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 28.15, basically unchanged from the prior week’s 28.13, 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 61.96, down from the prior week’s 62.46.
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:
U.S. Stocks ended the week modestly lower as investors awaited the inauguration of Donald Trump to President of the United States. The Dow Jones Industrial Average rallied +94 points on Friday, but ended the week down -58 points, or -0.29%, for the week. Likewise, the NASDAQ Composite also ended down, giving up -18 points to close at 5,555.33, down -0.34%. Smaller stocks had a more difficult week, compared to larger stocks. The LargeCap S&P 500 was down only -0.15%, while the S&P 400 MidCap index fell -0.69%, and the SmallCap Russell 2000 lost over -1.4%.
In international markets, Canada’s TSX gained a third of a percent, while the United Kingdom’s FTSE reversed last week’s gain by falling -1.9%. On Europe’s mainland, markets were mixed. France’s CAC 40 fell -1.46%, while Germany’s DAX ended flat, up a miniscule +0.01%, and Italy’s Milan FTSE ended down -0.18%. In Asia, China’s Shanghai Stock Exchange index rose +0.33%, while Japan’s Nikkei fell -0.77%. As a group, developed markets (as measured by the MSCI Developed Markets Index) ended down -0.3%, while emerging markets (as measured by the MSCI Emerging Markets Index) also fell -0.7%.
In commodities, precious metals had a fourth week of gains. Gold added +$8.70 to close at $1,204.90 an ounce, up +0.73%. Likewise, silver rose +$0.27 to $17.03 an ounce, up +1.59%. Oil consolidated for a 7th straight week, rising +1.62% to $53.22 per barrel of West Texas Intermediate crude. The industrial metal copper retraced much of last week’s gains by falling -2.4%.
In economic news, the number of workers laid off fell back to a more-than-40-year low just as the new President was set to take office. Initial jobless claims fell -15,000 to 234,000 last week, slightly above the post-recession low. Economists had expected new claims to only fall by -5000. The 4-week average of claims, which reduces the volatility of the weekly reading, also fell by -10,250 to 246,750—the lowest level since November 1973. Initial claims for unemployment have been under the key 300,000 level for 98 straight weeks, a streak not seen since 1970.
Sentiment among home builders fell back to earth following the euphoria among builders following the 11-year high reached right after the presidential election. The National Association of Home Builders’ (NAHB) index fell ‑2 points to 67 in January. In its release the NAHB stated builders are still “optimistic that a new Congress and administration will help create a better business climate for small businesses, particularly as it relates to streamlining and reforming the regulatory process.” In the details of the report, the present-sales conditions slipped -3 points to 72, while the index of prospective-buyer traffic fell -1 point to 51. In its statement, builders still had the same concerns about headwinds from higher-priced land, skilled labor shortages, and now rising mortgage rates.
Housing starts surged last month to their second-highest level since the end of the Great Recession. Builders broke ground on more homes as confidence in the economy and demand for properties remained strong. Housing starts were at a seasonally-adjusted annual pace of 1.23 million homes in December, +11.3% higher than November and up +5.7% from the same period a year-ago. Permit applications were -0.2% lower than in November, suggesting that future growth may flatten. Ralph McLaughlin, chief economist for Trulia wrote in a note, “While there is much room for growth in starts as the economy continues to grow, the recovery in new construction will be slow and steady.”
Manufacturing in the New York area expanded for the third straight month, but pulled back after reaching an 8-month high at the end of last year. The New York Fed’s Empire State general business conditions index fell to 6.5 from a revised 7.6 in December. Economists had expected a reading of 8. Of most concern, new orders fell ‑7.1 points to 3.1, while shipments fell a little over a point to 7.3. A gauge of hiring improved but still showed that factories were cutting jobs. The report adds to evidence that manufacturing is growing modestly, but not fast enough to spur hiring. On a positive note, a measure of expected business conditions in six months nearly matched December’s five-year high.
In the city of brotherly love, manufacturing expanded at the fastest pace in more than two years. The Philadelphia Federal Reserve’s index of business conditions rose to 23.6 this month, up +3.9 points from December – the fastest pace since November 2014. Economists had expected a drop to 16. The underlying details indicated strength in labor demand as the employment index surged +9.2 points from December to 12.8 – the highest level in almost 2 years. New orders rose to 26 from 14.9, and shipments were also strong. Most manufacturers in the Philadelphia region expect business to be better six months from now. The future expectations index hit its highest level since the summer of 2014.
Output at America’s factories, mines and utilities rebounded last month posting its strongest advance in two years, with consumer goods and utilities leading the way. The Federal Reserve reported the Industrial Production index rose +0.8%, beating analyst expectations of +0.6%. The monthly increase was driven by a +1.1% jump in consumer durables, such as autos, which outweighed a drop in home electronics. In addition, utilities had a +6.6% surge in output driven by colder winter temperatures. Compared with the same period in 2015, production is up +0.5%. Analysts took the report with cautious optimism. Following the release, Jim O’Sullivan, chief U.S. economist at High Frequency Economics, stated “Through the volatility, the trend in manufacturing is probably at least modestly positive.”
Economic activity continued to expand at a modest pace across most of the twelve Federal Reserve Districts in December according to the latest Beige Book. The Federal Reserve’s Beige Book is a collection of anecdotes about the economy gathered before the central bank makes interest-rate decisions. Consumer spending was mostly positive with expanding retail sales, but some noted that holiday sales were disappointing. Manufacturers in most Districts reported increased sales, and firms across the country were optimistic about growth in 2017. Employment continued to expand with labor markets described as “tight” and “tightening”. Wage growth was generally modest, with price growth intensifying somewhat since the last report.
Inflation rose at the fastest pace in 5 years, up +0.3% last month according to the Bureau of Labor Statistics. Rising rents, medical care, and gas prices all contributed to the increase. Excluding the volatile food and energy categories, consumer prices were up +0.2%. In the 12 months through December, the CPI increased +2.1 percent, the biggest year-on-year rise since June 2014. The Fed has a 2 percent inflation target and tracks an inflation measure which is currently at 1.6 percent. Rising wages due to a tightening labor market also is contributing to higher inflation. Jim Baird, chief investment officer at Plante Moran Financial Advisors commented “Further momentum in consumer prices could add to the perception of a more hawkish Fed and the potential for more aggressive tightening.”
In international news, on Friday Canadian Prime Minister Justin Trudeau highlighted the importance of his country’s close economic ties to the U.S. and praised U.S.-Canadian relations as “one of the closest relationships between any two countries in the world” in a statement congratulating President Trump. “Together, we benefit from robust trade and investment ties, and integrated economies, that support millions of Canadian and American jobs. We both want to build economies where the middle class, and those working hard to join it, have a fair shot at success,” he said. It’s common for U.S. and Canadian leaders to boast about their nations’ close economic ties, but Trudeau’s emphasis on economic integration was in sharp contrast to Trump’s statements of turning economic policy inward.
Across the Atlantic, the International Monetary Fund has raised its forecast for the United Kingdom’s economic growth in 2017. Following the much better-than-expected economic performance following the Brexit vote, the IMF is now reversing its earlier wrong predictions of economic recession, crumbling home prices and a crash in the UK stock market. The IMF now expects the UK to grow by +1.5% this year. In its latest World Economic Outlook, the IMF sheepishly reported, “Preliminary third-quarter growth figures were somewhat stronger than previously forecast in the United Kingdom, where domestic demand held up better than expected in the aftermath of the Brexit vote.”
On Europe’s mainland, French National Front candidate Marine Le Pen has taken the lead in the latest opinion poll. Le Pen edged ahead of conservative rival and former frontrunner Francois Fillon, according to the French daily newspaper Le Monde. Le Pen now commands 25-26% support among likely voters, ahead of the 23-25% for Fillon, and Independent Emmanuel Macron with 17-20%. Le Pen is hoping to ride the same wave of populist sentiment that helped propel Donald Trump into the White House. The National Front leader has been a sharp critic of German Chancellor Angela Merkel’s refugee policy which has allowed almost 1 million migrants into Germany in the past year alone.
In Germany, economic sentiment brightened at the beginning of year, according to Germany’s ZEW think tank. Its measure of economic expectations rose to 16.6 points, up +2.8 points from December. Achim Wambach, ZEW’s president stated that the rise should be seen as a “leap of faith for 2017”. The ZEW survey reflects the assessment of financial analysts and institutional investors, but many economists also prefer to view related business surveys to gauge the underlying strength of Europe’s largest economy.
In Italy, the Bank of Italy said its economy will continue to grow this year at roughly the same weak rates as the last 2 years. However, in a warning it stated that the outlook was more likely to deteriorate rather than to improve. The Eurozone’s third largest economy has been one of the most sluggish performers in the bloc for more than a decade. GDP increased just +0.9% and will post an identical increase in 2017, according to its quarterly economic bulletin. “Overall the risks for growth are still on the downside,” the bulletin said, citing difficult conditions for Italy’s banks and warning that global growth could be weaker than expected due to possible protectionist policies.
China, the world’s second largest economy, hit its growth target last year and even accelerated into the end of the year, but its central bank still took the unusual step of injecting more money into its economy over the next month. China’s economy grew +6.7% last year according to the government’s statistics bureau, but the data comes after the leader of one Chinese province admitted GDP data has been faked for several years. The governor of Liaonin, Chen Quifa, said his province had been “involved in large scale financial deception” between 2011 and 2014 and that economic data had been altered. Addressing reporters’ questions about the Liaoning admission, the director of the National Bureau of Statistics said on Friday that the national data was “truthful and reliable”. Ning Jizhe added that “statistics departments on various levels will also be strengthening the law enforcement, supervision, and checks on figures” and “resolutely guarding and preventing” the fabricating of data.
Japanese Prime Minister Shinzo Abe, speaking in parliament hours before U.S. President-elect Donald Trump took office, said he wanted to further strengthen the Japan-U.S. alliance. “The Japan-U.S. alliance has been, is, and will be the cornerstone of our country’s diplomatic and security policies. This is an immutable principle,” Abe said in his policy speech at the start of the regular parliament session. “I am aiming to visit the United States as soon as possible to further fortify the bond of alliance together with new President Trump.” Abe met with Trump in New York after the election in November and called him a “trustworthy leader”.
Finally, as this week marked the inauguration of Donald Trump to President of the United States, researchers at MarketWatch.com thought it useful to take a look at the stock market’s performance during the first 100 days of a new President’s term. The results were surprising. Most would assume that the pro “Big Business” Republican Party would have the highest gains, but it was actually the Democratic Party that had the higher returns. Sam Stovall, chief investment strategist at CFRA reported since 1953 the S&P 500 has gained +1.6% on average during the first 100 days of a new President. The first 100 days of Republican presidency in that time period have returned a loss of -0.4%, while the first 100 days under Democrat presidents returned +3.5%. Shall we expect a similar result now? As Stovall reminded readers, history is only a guide and “never gospel”.
How stocks perform in a new president’s first 100 days
|S&P 500’s average % change||Higher what % of the time|
|All new presidents’ first 100 days||+1.6%||70%|
|New Republican presidents’ first 100 days||-0.4%||60%|
|New Democratic presidents’ first 100 days||+3.5%||80%|
Source: marketwatch.com and CFRA/S&P Global Data
(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 slipped slightly to 20.50 from the prior week’s 20.25, while the average ranking of Offensive DIME sectors rose to 13.25 from 14.25. 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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