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 26.80, up from the prior week’s 25.82, 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 53.47, up from the prior week’s 51.91.
In the intermediate picture:
The Intermediate (weeks to months) Indicator (see Fig. 4) turned positive on November 10th. The indicator ended the week at 19, up from the prior week’s 14. 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:
U.S. stocks enjoyed their best week since 2011 as investors reassessed future corporate earnings, overall economic growth, and inflation expectations following the surprise victory of Donald Trump in the U.S. presidential election. Although all major indexes recorded solid gains, small-cap equities smartly outperformed large caps. The blue chip Dow Jones Industrial Average reached a record high of 18,847 rallying +959 points to end the week up +5.36%. That impressive move was eclipsed by the +10.2% surge in the SmallCap Russell 2000. The MidCap S&P 400 also had a strong week, rallying almost +5.7%. The S&P 500 LargeCap index gained +3.8% while the tech heavy NASDAQ Composite brought up the rear with a gain of +3.78%.
Canada’s TSX gained a modest +0.32%, held down by lower gold and energy prices. Across the Atlantic, the United Kingdom’s FTSE added half a percent. On Europe’s mainland France’s CAC 40 rose +2.55% and Germany’s DAX gained +3.98%. In Asia, markets were mostly green with China’s Shanghai Composite rising +2.26% and Japan’s Nikkei gaining +2.78%, but Hong Kong’s Hang Seng fell half a percent. As a group, emerging markets (as measured by the MSCI Emerging Markets Index) fell -3.8%, hurt by rocketing interest rates on emerging market debt, while developed markets (as measured by the MSCI Developed Markets Index) gained +0.8%.
Commodities markets diverged sharply. In precious metals, Gold surrendered 4 weeks of gains, plunging over ‑$80 to $1,224.30 an ounce, a loss of -6.15%. Silver had a similar move, also plunging over -5.4% to $17.38 an ounce. The industrial metal copper, though, had a 3rd week of strong gains by surging over +10.7% last week. Weakness was also the theme in the energy markets, where a barrel of West Texas Intermediate crude oil fell ‑1.5% to $43.41 a barrel, a 3rd consecutive week of losses. The hoped-for OPEC production limit agreement has seemingly fallen apart before it was even implemented, and the continued supply glut seems a higher probability.
In U.S. economic news, the number of people who applied for unemployment benefits the first week of November fell by -11,000 to 254,000. Initial claims have remained below the key 300,000 threshold for 88 straight weeks, an achievement not seen since 1970. Economists had forecast a reading of 260,000. The less-volatile 4-week moving average of claims rose slightly to 259,750 according to the Labor Department. Stephen Stanley, chief economist at Pierpont Securities wrote, “Whether initial claims are 250,000 or 270,000 in a given week is virtually irrelevant in the big picture. Either one points to an extremely slow pace of layoffs and is consistent with a very healthy and tight labor market.” Continuing claims, those people already receiving unemployment benefits, increased by 18,000 to 2.04 million.
According to a government survey of employers known as the Job Openings and Labor Turnover Survey (JOLTS) companies were intent on hiring 5.49 million people in September, up from 5.45 million the previous month. The JOLTS report showed that the number of job openings rose slightly and remains near record levels—more evidence that companies are willing to hire despite economic uncertainty. In addition, the percentage of people who quit their jobs in September was 2.1%, unchanged from the prior month. The rate of people quitting their jobs rose to normal levels earlier this year for the first time in over 8 years. Workers are more likely to quit their jobs only when they get a better offer or think they can quickly find a better job. The rapid pace of hiring has pushed the unemployment rate below 5% and the tighter labor market is forcing many companies to raise wages to retain and attract skilled workers.
Commercial real estate loans are getting more difficult to obtain as banks continued to tighten lending standards in the 3rd quarter. In a survey by the Federal Reserve of senior loan officers at 69 domestic banks and 21 U.S. branches of foreign banks, standards were tightened on all types of commercial real estate (CRE) loans. Standards for commercial and industrial (C&I) loans were basically unchanged. Demand for C&I loans was slightly weaker among large and middle-market firms. For CRE loans, stronger demand was noted for construction and land development loans, while demand for loans secured by multifamily residential and nonfarm residential properties remained basically unchanged.
Optimism among small business owners rose slightly last month according to the National Federation of Independent Business (NFIB). The NFIB’s Small Business Optimism Index rose +0.8 point to 94.9, beating economists’ forecasts by 0.6 point. More respondents said that now is a good time to expand, however more also reported they expect business conditions to worsen before they improve. In the release, the NFIB stated small business owners are experiencing “record levels” of uncertainty that’s “paralyzing” them. Specifically referenced were “high taxes, ball-and-chain regulations, and spiraling health insurance costs.” According to the survey, the single biggest problem facing small businesses were “taxes” and “government regulations and red tape”.
The confidence of American consumers soared earlier this month as Americans reported that their economic outlook brightened. The University of Michigan’s Consumer Sentiment reading, taken before the results of the presidential election, rose +4.4 points to 91.6. The result was 0.3% higher than the same time last year, and also above the 2016-to-date average of 91.1. Economists had predicted a reading of 88. Sentiment improved even as inflation expectations for the near and long term rose +0.3% to 2.7%. Richard Curtin, director of the survey, released in a note that the change may be a one-time event and that “it may be viewed as added justification for next month’s expected interest rate hike.”
Credit balances of U.S. consumers rose in September, led by student and auto loans according to the Federal Reserve. Outstanding consumer credit, a measure of nonmortgage-related debt, rose by $19.29 billion in September from August. Economists had expected an increase of $18.8 billion. September’s 6.28% seasonally-adjusted annual growth rate was down from August’s 8.77% rate. Household balance sheets have been expanding steadily since early 2011. Of the increase, $15.1 billion was non-revolving credit, namely student and auto loans. This category rose at an annualized 6.68% growth rate in September, following a 9.41% annualized rate in August. Revolving credit, made up of mostly credit card debt, rose at a 5.16% annualized rate in September.
In international news, for the first time ever Canadians’ household debt is now worth more than the country’s entire economy. According to Statistics Canada in the second quarter total household debt amounted to 100.6% of Canada’s gross domestic product. Desjardins economist Benoit P. Durocher noted that Canadians now carry more debt than people in any other G7 country calling it a “fairly troubling snapshot” of Canadians’ finances. “The high level of household debt is undermining the Canadian economy and this represents a significant risk over the medium and long terms,” he wrote in a recent client note. Durocher blamed rising house prices along with piling up on non-mortgage debt. Average consumer non-mortgage debt balances rose to $21,686 at the end of the third quarter, up from $21,195 in the same quarter last year.
In the United Kingdom, under revised rules from the Bank of England, the UK’s largest banks will no longer be “too big to fail” by the year 2022. The new regulations will force banks to hold enough money from their investors to absorb losses without help from the taxpayers. If any bank does collapse, remaining funds will be used for an orderly wind-down. Mark Carney, Governor of the Bank, said the new rules were a “significant milestone”. “The implementation of [the rules] will ensure that banks that provide essential economic functions hold sufficient resources to be resolved in an orderly way, without recourse to public funds, and whilst allowing households and businesses to continue to access the services they need,” he said.
Across the Channel, France saw its fastest job creation in 9 years last quarter with 52,200 jobs created. National statistics office INSEE showed the +0.3% increase in non-farm private sector jobs was driven by an increase of 29,600 temporary jobs. The jobs report is a good sign for a fragile economy whose unemployment rate has been hovering around 10%. With one of the higher birth rates in Europe, France in particular needs to create more jobs to absorb the rise in the labor force.
In Germany, the country’s economic ministry reported several data sets that point to slower growth in the 3rd quarter. Total industrial output fell by -1.8%, reversing much of last month’s 3% gain. Berenberg economist Florian Hense does not believe the decline is the start of a new trend, but rather just monthly volatility. Germany’s adjusted trade surplus was lower than the expected 23 billion euros, coming in at only 21.3 billion euros. Despite those disappointments, economists point to the positive sentiment among German firms. The country’s IFO business survey has risen 2 months in a row, and a purchasing managers’ survey last week hit a nearly 3-year high.
In Asia, economic cooperation between China and Russia is meeting the two countries’ expectations. The two did more than $40 billion in trade this year, according to Russian Prime Minister Dmitry Medvedev. Moscow and Beijing are making additional efforts to increase trade to $200 billion in the next 3-7 years. Medvedev noted that the establishment of a preferential trade regime between the two countries would importantly allow the use of their own national currencies in settlements.
In Japan, gross domestic product was estimated to have grown an annualized +0.9% in the 3rd quarter according to a survey of economists. If so, it would mark the longest stretch of growth for Japan in 3 years. Household spending, which accounts for roughly 60% of Japan’s GDP, is expected to fall -0.1% on the quarter. The gain is estimated to have come from a +1.9% rebound in exports for the quarter, combined with a fall in imports. Together, economists predict that net exports added 0.5% to the figure. Despite the weak demand at home, the 0.9% estimate was still welcome news to Japan’s leadership. The Bank of Japan most recently estimated Japan’s growth rate at 0.24%, while the Cabinet Office estimates 0.3%.
Finally, trading in the financial markets has become quite sophisticated over the last decade. Added to traders’ lexicon are terms like algorithmic trading, dark pools, and high-frequency trading. However, one aspect of trading continues to be the Wild West—the so-called “after-hours” or overnight market. After-hours sessions almost always have less liquidity and far fewer participants than the day session, which means prices spike up and down much more violently, orders receive poor executions (“fills”), and overall trading can be more costly. Late on Tuesday evening, when the presidential election began to tilt in favor of Donald Trump, the bottom started falling out of the overnight market. At one point, Dow futures had plunged over -800 points and the S&P lost -5.7% as panicked investors sold. Selling begets selling when “stops” are hit, triggering further selling. Paul Krugman, leftist economist at the New York Times, aghast at the thought of a President Trump, tweeted when the markets were falling “If the question is when markets will recover, a first-pass answer is never….we are very probably looking at a global recession, with no end in sight.” His hyperbole was completely overblown, of course, as by market open almost all of the overnight carnage had disappeared. Investors who sold in the after-hours market missed out on the recovery rally that took place that morning and continued the rest of the week. Bespoke Investment Group used the opportunity to remind investors in a blog post that “The best advice anyone could ever receive in their formative years is that whenever an important and emotional decision needs to be made, it often helps to ‘sleep on it.’” Marketwatch.com added another timeless piece of wisdom: “Teenagers and investors alike should be reminded that nothing good ever happens in the middle of the night!”
(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 fell to 23.25 from 20.25, while the average ranking of Offensive DIME sectors rose to 11.25 from the prior week’s 14.00. 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®