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 27.99, up from the prior week’s 27.92, and now exceeding 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 62.01, up from the prior week’s 60.94.
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, unchanged from the prior week. 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:
After a strong start, the major equity indexes drifted lower and ended the week only marginally higher. The Dow Jones Industrial Average rose for a 7th straight week, adding +90 points to close at 19933. The Dow is inching closer to the psychologically-significant 20,000 level, up +0.46% for the week. The LargeCap S&P 500 edged higher by +0.25%, while the S&P 400 MidCap and Russell 2000 SmallCap indexes rose +0.35% and +0.52% respectively, continuing their 2016 outperformance relative to the LargeCaps.
In international markets, Canada’s TSX advanced +0.5%. Across the Atlantic, the United Kingdom’s FTSE rose for a third consecutive week, gaining +0.8%. On Europe’s mainland, France’s CAC 40 added +0.13%, Germany’s DAX gained +0.4%, and Italy’s Milan FTSE rose a fifth straight week, up 1.74%. In Asia, a mixed bag: Japan’s Nikkei had its seventh consecutive week of gains, rising +0.14%, China’s Shanghai Composite suffered a fourth straight week of losses losing -0.4%, and Hong Kong’s Hang Seng fell -2%. As a group, developed markets (as measured by the MSCI Developed Markets Index) rose +0.25%, while emerging markets (as measured by the MSCI Emerging Markets Index) fell -1.36%.
In commodities, precious metals are still searching for a bottom as Gold fell another -$3.80 an ounce to $1,133.60, and Silver caught up to Gold’s weakness losing -2.8% to end the week at $15.76 an ounce. Oil was basically flat, rising +$0.07 to $53.02 a barrel for West Texas Intermediate crude. Coincident with the rebound in oil prices, the number of U.S. previously-idled oil rigs going back into production surged to its highest level since January.
In U.S. economic news, the Labor Department reported that the number of newly unemployed jumped to the highest level since early summer. Initial jobless claims rose a seasonally-adjusted 21,000 to 275,000, a 6-month high. However, it also marks the 94th consecutive week of initial claims below 300,000—a threshold many analysts use as the sign of a healthy job market. Continuing jobless claims, the number of unemployed already receiving benefits, fell by almost 79,000 to 2.04 million.
Sales of previously owned U.S. homes rose +0.7% last month to an annual pace of 5.61 million, according to the National Association of Realtors (NAR). Analysts noted that higher prices and lean inventories continue to weigh on the housing market. NAR Chief Economist Lawrence Yun noted the “big obstacle is the ongoing housing shortage”. At the current pace of sales, there is a just a 4 month supply of homes on the market, compared to the more-desirable 6 month supply. The shortage of homes is pushing prices up: the median home price across the country is $234,900, an increase of +6.8% over November of last year. Sales were mixed regionally. In the Northeast, sales increased +8% accompanying a +1.4% gain in the South. The Midwest and West both declined, ‑2.2% and -1.6% respectively. First-time buyers made up 32% of all purchases last month.
Sales of new homes jumped last month to its second-highest pace since early 2008, another sign of robust housing demand. The Commerce Department reported that sales ran at a 592,000 seasonally-adjusted annual rate, up +5.2% from October and up +16.5% from this time last year. The median sales price was $305,400 in November, up $2,700 from October. The stronger sales continued to deplete the supply of new homes for sale, with 5.1 months’ worth of new homes available for sale last month, down from 5.4 months a year ago.
U.S. Consumer spending slowed in November after several months of gains as income growth flattened. Personal incomes were unchanged and spending rose +0.2%, according to the Commerce Department. Inflation also remained unchanged. The personal consumption expenditures (PCE) index rose +1.4% compared to this time last year. The PCE price index is the favored inflation gauge of the Federal Reserve. Ex-food and energy, the index is up +1.6% – a retreat from the +1.8% annual increase in October and a step further away from the Fed’s 2% target.
Confidence among consumers continued the surge following the election of Donald Trump to President, hitting its highest level in 12 years. The University of Michigan’s Consumer Sentiment index rose to 98.2, up a steep 5 points from November. The index is now at its highest level since January of 2004. Survey respondents stated that they expected a stronger economy that would create more jobs. Blerina Uruci, economist at Barclay’s, stated “Ongoing solid readings of consumer confidence reinforce our view that GDP growth should remain firm in the near term, and we see the level of confidence as consistent with ongoing strength in consumer spending.”
Orders for long-lasting “durable” goods fell last month for the first time in five months. Orders for durable goods fell -4.6% last month, led by a drop in orders for Boeing aircraft. The drop almost completely retraces the +4.8% increase in October. In an unusual twist, the details of the report were actually more optimistic than the headline. Ex-transportation (i.e., remove Boeing), orders for durable goods were up over +0.5%, the fifth straight monthly gain. Citi economists released a note stating “Core orders are a particularly important series to follow over the next few months as we try to discern whether investment spending is picking up in post-election data. Today’s number implies that at the very least equipment investment did not decline and may be a first hint that it is on a more favorable trajectory.”
Factory production weakened last month, according to the Chicago Federal Reserve. The Chicago Fed’s National Activity Index fell to -0.27 last month, down -0.22 from October. The index is a weighted average of 85 economic indicators, designed so that readings above zero indicate trend growth. Production-related indicators decreased to -0.2 in November falling from -0.01, reflecting weakness in the nation’s manufacturing sector. Steven Shields, economist with Moody’s wrote, “A reading of -0.27 still suggests the U.S. economy expanded at a below-average rate and is easing its foot off the accelerator after a stronger performance in early summer.”
The overall U.S. economy grew at a faster pace than originally thought in the 3rd quarter, according to the Commerce Department. Upward revisions in consumer spending and business investment pushed the latest GDP estimate up +0.3%, to a healthy 3.5% annualized rate. In addition, strong trade data in the form of a +10% spike in exports also contributed. Michael Gapen, chief U.S. economist at Barclay’s noted that the data signaled “the manufacturing, trade, and energy sectors stabilized during the quarter after nearly two years of contraction.”
In Canada, the steep rise of home prices has reached a level such that the Bank of Canada made the remarkable move of taking its warning of high household debt levels and red-hot home prices online in a most modern way: a video posted on YouTube. The Bank of Canada has voiced its concerns to Canadians for months, but it appears to have fallen on deaf ears. For example, Toronto home prices are up nearly +15% since this summer when Bank of Canada governor Stephen Poloz warned that price gains were “difficult to match up with any definition of fundamentals that you could point to.” In addition, Statistics Canada showed that the household debt-to-income ratio broke yet another record last quarter, further increasing the Bank of Canada’s unease.
In France, International Monetary Fund chief Christine Lagarde was found guilty of criminal negligence for an improper government payout to French businessman Bernard Tapie eight years ago while she served as France’s finance minister. The French court chose not to sentence Lagarde to a fine or jail time. In a statement Monday, Lagarde said she was not satisfied with the court’s decision but had chosen not to appeal.
In Germany, the Finance Ministry predicted that German economic activity will be shown to have picked up in the fourth quarter as household spending remains strong and exports are likely to show improvement. “For the final quarter, indicators are signaling a light acceleration in overall economic activity,” the Finance Ministry said in its monthly report.
The Italian government agreed to bail out the world’s oldest bank, Monte dei Paschi di Siena, after the bank failed to raise five billion euros from private investors. Paolo Gentiloni, Italy’s new prime minister said that the government would tap a 20 billion euro fund that had already been approved by the parliament earlier this week. In an effort to curb losses for Italy’s small investors that hold bank notes, finance minister Pier Carlo Padoan said the government would compensate small savers for their bank losses. Small investors are estimated to hold roughly 2 billion euros worth of Monte dei Paschi’s bonds.
The Bank of Japan is more optimistic about the Japanese economy, raising its assessment for the first time since May 2015. The BOJ’s more optimistic tone came as the government released its growth forecast for the coming year. The government now sees the economy picking up speed to a 1.5% growth rate, from the prior 1.3%. In a move widely expected, the BOJ kept its short-term rate target at -0.1% and its 10-year Japanese government bond yield at near zero. It also said it would continue to buy Japanese government bonds at the previous pace of around 80 trillion yen a year.
Finally, for more and more of us, online shopping has become the new normal. The primary beneficiary of this trend has been Amazon. Market research firm Slice Intelligence looked at 1.7 million online shopping receipts from early November to mid-December and discovered that the leader in online purchases is far-and-away Amazon, with a 36.9% share of the online market. No one else is even close. The next four are brick-and-mortar retailers with major online operations, but their combined market share adds up to only 12%. (Chart from CNBC)
(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 21.25 from 22.25, while the average ranking of Offensive DIME sectors slipped to 11.75 from 11.25. The Offensive DIME sectors continue to strongly 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®