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 29.14, up from the prior week’s 28.70, 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 31, up 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. stocks posted impressive gains for the week with the Dow Jones Industrial Average enjoying the best return while the smaller indexes lagged. The Dow Jones Industrial Average surged +354 points to end the week at 20,624, up +1.75%. By market cap, the LargeCap S&P 500 gained +1.5%, while the S&P 400 MidCap index added +0.81%, and the SmallCap Russell 2000 rose +0.79%. The week’s winner was the tech-heavy NASDAQ Composite, which continued its surge above the now-distant 5000-level by rising +104 points last week to 5838, up +1.82%.
In international markets, Canada’s TSX rose for a second week, adding +0.7%. Across the Atlantic, the United Kingdom’s FTSE gained +0.57%. Across the Channel, major markets were green across the European continent. France’s CAC 40 rose for a second week, climbing +0.81%, and Germany’s DAX and Milan’s FTSE each rose +0.77%. In Asia, major markets were mixed. Japan’s Nikkei fell -0.74%, while, the Shanghai Composite rose a modest +0.17%. As grouped by Morgan Stanley Capital International, emerging markets rose a fourth straight week, up +0.44%, while developed markets added +0.60%.
Precious metals continued to shine this week. Gold rose for a third straight week, rising +$3.20 to $1,239.10 an ounce. Silver had its eighth consecutive week of gains, rising +0.54% to $18.03 an ounce. The industrial metal copper, viewed by some as a proxy of global economic health, retreated from last week’s gain by falling -2.2%. Oil continued to trade in its extraordinarily tight trading range, falling a negligible -$0.08 to $53.78 a barrel for West Texas Intermediate crude oil.
In U.S. economic news, the number of Americans that applied for new unemployment benefits last week rose 5,000 to 239,000, according to the Labor Department, remaining well below the key 300,000 level that analysts view as a healthy job market. New claims have remained below 300,000 for 102 straight weeks—the longest stretch since the early 1970’s.
Construction on new houses fell -2.6% last month, but analysts were quick to point out a positive detail in the report. The Commerce Department reported Housing Starts were at an annual rate of 1.25 million units last month. By region, starts plunged -41% in the West and -18% in the Midwest. However, the Northeast surged +55%, and the South rose by +20%. Multi-dwelling units, such as apartment complexes and condominiums, were responsible for the decline—falling nearly -8%. On a positive note, single-family homes rose almost +2% to an annual rate of 823,000. Single-family starts remain near a 10-year high. The aforementioned positive detail in the report was the number of permits to build new homes. That number climbed +4.6% in January to a pace of 1.29 million, up +8.2% in the past year.
Sentiment among home builders retreated for a second month, after the presidential election sent builder sentiment soaring to an 11-year high. The National Association of Home Builders (NAHB) sentiment index fell ‑2 points to 65 in February; economists had predicted an uptick to 68. Readings over 50 indicate improving conditions. All three sub-components of the index fell. The current sales conditions sub-index fell -1 point to 71, while sales expectations for the next 6 months declined -3 points to 73. Buyer traffic went into contraction, falling ‑5 points to 46. Overall, analysts remained optimistic. Michael Gapen, economist for Barclays noted, “In the near term, we expect a slight moderation in housing activity owing to higher mortgage rates, but the picture for 2017-18 remains one of modest trend improvement.”
Among small business owners, nearly one-third of business owners reported having job openings they’ve been unable to fill according to the National Federation of Independent Business (NFIB). The NFIB reported its index ticked up +0.1 point last month to 105.9, as business owners remained optimistic about better economic prospects under the Trump administration. Along with unfilled job openings, 18% of small businesses plan to create new jobs—the strongest reading since late 2006. Other components were all near long-time or record highs. In its release the NFIB stated, “Small business owners like what they see so far from Washington.” The group noted the similarities between the recent jump in sentiment and the surge in 1983 which ushered in “years of economic prosperity”.
Retailers in the U.S. posted strong sales last month, according to the Commerce Department. Sales rose +0.4% in January, and December’s result was revised up an additional +0.4% from its initial reading. Every major retail sector reported higher sales, except for autos. Ex-autos and gasoline, U.S. retail sales were up a strong +0.7%. Sales were strong across several fronts. Electronics and appliance sales were up +1.6%, along with clothing stores and sporting goods which each rose more than +1%. Of concern was the +2.3% spike in gasoline sales, reflecting higher energy prices. A significant rise in the price of gasoline could depress sales at other retailers.
Inflation at the wholesale level posted its biggest increase since 2012 last month, led by rising gasoline prices. The Producer Price Index (PPI) rose +0.6% last month, its largest advance since late 2012. Over the past 12 months, wholesale costs are up +1.6%. Analysts note that if prices continue to rise, the Federal Reserve could take a more aggressive approach by raising interest rates more than currently expected to keep inflation under control. The Fed has maintained an inflation rate of 2-2.5% as its target. The recent move in wholesale prices was led by a +13% surge in gas prices in January. But stripping out food and energy, the less-volatile “core” PPI was up only +0.2%. Core PPI has risen 1.6% over the past year, down from a two-year high of 1.8% two months ago.
Confirming the rise at the wholesale level, the Bureau of Labor Statistics reported the prices Americans pay for goods and services surged last month by the largest amount in four years. As with the wholesale PPI, the surge in the price of gasoline was the culprit. The Consumer Price Index (CPI), also known as the cost of living, rose a seasonally-adjusted +0.6% in January. Economists had only expected a +0.3% increase. Over the past year, the CPI has risen +2.5%, its sharpest year-over-year increase in 5 years. Along with gas, the cost of rent and medical care have also increased. Stripping out the volatile food and energy categories, core consumer prices were up only +0.3% last month. Year over year, core CPI was up 2.3%, about the same as last month.
Manufacturing on the East Coast recorded strong results, according to two separate reports. First, in the New York area, the New York Fed’s Empire State index jumped to its highest level in two years by rising +12.2 points to 18.7 this month. The reading was well above economists’ forecasts and the highest since fall of 2014. The details of the report were also strong. The new orders sub-index rose +10.4 points to 13.5, shipments rose +10.9 points, and unfilled orders sub-index rose above 0 for the first time in over five years. In addition, the Philadelphia Fed’s manufacturing index roared to a 33-year high, hitting 43.3. It was the biggest one-month gain in the index since 2009. Manufacturing in the Philadelphia region has been improving since the middle of last year. Stephen Stanley, chief economist at Amherst Pierpont Securities wrote, “It is an exaggeration to suggest that we are on the cusp of Morning in America, but factory managers are clearly feeling very good about their prospects in the wake of the election.” For the nostalgic, “Morning in America” was the famous commercial run by President Ronald Reagan during his re-election campaign that discussed economic revival.
Federal Reserve Chairwoman Janet Yellen gave testimony to the Senate Banking Committee that left open the possibility of an interest-rate increase as early as March. Yellen stated, “At our upcoming meetings, the Fed will evaluate whether employment and inflation are continuing to evolve in line with…expectations, in which case a further adjustment of the federal funds rate would likely be appropriate.” At future meetings, she stated the Fed would rely heavily on economic data to determine the strength of the labor market and whether inflation is moving to the central bank’s 2% target. Analysts diverged on the timing of the next rate increase. Of note, Senator Dean Heller of Nevada asked directly if the Fed would raise rates next month. Ms. Yellen’s enigmatic response was “every meeting is live.”
In Canada, Prime Minister Justin Trudeau state the whole world benefits from a strong European Union and that the bloc and his country are needed to lead the international economy in challenging times. Mr. Trudeau told the European Parliament that the Union was an unprecedented model for peaceful cooperation. Analysts view the speech as his distancing his country from both the United States under new President Donald Trump who has questioned the effectiveness and future of the bloc, and from Britain, which has voted to leave it. Mr. Trudeau said that Canada and the European Union shared a belief in democracy, transparency and the rule of law, in human rights, inclusion and diversity. “We know that, in these times, we must choose to lead the international economy, not simply be subject to its whims,” he said.
The latest economic forecasts from the European Commission show that France’s next president will be on a collision course with Eurozone headquarters almost immediately. The report states that the French government has repeatedly failed to stick to Eurozone budgetary rules, and is set to breach the 3% deficit limit by next year. France’s public debt currently runs at 97% of its national output. Three of the leading candidates (Marine Le Pen, Benoit Hamon, and Francois Fillon) have all stated that without radical change, France is doomed to decline. While originally a divisive issue, French voters on all points along the political spectrum now all seem to share that view.
In Germany, the Economy Ministry released a report expecting solid growth at the start of this year, driven by manufacturing and robust construction. However, uncertainties over the Brexit vote and U.S. President Donald Trump’s trade policies have clouded the outlook for its export-oriented economy. The Ministry’s report was mirrored in a survey that showed the mood of German investors had soured more than expected in February. Germany derives nearly half of its economic output from exports, and recently Trump’s top trade adviser has accused Germany of using a “grossly undervalued” euro to gain advantage over the United States and other EU trading partners.
Seeking to mend U.S. relations with China, the new U.S. Treasury Secretary Steven Mnuchin highlighted the need of a strong “but balanced” economic relationship between the world’s two largest economies in phone calls with China’s top economic officials. The U.S. Treasury Department said Mnuchin had made separate calls to several of China’s top finance officials. “In each of these calls, Secretary Mnuchin underscored that he looked forward to fostering strong US-China engagement during his tenure. The secretary emphasized the importance of achieving a more balanced bilateral economic relationship going forward,” the statement said. Inter-government contact between China and the U.S. stepped up following a phone call between Trump and Xi in the prior week.
The Japanese economy grew at an annualized pace of +1% in the final quarter of last year as weakness in Japan’s currency, the yen, spurred exports and business investment. The result confirms Japan’s economy is back on track after weakness last summer. Of concern, consumption was stagnant with no growth in the fourth quarter compared with the third. Analysts note that Japan is still struggling to escape from its two decades of on-and-off deflation. Harumi Taguchi, principal economist at IHS Markit in Tokyo remarked, “The momentum will probably continue the same way: weak domestic demand offset by external demand and hence continuing moderate growth.”
Finally, we often hear talk about the U.S. falling behind in this or that area. But one measure of forward progress is innovation, which can be concretely measured by the number of patents filed per country. On that score, the U.S. is the indisputable leader, and no other country is even close. This infographic shows that the U.S., at 3.03 million patents filed between 1977 and 2015, is almost 3 times as prolific as the next country, Japan. In fact, just the state of California outweighs all other countries but Japan!
(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 slightly to 22.25 from the prior week’s 22.50, while the average ranking of Offensive DIME sectors rose to 15.75 from 16.25. 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®