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 28.44, up from the prior week’s 28.15, 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 63.63, up from the prior week’s 61.96.
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 30, up 1 from the prior week’s 29. 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. stock benchmarks reached new highs this week, supported by better-than-expected earnings reports from several prominent firms and optimism of future economic growth. The tech-heavy NASDAQ Composite performed the best, but most of the focus was on the Dow Jones Industrial Average finally breaking through the 20,000 barrier. For the week, the Dow Jones Industrial Average added +266 points (+1.34%) to close at 20,093. The NASDAQ composite added +1.9% to close at 5,660. Smaller capitalization stocks edged large caps as the S&P 500 gained 1.03%, while the S&P 400 MidCap index and SmallCap Russell 2000 rose +1.25% and +1.39%, respectively.
In international markets, Canada’s TSX was essentially flat, rising just +0.18% Across the Atlantic, the United Kingdom’s FTSE fell -0.19%, while on Europe’s mainland France’s CAC 40 declined -0.22% and Italy’s Milan FTSE ended down -0.77%. Germany’s DAX bucked the trend by rising +1.58%. China’s Shanghai Stock Exchange had a second week of gains, adding +1.15%, and Japan’s Nikkei reversed two weeks of losses by rising +1.7%. As a group, developed markets (as measured by the MSCI Developed Markets Index) added +0.98%, while emerging markets (as measured by the MSCI Emerging Markets Index) rose +2.88%.
In commodities, precious metals were mixed; gold gave up much of its recent gains by falling -$16.50 to $1,188.40 an ounce, while silver rose +$0.10 to $17.14 an ounce. Oil continued its eighth week of consolidation in a tight range, closing down only -$0.05 to $53.17 per barrel of West Texas Intermediate crude. Copper, the industrial metal some analysts view as a gauge of worldwide economic health, returned to November’s highs by gaining +2.46%.
In U.S. economic news, the Labor Department reported the number of Americans who applied for unemployment benefits rose 22,000 to 259,000 last week, but overall the level of benefit claims remains extremely low. New claims remained under the key 300,000 threshold for the 98th straight week—a record last seen in the early 1970’s. The less volatile four-week moving average of claims fell by 2000 to 245,500, according to the Labor Department. Continuing jobless claims, those people already collecting unemployment benefits, rose by 41,000 to 2.1 million in the week ended January 14. That number is reported with a one-week delay.
Sales of previously-owned homes slipped in December, as tighter inventories, higher asking prices and higher mortgage rates may have finally begun weighing on home sales. Existing-home sales ran at a seasonally-adjusted annual pace of 5.49 million, according to the National Association of Realtors, down -2.8% from November’s upwardly revised reading. Existing home sales closed out 2016 up +3.8% compared to the full year 2015. Inventory continued to tighten as there were only 1.65 million homes available for sale at the end of December -the fewest since 1999. Given the current sales pace, there is approximately a 3.6 months’ supply of available homes. Jim O’Sullivan, chief U.S. economist for High Frequency Economics commented, “The recent rise in mortgage rates could lead to weakening, of course, but on the positive side consumer and builder confidence measures both show sizable gains in recent months.”
Following disappointment in existing home sales, new-home sales likewise tumbled to a 10-month low last month. The Commerce Department reported that new-home sales declined to a seasonally-adjusted annual rate of 536,000, -10.4% lower than November’s pace, and down -0.4% from a year earlier. Economists had forecast a 595,000 rate. The median sales price was $322,500, +4.3% higher than in November and almost +8% higher than in December of 2015. Lower sales increased the amount of available supply to 5.8 months. Economists note that new home sales data is notoriously volatile, and that overall the trend in new home sales remains up. The Commerce Department noted that 563,000 new homes were sold in 2016, over +12% higher than 2015 and the most number of homes sold since 2007.
The Commerce Department reported that the U.S. economy’s expansion slowed in the fourth quarter as the nation’s Gross Domestic Product (GDP) expanded at a 1.9% annual rate in the final quarter of 2016. That’s a significant drop from the 3.5% growth rate in the 3rd quarter and well below the consensus of 2.2%. For the entire year, the U.S. grew just 1.6%, compared with the 2.6% increase in 2015. Newly-elected President Trump has vowed to make economic growth a key part of his administration, promising to cut taxes, reduce regulations, and spend more on public works. In the details of the report, a wider trade deficit was the biggest negative factor on the GDP calculation. Had the trade gap been unchanged, the economy would have grown over 3%. Trade has been a drag on the U.S. due to a softer global economy and a stronger dollar that makes American exports more expensive.
Manufacturing in the U.S. ended the year on a solid note according to the Institute of Supply Management’s Purchasing Manager’s index (PMI). In its latest reading, January’s PMI rose to 55.1 in January up from December’s 54.3. The solid improvement in business conditions was driven by sharp increases in output and new orders. In addition, companies raised their purchasing activity to highest rate since early 2015 and increased payrolls to meet the greater production requirements. Chris Williamson, Chief Business Economist at IHS Markit commented, “US manufacturers are seeing a bumper start to 2017, with production surging higher in January on the back of rising inflows of new orders. New work is growing at the fastest rate in over two years, thanks mainly to rising demand from customers in the home market.”
However, according to the Commerce Department, orders for long-lasting, or so-called “durable” goods, fell last month – its second decline in row. New orders for durable goods fell -0.4% last month, missing analyst expectations for a +2.5% rise. The decline was led by a decline in orders for defense-related equipment such as jets and other major hardware. However, other areas of the U.S. manufacturing base remained resilient. Core durable goods orders, which excludes autos and transportation equipment, rose +0.5% in line with expectations.
Consumers’ views of the economy and personal finances jumped in January according to new data from the University of Michigan’s Survey of Consumers. The index rose +0.3 points to 98.5, exceeding forecasts and +7.1% higher than the same time last year. The sub-index of current economic conditions fell -0.6 point to 111.3, however the expectations gauge rose +0.8 point, +9.2% higher than the same time last year. Survey director Richard Curtin wrote in the release, “Consumers expressed the most positive outlook for their personal finances in more than a decade.” Curtin was quick to caution that the euphoria among respondents was “based on political promises”, and not yet on economic outcomes.
According to two indicators released this week, there are signs the U.S. economy is accelerating. The Conference Board’s Leading Economic Index (LEI) rose +0.5% last month, the fourth consecutive rise. The index gain was driven by expectations that the election of Donald Trump will stimulate the economy. Ataman Ozyildirim, director of business cycles and growth research at The Conference Board stated, “The U.S. Leading Economic Index increased in December, suggesting the economy will continue growing at a moderate pace.” The major contributors to the index improvement came from the increase in the 10-year bond (presumably an expectation of growing inflation), gains in the S&P 500 index, the rise in consumer confidence, and the gain in the new orders component of the manufacturing survey.
Separately, activity in the U.S. services sector increased in January according to market research group Markit. Markit reported that its flash reading of the services Purchasing Managers Index (PMI) rose to 55.1, up +1.2 point from December, to its highest level in more than a year. Services make up approximately 80% of the U.S. economy, which makes this data key for gauging economic growth. Markit indicated that the survey showed faster rises in business activity and new work with firms reporting the strongest business outlook in almost 2 years. Markit chief economist Chris Williamson commented, “The strong start to 2017 and bullish mood for the year ahead adds to our expectation that we will see the Fed hike rates a further three times in 2017.”
In international economic news, Canadian exporters are scrambling to find ways to avoid a potential 10% import tax proposed by U.S. President-elect Donald Trump. Strategies have been proposed up to and including shifting of production or supply lines south to the United States. Jim Rakievich, chief executive of Edmonton-based McCoy Global, which makes oil and gas industry equipment states, “We’re a Canadian company, we like to build things in Canada and export them…but you can’t sell stuff and not make money. We could move our production down into the U.S. fairly quickly, we could absorb that production (in our U.S. plants) if we had to.” With about 74% of all Canadian goods heading south, the U.S. is by far Canada’s largest export market. Canadian companies with U.S. affiliates appear to be best positioned to handle new tariffs, if they are able to shift production or investment to their U.S. plants to avoid an import tax.
In the United Kingdom, the economy grew by -0.6% in the fourth quarter according to the Office of National Statistics (ONS). The ONS added that the services sector was the primary driver, with strong contributions from consumer-focused industries such as retail sales and travel agency services. The UK ended the year on a high as growth in final quarter showed little to no sign of any negative effects of the Brexit vote. Darren Morgan, head of GDP at the ONS said, “Strong consumer spending supported the expansion of the dominant services sector and, although manufacturing bounced back from a weak third quarter, both it and construction remained broadly unchanged over the year as a whole.”
In France, economic momentum continued to accelerate to its strongest in more than five years last month, data from research firm IHS Markit show. December’s PMI for Manufacturing and Services rose +0.7 point to 53.8 – solidly above the 53.2 median estimate and the highest level since June 2011. Alex Gill, economist at IHS Markit stated, “The French private sector continued to grow at a solid rate in January. The expansion was broad-based with marked increases in output evident in both the manufacturing and services sectors, driven by firm underlying client demand.”
In Germany, President-elect Trump’s vow to leave the Transpacific Partnership has German leaders eyeing their economic opportunities in the region. In an interview with Handelsblatt newpaper, German Vice Chancellor Sigmar Gabriel commented on the possibilities that surround Trump’s new “America First” approach. If the U.S.’s trade relations with Asia and South America were to sour, Gabriel remarked “it will open up opportunities for us.” While the U.S. is Germany’s largest export destination, Gabriel made it clear that Europe and other nations around the world would collectively account for much more.
In China, Alibaba executive chairman Jack Ma said China’s short-term economic outlook will be “tougher than expected” and that trade friction with the U.S. was “inevitable”. In addition, the e-commerce billionaire remarked, “In the coming three to five years … the economic situation will be even more arduous than everyone had expected.” China’s economy grew by about +6.7% last year, the slowest in 26 years. Reuters cited policy sources as saying China would lower it 2017 economic growth target to about +6.5% from last year’s range of 6.5%-7%. Ma also said it was “only natural” that China’s rapid growth over the past three decades could not continue, and that the focus should be shifted to the quality of growth, such as upgrading its manufacturing industry.
Chief Japanese government spokesman Yoshihide Suga said Japan is preparing for all possible contingencies regarding trade talks with the U.S. The remarks followed U.S. President Donald Trump’s decision to cancel the Trans-Pacific Partnership. An official in Trump’s administration said Trump would seek quick progress towards a bilateral trade agreement with Japan in place of the broader Asia-Pacific deal. At a news conference, Suga commented, “It is true that we are preparing to be able to respond to any possible situation. The alliance and the economy between Japan and the U.S. is very important, so we would like to have talks at various levels with the U.S. (about) how we can develop.”
Finally, as disputes over the proposed border wall and lopsided trade between the U.S. and Mexico continued this week, an examination of the actual facts of the US-Mexico trade situation is timely.
In President Trump’s apparently preferred way to communicate with the U.S. public, Trump tweeted that the 1994 agreement known as NAFTA was a “one-side deal from the beginning.” Trump noted that Mexico ran a trade deficit with the U.S. from 1991 to 1994 (the year NAFTA went into effect), but moved to a surplus the next year (1995) – and has remained there ever since, growing annually.
Mexico has become a major producer of automobiles, electronics and appliances, in addition to oil exports. For 2016, the estimated trade deficit has ballooned to nearly $60 billion – about 12% of the overall U.S. annual trade gap. U.S. companies have invested heavily in Mexico, employing more than 1.29 million Mexicans.
The graphic on the next page, from Marketwatch.com, shows that the U.S. runs a trade deficit in 12 of the 16 trade categories monitored by the U.S. Census Bureau.
(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 to 21.50 from the prior week’s 20.50, while the average ranking of Offensive DIME sectors rose slightly to 13.00 from 13.25. 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®