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 27.01, up modestly from the prior week’s 26.80, 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 55.40, up from the prior week’s 53.47.
In the intermediate picture:
The Intermediate (weeks to months) Indicator (see Fig. 4) turned positive on November 10th. The indicator ended the week at 27, up sharply from the prior week’s 19. 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:
Stocks added to the strong post-election rally, pushing many of the major benchmarks to new all-time highs. The smaller-cap indexes, typically more volatile, performed the best. The Dow Jones Industrial Average rose +20 points to 18,867, up +0.11%, while the tech-heavy NASDAQ Composite rallied +1.6% to 5,321. The LargeCap S&P 500 added +0.8%, but was sharply outpaced by its Small- and Mid- brethren: the MidCap S&P 400 index surged +2.75% and the Russell 2000 SmallCap index gained +2.59%.
In international markets, Canada’s TSX rose +2.12%, a second week of gains. Across the Atlantic, the United Kingdom’s FTSE recovered a bit more from early November’s plunge adding +0.67%. On Europe’s mainland, France’s CAC40 gained +0.34%, Germany’s DAX ended nearly flat, down just -0.03%, and Italy’s Milan FTSE fell ‑3.25%. In Asia, China’s Shanghai Stock Exchange was flat-to-down at -0.1%. Japan’s Nikkei surged a very handsome +3.4%, possibly due to views that President-elect Trump’s economic policies may benefit Japan—more on that below.
In commodities, precious metals had a second difficult week as Gold fell another $15.60 an ounce to $1208.70, down -1.27%. Silver plunged even further down -4.36%. Precious metals typically respond negatively to a rising dollar, and that has been the situation of late – in spades – as the dollar has ripped higher since the election all the way to a 14-year high. The industrial metal copper gave back some of last week’s gains by falling -1.65%. Crude oil rebounded following 3 weeks of losses, rising $2.95 a barrel to end the week at $46.36, a weekly gain of +6.8%.
In U.S. economic news, jobless claims are at a 43-year low as the number of people who applied for unemployment benefits last week fell by 19,000 to 235,000. Initial claims have now remained under the key 300,000 threshold level for 89 straight weeks, the longest stretch since 1970. The U.S. unemployment rate also remains near an 8 year low of 4.9%. Continuing jobless claims, the number of people already receiving unemployment benefits, also decreased by 66,000 to 1.98 million – the first time that number has been below 2 million since mid-2000.
Sentiment among home builders remained unchanged in November, according to the National Association of Home Builders’ (NAHB) index. The latest reading of 63 matched the median forecast among economists. Current sales conditions and sales expectations were at 69, while the index of buyer traffic rose a point to 47. Readings over 50 signal improving conditions. Robert Dietz, the home builder trade group’s chief economist, said in a statement “Ongoing job creation, rising incomes and attractive mortgage rates are supporting demand in the single-family housing sector. This will help keep housing on a steady, upward glide path in the months ahead.”
Construction of new houses jumped 26% last month to the highest level in 9 years, boosted by a spike in multi-family units. Housing starts climbed to an annual rate of 1.32 million from 1.05 million in September, according to the Commerce Department. Economists had expected only 1.17 million new starts. Higher prices and a shortage of properties for sale have encouraged builders to step up construction. New construction accelerated in all regions of the country, surging by more than +44% in the Northeast and Midwest. Construction of apartment buildings, condominiums, and multi-unit dwellings were up +75% last month. Single-family home starts rose almost +11%, the fastest pace since October, 2007. Future building activity also looks promising as permits are running about +5% above year-ago levels.
Retail sales surged for a second consecutive month for the best two-month performance since early 2014. October retail sales jumped +0.8% last month, following a +1% rise in September. Economists had forecast a +0.7% gain. With consumer spending a main driver of economic growth, the increase in retail sales suggests that the U.S. economy got off to a good start in the 4th quarter. Alan MacEachin, an economist at Navy Federal Credit Union, stated “A solid jobs market is driving up household incomes and boosting spending power.” A large portion of the gains were due to auto dealers where sales hit an 11-month high following strong incentive programs. Even ex-autos and gas, sales were still up a healthy +0.6%.
The New York Fed’s Empire State Index turned positive for the first time in four months following improvement in new orders and shipments. The Empire State Manufacturing sub-index rose back into expansion by rising +8.3 points to 1.5. New-orders surged +8.7 points to 3.1, and shipments jumped +9.1 points to 8.5. Inventory levels declined significantly, plunging -11.3 points to -23.6—a multiyear low.
Manufacturing in the mid-Atlantic region recorded slightly slower growth, according to the Philadelphia Fed’s manufacturing index. The index slowed slightly to 7.6, down -2.1 points from September. The index has remained above the 0 level, indicating improving conditions, for four consecutive months. Most sub-indexes remained positive with general activity, new orders, and shipments all recording strong results.
Inflation at the wholesale level remains low, coming in unchanged for October, but the reading follows several years of weaker prices. Higher costs for natural gas and gasoline were offset by declines in food and services. Taking a long-term view, over the past 12 months wholesale costs have risen +0.8%, the highest one-year change since the end of 2014. Stripping out the volatile food, energy, and trade margin categories yields the so-called core producer prices. That measure is rising at an even faster rate, up +1.6% over the past 12 months, the fastest in 2 years. If these trends continue, higher wholesale prices will eventually lead to higher prices for consumer goods and services.
Consumer inflation rose at the fastest rate in 6 months, according to the latest Consumer Price Index (CPI) reading. The Labor Department reported that the index rose +0.4% last month, after rising +0.3% in September. On an annualized basis, the CPI is up +1.6% – the biggest year-over-year increase since October of 2014. The increase was in line with economists’ forecasts. Core inflation, which strips out potentially volatile food and energy costs, climbed +0.1% last month. Annualized, core inflation is currently 2.1% – right in line with the Federal Reserve’s 2% inflation target. The firming inflation along with the labor market approaching full capacity leads many analysts to believe that the Federal Reserve will have the green light to raise interest rates at its December 13-14 policy meeting.
Industrial production—a measure of output from America’s factories, utility plants, and mines—was unchanged in October, said the Federal Reserve, as a sharp drop in utilities production was offset by modest gains in factory output. Economists had forecast a +0.2% gain. In the details of the report, manufacturing output rose +0.2% and mining output jumped by +2.1%, but utilities production plunged 2.6%. High Frequency Economics chief U.S. economist Jim O’Sullivan said in a note to clients “Through the volatility, the trend in manufacturing appears to be at least modestly positive, and the oil-drilling-led plunge in mining seems to have ended.” Capacity utilization, a gauge of slack in the industrial economy, ticked down 0.1 percentage point to 75.3% last month in line with expectations.
In international economic news, the Bank of Canada said it won’t necessarily move in lockstep with the Federal Reserve if the U.S. central bank hikes its key interest rate next month, a move which is widely expected. Deputy Governor Timothy stated “We are free to adjust our policy interest rate in the context of Canadian economic conditions—and in particular, we do not need to move in step with the Federal Reserve” in a speech in Waterloo, Ontario. Mr. Lane pointed out that Canadians will no doubt feel the reverberations from whatever the U.S. does. Higher U.S. interest rates will likely push the Canadian dollar lower, boost exports, and push up some Canadian rates. As a net importer of foreign capital, Canada’s economy is exposed to the “vagaries of global flows”, Mr. Lane acknowledged.
In France, Emmanuel Macron formally declared that he will seek the French presidency in next year’s election, ending months of speculation. The 38-year-old former economic minister and protégé of President Francois Hollande left his government post in August saying he wanted more freedom for his ideas to repair France’s ailing economy and growing social divisions. Macron created his own political movement known as “En Marche” roughly translated as “On the Move!” and remains a popular political figure. His platform offers voters a pro-EU platform, in contrast with the National Front party of Marine LePen, the current front-runner.
German economic growth slowed in the third quarter of the year, hampered by weaker exports. Europe’s largest economy grew by just +0.2%, half the rate of the second quarter and far below the first quarter’s +0.7% advance. Germany’s Federal Statistics Office stated “Exports were slightly down while imports were slightly up compared with the second quarter of 2016. Positive impulses on the quarter came mainly from domestic demand. Both household and state spending managed to increase further.” Some analysts stated that the uncertainty caused by Britain’s vote to leave the EU may have counteracted the country’s solid domestic activity. In addition, worries of a more protectionist U.S. economy added to fears. ING Bank economist Carsten Brzeski said, “If Germany’s single most important trading partner, the US, really moves towards more protectionism, this would definitely leave its mark on German growth.”
In Asia, the election of Donald Trump may have put China in the driver’s seat for a new trade deal in the Pacific Rim. A decade-old plan for a free-trade area in Asia is set to be resurrected at a meeting of Pacific Rim country leaders in Peru, as the region works on an alternative to the U.S.-led Trans-Pacific Partnership. Donald Trump had taken a strong anti-TPP stance during his campaign. Leaders are looking to resurrect the Free Trade Area of the Asia Pacific (FTAAP). Completion of the deal would hand Chinese President Xi Jinping the reins in a most important geopolitical shift.
In Japan, Goldman Sachs chief Asia Pacific economist Andrew Tilton released a note that a firmer U.S. dollar is positive for Japan, even as Donald Trump’s victory cast uncertainty over the Asian economic outlook. The dollar surged to a 14 year high against a basket of major currencies and U.S. debt yields hit nearly one-year highs on expectations that Trump’s policies will boost the U.S. economy. Tilton told the Reuters Global Investment Outlook Summit in Hong Kong, “More Fed tightening and a stronger dollar is probably good for Japan. Japan is a very low-inflation country that is trying to stimulate the economy… but can’t really lower rates feasibly much further. So if the U.S. can raise rates and raise the currency versus the yen, then yen can depreciate without Japan having to do anything else. For Japan, this is great news.”
Finally, treasury yields have soared following the surprising election of Donald Trump for President of the United States. Theories abound regarding the causes and consequences of the move, but as always it is good practice to step back and take a look at the big picture. Veteran technical analyst Louise Yamada, in a CNBC interview, looked at interest rates in the U.S. over the last 200 years and draws our attention to a few points. First, according to Ms. Yamada, is that interest rates are most likely to only go up from here. Yamada refers to an apparent “bottoming formation” that has been forming over the last several years. On the 10-year Treasury note, a move above 3% would confirm her assessment because that’s the “level at which we can definitively say that rates have reversed”, Yamada states. Yamada predicts that higher rates will boost equity prices in the near term, as in past cycles. However, she will be watching the roughly 5% level where “you’ll start having problems.” 10-year Treasury notes finished this past week at 2.34%, so we’re a long way away from her danger zone.
(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 slightly to 23.50 from 23.30 , 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®