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 28.13, basically unchanged from the prior week’s 28.16, 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 62.46, up from the prior week’s 61.42.
In the intermediate and Shorter-term picture:
The Shorter-term (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 Intermediate-term Quarterly Trend Indicator – based on domestic and international stock trend status at the start of each quarter – was positive entering January, indicating positive prospects for equities in the first quarter of 2017.
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. In the intermediate timeframe, the Quarterly Trend Indicator (months to quarters) is positive for Q1, and the shorter (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:
The major U.S. benchmarks ended the week mixed as the first significant fourth-quarter earnings results began to roll in. The tech-heavy NASDAQ Composite performed the best and reached record highs. The Dow Jones Industrial Average retreated -78 points, falling a bit further away from the 20,000 level to end the week at 19,885. The NASDAQ Composite rose +53 points to close at 5,574, up +0.96%. Smaller caps edged LargeCaps as the SmallCap Russell 2000 and S&P MidCap 400 gained +0.35% and +0.32%, respectively, while the large cap S&P 500 declined a modest -0.1%.
In International markets, Canada’s TSX ended the week flat. In Europe, major markets were green across the board. The United Kingdom’s FTSE added +1.77%, along with France’s CAC 40 and Germany’s DAX that each gained +0.26%. But Italy’s Milan FTSE gave back last week’s gains and declined -0.88%. Asian markets were mixed. China’s Shanghai Stock Exchange fell -1.3% and Japan’s Nikkei retreated -0.86%. However, Hong Kong’s Hang Seng had a third week of gains rising +1.93%. As a group, developed markets (as measured by the MSCI Developed Markets Index) rose +0.9%, while emerging markets (as measured by the MSCI Emerging Markets Index) notched a third week of gains by rising +2.06%.
In commodities, precious metals are beginning to shine again as both Gold and Silver tacked on a third week of solid gains. Gold rose +1.94% or $22.80 to close at $1,196.20 an ounce. Likewise, Silver added +1.49% to end the week at $16.76. The industrial metal copper, seen by some as an indicator of world economic health, surged +5.66%. Crude oil had a difficult week, falling -3% to close at $52.37 a barrel for West Texas Intermediate crude oil.
In U.S. economic news, the number of Americans who filed for new unemployment benefits rose by +10,000 in the first week of the new year to 247,000, according to the Labor Department. Analysts were quick to point out that the number still remains at an exceptionally low level. Initial claims have been under 300,000 for 97 straight weeks, a record that’s been intact since 1970. Many companies continue to complain of a shortage of good help to hire. The less volatile smoothed four-week average of new claims declined by -1,750 to 256,000. Continuing jobless claims, those already receiving unemployment benefits, dropped by -16,000 to 2.1 million in the final week of 2016.
Job openings were essentially flat in November, according to the Job Openings and Labor Turnover Survey (JOLTS), but analysts pointed to other signs that the job market is improving. The Labor Department reported that there were 5.5 million openings on the last day of November, 1.3% higher than October. In addition, the number of hires rose 1.1% to 5.2 million. Of note to analysts, the number of people who quit jobs voluntarily also rose, to 3.1 million—the second highest level since before the recession. A rising number of people quitting their jobs is viewed by analysts as a measure of confidence among workers that there are even better opportunities available.
Sales at U.S. retailers rose +0.6% last month, led by auto dealers who set a new sales record at the end of last year. Auto sales jumped +2.4% in December, the biggest gain since April. In addition, gas station sales rose +2%, largely due to higher gas prices. However, excluding the large auto sector (which accounts for 20% of overall retail business) and gas, retail sales were overall flat. Taking into account the flattish overall sales figures, Ian Sheperdson, chief economist at Pantheon Macroeconomics stated in a research note that December sales report suggests “that the surge in consumers’ confidence since the election has not yet translated into spending.” Of particular interest, internet stores were the only other retailers to post strong gains in December, rising +1.3%. Online sales were up an impressive +13.2% for the entire year, as shoppers continued transitioning to purchasing online rather than from traditional brick-and-mortar retailers.
Sentiment among small-business owners surged to 12-year highs in the wake of the U.S. presidential election, according to the latest report from the National Federation of Independent Business (NFIB). The NFIB said its optimism index rose +7.4 points to 105.8. Economists had only expected a rise to 99.6. Most of the improvement last month came from the “expectations” component of the index. A net 50% of respondents expect the economy to improve, a gain of +12 points from last month, and 31% expect sales volumes to increase—an improvement of +20 points. Owners are also increasingly reporting that “now is a good time to expand”. In its release, the NFIB said “Trump and the Republican Congress have the momentum, but maintaining it will likely be a challenge as the political process takes hold.”
Along with small businesses, sentiment among consumers was also near 13-year highs but retreated slightly this month, according to the University of Michigan. Their consumer sentiment survey fell to 98.1, down -0.1 point from December. This month’s report had a bit of a twist. Richard Curtin, the Surveys of Consumers chief economist stated the post-election surge in optimism was accompanied by “an unprecedented degree of both positive and negative concerns about the incoming administration spontaneously mentioned when asked about economic news.” The partisan divide on the Expectations Index was a stunning 42.7 points (108.9 among those who favorably mentioned likely Trump-government policies, and 66.2 among those who made unfavorable references).
Wholesale inventories rose +1% in November, the largest increase in two years according to the Commerce Department. Inventories of durable goods, such as new cars and appliances, rose +1% last month. Non-durable goods inventories, items such as clothing and groceries, also increased +1%. The component of wholesale inventories that goes into the calculation of gross domestic product – wholesale stocks ex-autos – increased +0.7%. Sales at the wholesale level also increased, up +0.4%. Using the latest data, it would take wholesalers 1.32 months to clear shelves, up +0.01 from October.
The Labor Department reported that the producer price index, which measures price changes at the wholesale/producer level rose +0.3% last month. The gain was led by a large increase in wholesale gas prices, which rose +7.8%. Overall, the index increased +1.6% last year, the biggest annual gain since September of 2014. Analysts point out that the annual increase is still low historically and that inflation is not currently an issue.
Consumers increased their borrowing at the fastest pace in 3 months in November, rising +7.9%. Total borrowing climbed $24.5 billion bringing total debt to $3.75 trillion according to the Federal Reserve. The category that covers credit card debt, called “revolving debt”, rose by $11 billion. It was the largest monthly increase since March and analysts note that it was a good sign for the start of the holiday shopping season. The category that covers student and auto loans, non-revolving debt, rose $13.5 billion, or +5.9%.
In international news, Canada’s Finance Minister Bill Morneau said he will exercise prudence as he plans the upcoming federal budget “to ensure that we have the capacity to deal with the environment that we find ourselves in.” Morneau’s statements come amid concerns of protectionist measures implemented by the incoming Trump administration. Morneau met with a dozen private sector economists in Toronto, but provided no details when asked about how Trump’s election win has impacted the budget preparation process. There have been concerns that the new U.S. administration could spell trouble for the Canadian economy, especially if border tariffs are implemented.
In the United Kingdom, the World Bank cut the UK’s growth forecast in its first review since the “Brexit” vote. In the sweeping global report, the Washington-based group says that it anticipates the UK economy to grow +1.2% this year and +1.3% in 2018, a downward revision from previous estimates of +2.1% annually for both years. According to its release, “The Brexit vote had limited short-term cross-border financial market spillovers, partly reflecting the commitment for further policy accommodation by major central banks.” In the longer term, the World Bank says the magnitude of any long-term adverse effects will depend on the type of relationship that the UK ends up negotiating with the remainder of the block. It is worth mentioning that none of the other universally-negative economist predictions about the effects of the Brexit vote have yet come to pass.
Across the Channel in France, authorities are investigating carmaker Renault for suspected fraud in its diesel emissions controls. Renault insisted that its cars are not equipped with pollution cheating software, and that the company complies with all French and European laws. French authorities raided Renault company premises after the German car manufacturer Volkswagen was found to have used engine software to cheat U.S. diesel emissions tests. In a statement Friday, Renault took note of the investigation but said its “vehicles are not equipped with cheating software affecting anti-pollution systems.” It said the company supports European moves to toughen emissions testing and has taken steps to reduce its own cars’ emissions over the past year.
The German economy grew at its fastest pace in 5 years last year as GDP rose +1.9%. The country also recorded its third successive year of budget surpluses. The current public sector budget surplus stands at 6.2 billion euros. Finance Minister Wolfgang Schauble acted to head off debate about using the budget surplus to fund tax cuts or public investments, pledging instead to use it to pay off debt. The message appeared intent on reassuring Chancellor Angela Merkel’s conservative support base. Germany’s growth has been powered by increased employment, rising wages, and higher spending. Unemployment is at a record low and the number of people employed is at its highest since 1990.
In Italy, Societe General strategist Albert Edwards, frequently labeled a “permabear”, spoke at a conference in London stating essentially that it was a waste of time to save Italian banks. The strategist said that Italy is in the midst of a serious banking crisis, but the government is wasting both time and money trying to save the country’s struggling lenders. Edwards argues that the banks will continue to suffer until more drastic measures are taken, alleging that the mountains of bad loans on the banks’ books are only a symptom and not the cause of Italy’s problems. Edwards argues that Italy needs to leave the Eurozone so that it will be able to control its own currency and interest rates. By returning to the lira and devaluing it, Italy could make its products much cheaper for foreign buyers.
Japan defended its trade relations with the United States, a day after President-elect Donald Trump said at a press conference “hundreds of billions of dollars of losses” face the country because of a trade imbalance with partners like Japan. Tokyo’s Chief Cabinet Secretary Yoshihide Suga told reporters Japan favors “active trade and investment” because it is at “the root of the vitality of U.S.-Japan economic relations.” The official also said Japanese companies have invested a total of $411 billion and employs about 840,000 Americans, quoting U.S. Department of Commerce data. “Japanese companies are good corporate citizens of the United States and are well known to Americans,” Suga said.
In China, exports suffered a sharp drop at the end of last year and fears are growing that its trading position will weaken further in 2017 if Donald Trump’s protectionist policies prompt a trade war. Trump has pledged to impose high tariffs on imports from China and to brand the country a currency manipulator. The President-elect has maintained that China has been devaluing its currency in order to make its exports more competitive in overseas markets. Beijing’s concern comes following a report showing exports fell for the second straight year in 2016, dropping -7.7%. The drop was the biggest fall since 2009. In addition, imports fell by over -5%.
Finally, since now is the time the media scours the planet looking for pundits to give forecasts for this new year, it might be useful to inoculate ourselves against then by keeping in mind these wise observations:
“We’ve long felt that the only value of stock forecasters is to make fortune tellers look good.”
“We have two classes of forecasters: Those who don’t know – and those who don’t know they don’t know.”
John Kenneth Galbraith
“Forecasts create the mirage that the future is knowable.”
“It ain’t what you don’t know that gets you into trouble. It’s what you know for sure that just ain’t so.” Mark Twain
(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 was unchanged at 20.25, while the average ranking of Offensive DIME sectors slipped to 14.25 from 13.75. 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®