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 28.70, up from the prior week’s 28.47, 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 67.60 up from the prior week’s 65.42.
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:
U.S. Stocks rose for the week bringing almost all of the major benchmarks to new highs. The Dow Jones Industrial Average rose +197.9 points to close at 20,269, up +0.99%. Likewise, the tech-heavy NASDQ Composite added +67 points to end the week at 5,734, up +1.19%. By market cap, gains were fairly equal with the LargeCap S&P 500 rising +0.81%, MidCap S&P 400 adding +0.83%, and the SmallCap Russell 2000 up +0.8%.
In international markets, Canada’s TSX rebounded from last week’s drop by climbing +1.6%. Across the Atlantic, the United Kingdom’s FTSE gained +0.98%, while on Europe’s mainland France’s CAC 40 and Germany’s DAX rose less robustly at +0.06% and +0.13%, respectively. Italy’s Milan FTSE fell a second week losing -1.3%. In Asia, major markets were green across the board. China’s Shanghai Composite rose +1.8%, along with Japan’s Nikkei that rebounded +2.4%. Hong Kong’s Hang Seng index added +1.9%. Overall, as measured by the Morgan Stanley Capital International group indexes, emerging markets rose a third straight week by gaining +1.2%, while developed markets were unchanged on the week.
In commodities, precious metals continued to shine. The price of gold rose $15.10 to $1,235.90 an ounce, a gain of +1.24%. Silver, as might be expected, was strong as well rising +2.6% to $17.93 an ounce. Oil continued to trade in a very tight range, rising just +$0.03 to $53.86 for a barrel of West Texas Intermediate crude oil. Copper, seen by some as an indicator of worldwide economic health, surged sharply, gaining +5.8%, reaching its highest level since June of 2015.
In U.S. economic news, the number of Americans who applied for unemployment benefits in the first week of February fell 12,000 to 234,000—the second lowest level since the end of the Great Recession. Economists had expected 249,000 initial claims for unemployment. Analysts view initial claims levels below 300,000 as indicative of a healthy job market. By that measure, initial claims have been at a healthy level for 101 straight weeks—the longest streak in 40 years. The smoothed four-week average of initial claims, used to reduce the volatility of the weekly number, fell by 3,750 to 244,250. That reading is the lowest level in 44 years. Companies continue to report tight labor market conditions with difficulty finding qualified workers.
The Labor Department reported in its monthly Job Opening and Labor Turnover Survey (JOLTS) report that the number of job openings was essentially unchanged, but hires continued to increase amid a robust labor market. There were 5.5 million job openings on the last day of the year, the same as November, but the number of people hired rose 100,000 to 5.3 million. The number of people that quit their job fell 100,000 to 3 million. Analysts view the “Quits” number as a signal of how confident workers are in their ability to secure another job elsewhere. Pantheon Macro Chief Economist Ian Shepherdson anticipates that job openings will surge over the next few months, writing “We now expect to see a renewed upward trend, following the clear recoveries in the several employer surveys of hiring intentions. These surveys tend to lead the JOLTS report.”
Whether you are a Republican or Democrat makes a big difference in your attitude as a consumer, according to the latest consumer sentiment data. The University of Michigan’s consumer sentiment survey dropped 2.8 points to 95.7 this month after hitting the highest level since 2004. Overall, Americans were fairly consistent with their opinion on current economic conditions; however views of expectations over the next 6 months differed substantially whether the respondent was Republican or Democrat. Roughly 60% of consumers polled made either positive or negative references to government action by the new Trump administration, an unusually high level per the report. Expectations among Democrats were near a historic low, while for Republicans were near a record high. The chief economist of the University of Michigan survey described the differences as “troubling”.
The Bureau of Economic Analysis reported the U.S. trade deficit hit its highest level in four years last year, reaching $502.3 billion. The trade gap continued to widen last year as the dollar value of exports fell faster than the value of imports. Analysts cited a stronger dollar that made American products more expensive overseas and a weaker global economy contributing to the deficit. Going back, the last time the U.S. had an actual trade surplus was in the mid-1970’s. Of the major U.S. trading partners, the gap with China is by far the largest. Trade with China was responsible for $347 billion of the deficit. The deficit with Mexico, of particular interest to the new Trump administration, rose +4.2% to $63.2 billion—a five year high. On a monthly basis, the deficit fell -3.2% in December, matching economist expectations.
Inflation may see an uptick later this year, as the cost of imported goods surged in January for the third time in four months. Import prices rose +0.4% last month after a +0.5% gain in December according to the Bureau of Labor Statistics. Overall, import prices are climbing at the fastest pace in five years, advancing +3.7% in the last year. Analysts believe the rise is mostly due to the rebound in the price of oil. Stripping out fuel costs, import prices actually fell -0.2% last month. This suggests that broader-based inflation is not yet taking hold. Turning to exports, the price of goods exported by the U.S. to other nations rose +0.1% last month and is up +2.3% over the past year. That’s also the largest increase in five years.
Consumer borrowing rose just $14.2 billion in December, missing analyst expectations of $20 billion as consumers’ use of credit cards slowed. Total consumer credit stood at $3.76 trillion, with a seasonally adjusted annual growth rate of +4.5%, according to the Federal Reserve. Revolving credit, which is predominantly credit card debt, slowed to $2.3 billion—an annual growth rate of +2.9%. That was the smallest rise since early 2016, and a plunge from November’s +14.4% increase. Richard Moody, chief economist at Regions Financial, described consumers’ use of credit cards as “judicious and selective” since the financial crisis, and wrote that the 2016 holiday shopping season was “fairly pedestrian compared to historic norms.” For all of 2016, total consumer credit rose +6.4%.
In international news, Canada’s “housing bubble has burst” warned David Madani of Capital Economics. Madani wrote, “The abrupt slowdown in Vancouver’s housing market serves as a warning shot. As things stand now, the performance of the economy this year could hinge on the direction of the much larger overheated Toronto housing market.” Vancouver home sales have plummeted 40 per cent over the last 12 months and despite mortgage rates remaining very low, house prices are also beginning to drop. “Overall, while the investment boom in housing supported the economy through the oil shock, the further deterioration in housing affordability and greater housing imbalances are worrisome, symptomatic of an economic crisis in the making caused by investor speculation and excessive financial leverage.”
In the United Kingdom, the Office for National Statistics reported Britain’s industrial output grew and its trade deficit improved in December, signaling a positive economic outlook despite the United Kingdom’s looming exit from the European Union. Industrial output climbed +1.1% over November with the metal and pharmaceutical sectors being particularly strong. Economists were expecting only a +0.2% rise. Scott Bowman, UK economist at Capital Economics stated, “Today’s economic activity data added to other evidence suggesting that the economy maintained a significant amount of momentum at the end of 2016 and implies that GDP (gross domestic product) growth is becoming more balanced.”
On Europe’s mainland, the Banque de France announced that its initial forecast for the French economy is for +0.3% quarter-on-quarter growth in the first 3 months of the year. That would be a -0.1% slowdown from the fourth quarter of last year. For all of this year, the French central bank expects +1.3% growth, a +0.2% increase over last year.
Germany’s trade surplus surged to a record high last year of $270.5 billion according to the Federal Statistics Office. The surplus is likely to increase tensions between Washington and Berlin, especially as U.S. President Donald Trump’s top trade adviser had accused Berlin of exploiting a “grossly undervalued” euro to its advantage. Marcel Fratzscher, head of the DIW economic institute stated, “The record surplus will continue to fuel the conflict with the USA and within the EU.” Responding to critics of its monetary policy, the European Central Bank’s finance minister Wolfgang Schaeuble said that the euro actually was too weak for Germany, but he noted that the ECB “must make policy that works for Europe as a whole.”
In Italy, formerly one of the single currency pioneers, many Italian voters now believe the euro is to blame for the country’s economic downturn since the euro launched in 1999. Michael Hessel, political economist at Absolute Strategy Research stated, “I would say Italians are probably the most disenchanted in Europe by the single currency. The net majority think their future is better outside the European Union, although not by much.” Currently three of the four major political parties vying for power are tapping into the increasing anti-euro sentiment in the country.
In Asia, China’s exports surged +7.9% last month from a year earlier to $18.3 billion. Imports also rose +16.7% to $13.1 billion. The better-than-expected results point to stronger growth in global trade and improving domestic demand. Capital Economics China economist Julian Evans-Pritchard said, “the big picture is that Chinese trade values have been picking up in recent months thanks to a revival in global manufacturing, the continued strength of China’s domestic economy and the rebound in global commodity prices.” It was the greatest year-over-year percentage increase since March 2016.
Japanese Prime Minister Shinzo Abe arrived Thursday in Washington for talks with Donald Trump. President Trump pledged close security and economic cooperation with Japan, stating “The bond between our two nations and the friendship between our two peoples runs very, very deep. This administration is committed to bringing those ties even closer. We are committed to the security of Japan and all areas under its administrative control and to further strengthening our very crucial alliance.” The visit was Mr. Trump’s second with a head of government since being sworn in last month.
Finally, a subtle change in the internals of the stock market bodes well for active portfolio strategies such as momentum, relative strength, trend-following and even individual stock picking. The change is a significant drop in correlations among stocks, away from the herd-like “risk on – risk off” moves in which all stocks go the same direction at the same time in the same magnitude. That herd-like behavior dominated the 2009-2015 period, but during 2016 (and so far in 2017), correlations among stocks have fallen sharply, back to levels that predominated in the 1990-2007 era (a great era for those active strategies). The lower correlations typically result in a much wider dispersion of returns, with much greater differences between top performers and low performers. Brian Belski, chief investment strategist at BMO Capital Markets, recently noted that active strategies “will be the key to delivering outperformance in the coming months, as opposed to the more passive strategies that have been mostly dominating the investment landscape the past several years.”
(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 to 22.5 from the prior week’s 21.25, while the average ranking of Offensive DIME sectors slipped to 16.25 from 13.50. 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®