresponding lean supply has been keeping prices relatively high. Home builders are just now starting to ramp up construction of new homes to a level that analysts believe will sustain a healthier housing market.
Sentiment among American consumers rose sharply following Donald Trump’s election, with many Americans expressing greater optimism now that the election is over according to the University of Michigan’s consumer sentiment survey. The monthly survey of 500 consumers measures attitudes toward topics like personal finances, inflation, unemployment, government policies and interest rates. The survey climbed to 93.8 last month, up a rather large move of +6.6 points to the highest level since early summer. Richard Curtin, chief economist of the U of M survey wrote, “The post-election boost in optimism was widespread, with gains recorded among all income and age subgroups and across all regions of the country.” However, he points out, “presidential honeymoons” can end quickly and consumers’ confidence in the economy can wane if the new administration doesn’t take quick action to improve the economy.
A gauge of manufacturing in the Midwest is running below its potential, according to analysts. The Chicago Fed’s national activity index rose +0.15 point to -0.08 last month as consumer spending, housing spending, factory production, and business orders all showed improvement. The Chicago Fed index is a weighted average of 85 different economic indicators, designed to have an average value of 0, so that a positive reading indicates growth above trend and negative readings correspond to growth below trend. As with other volatile data sets, analysts use a 3-month moving average to discern a clearer picture of the trend in economic activity and in this case it weakened to a -0.27. Bernard Yaros, economist with Moody’s stated that the weaker 3-month average is “indicating inflationary pressure from U.S. economic activity will be limited.”
Orders for long-lasting goods, known as durable goods, surged +4.8% last month, according to the Commerce Department. The increase is the fourth in a row and beat economists’ forecasts of a +3.3% gain. Behind the impressive result, was a +94.1% spike in new orders for passenger planes. Aircraft orders often swing sharply from month-to-month and their effects can wildly skew trends in durable goods data. Demand for autos fell ‑0.6%. Ex-aircraft and auto industries, orders for durable goods increased a much less impressive +1% last month. Joshua Shapiro, chief economist at MFR Inc. stated “The underlying details in the report were lackluster in October.” Core capital goods orders, a key measure of business investment, rose an anemic +0.4% following a drop in September. Although these orders have recovered slightly, they are 4% lower than this time a year ago.
Growth in the service sector reached its second highest level in 12 months according to Markit’s flash November Purchasing Managers’ Index (PMI). The service sector PMI came in at 54.7, down -0.1 from October. In the survey, respondents commented on “stronger demand from both businesses and consumers in November, helped by the improving economic backdrop.” In the details of the report, new business growth rose to the strongest pace since last November. Backlogs fell, but that was due in part to stronger hiring. Survey respondents were optimistic on growth prospects over the coming year. Markit reported that growth is continuing to accelerate as the year comes to an end.
Minutes of the most recent Federal Reserve meeting show senior Fed officials agreed that it may finally be appropriate to raise interest rates “relatively soon”, given the environment of an improving labor market and somewhat higher inflation. Minutes from a two-day session in early November, show that “most participants expressed a view that it could well become appropriate to raise the target range for the federal-funds rate relatively soon.” Noteworthy in the latest minutes is concern among several officials that the U.S. economy could be at risk if the central bank waits too long to raise rates, a marked change from just a few months ago. The Federal Reserve will reconvene in December where an increase in key interest rates is seen as essentially guaranteed. Financial markets see a 93.5% chance the central bank will raise its benchmark short-term interest rate range by a quarter point to 0.5%-0.75%, according to the Chicago Mercantile Exchange’s FedWatch Tool.
Canada’s Environment Minister Catherine McKenna announced that Canada will shutter all of its coal-fired power plants by 2030 as part of its strategy to cut greenhouse gas emission under the Paris climate accord. The plants, located in four provinces, produce an estimated 10% of Canada’s total CO2 emissions. Closing them will remove the equivalent of 1.3 million cars from Canada’s roads (roughly 5 megatons of greenhouse gas emissions), she announced. “As part of our government’s vision for a clean growth economy, we will be accelerating the transition from traditional coal power to clean energy by 2030,” she said. With an abundance of hydroelectric power, as well as nuclear, solar and wind power, 80 percent of Canada’s electricity production emits no air pollution.
In the United Kingdom, the global think-tank Organization for Economic Cooperation and Development (OECD) said that Britain’s economy is growing faster than the rest of the G7 – another sign that most of the fears surrounding the Brexit vote were (so far) unfounded. The UK grew by +2.3% in the third quarter of 2016, outpacing all other countries in the group. The average third-quarter growth rate of G7 economies was +1.4%. The robust economic growth comes after strong employment numbers, lower than expected inflation, and surging retail figures.
In France, Former French President Nicolas Sarkozy’s political career is essentially over after a humiliating defeat by his former Prime Minister Francois Fillon in the first round of the race to choose the Republican party’s candidate for the presidency next spring. Fillon, a social conservative and free-market reformer, came close to winning the nomination getting 43% of the vote. He now faces a runoff vote against a more moderate Alain Juppe. Mr. Juppe is the mayor of Bordeaux and former prime minister under Jacques Chirac. Sarkozy had come under fire following several legal investigations into corrupt campaign financing.
In Germany, Bavarian economic minister Ilse Aigner said that Germany needs a “comprehensive” new EU trade deal with the UK following the Brexit vote, in order to minimize the potential fallout for its own economy. She argued that Brexit poses a “high risk” to the German economy and that the UK is “one of the most important trading partners for Bavaria”, one of Germany’s most prosperous states. Britain’s leaders have been optimistic that Germany will help temper France’s call for Britain to pay a tough economic price for its decision to leave the EU.
Italian voters will head to the polls on December 4th in a referendum on constitutional reforms that will have far-reaching consequences for the country – and for the euro. If Italian leader Matteo Renzi loses the vote, it’s believed that the anti-euro 5-star Movement could take over as ruling party and reject the country’s debts. Market risk assigned to Italian government debt has consequently surged in recent weeks. European Central Bank vice-president Vitor Constancio said he is closely watching the outcome of Italy’s vote amid concerns that the outcome could impact stability in the whole of the European Union.
In Asia, refusal by the U.S., European Union, and others to recognize China as a market economy is the latest sign of friction in the trade between the Asian economic giant and other world powers. Penny Pritzker, U.S. Secretary of Commerce, said that the time “was not ripe” to grant China market-economy status under World Trade Organization rules. China’s status therefore remains a “non-market economy” under the treaty, meaning that Chinese products such as steel can be saddled with steep tariffs if it is determined that the country is “dumping” those goods. Recognition as a market economy would force trading partners to use domestic Chinese prices as a baseline for judgements about export prices, limiting their ability to impose restrictions. For many goods, prices are far lower in China than their international prices.
Japanese consumer prices fell last month extending the streak to the longest in 5 years, government data showed. Japan has been struggling to reverse a deflationary spiral of falling prices and tepid growth. October’s reading marked the 8th straight month of price declines, the longest since 2011. Bank of Japan governor Haruhiko Kuroda blamed weak crude oil prices. Yasunari Ueno, chief market economist at Mizuho Securities said he believed that “prices will turn into positive territory eventually, but so far upward movement of prices…is still weak.” In addition he stated that the reason behind the slow pace of price rises is because the economic recovery is very slow.
Finally, television executives and advertisers are concerned over a disturbing new trend: young people are turning off sports, crime dramas and – most especially – news at an alarming rate. On the other hand, comedy was enjoyed by 18-24 year olds much more than by older cohorts. Viewers between the ages of 18 and 24 were the least interested in news as a genre, according to a survey of 31,000 people across 10 countries carried out by research firm Ampere Analysis. The trend was most pronounced in the United Kingdom and United States.
(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 to 23.00 from 23.50, while the average ranking of Offensive DIME sectors was unchanged at 11.25. 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®