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 29.23, little changed from the prior week’s 29.36, and now exceeds 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 73.04 down from the prior week’s 74.28.
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, down from the prior week’s 33. 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 Positive.
In the markets:
U.S. stocks moved modestly lower, with the Standard & Poor’s S&P 500 Index recording its first weekly loss since mid-January. As has been the theme recently, smaller cap indexes underperformed large caps, now for four consecutive weeks. The SmallCap Russell 2000 index is now down roughly -3.5% from its all-time peak it established in early March, undoing some of the dominance that SmallCaps exhibited throughout 2016. The Dow Jones Industrial Average retreated -102 points to end the week at 20,902, a loss of -0.49%. The tech-heavy Nasdaq Composite ended down a slight -0.15%, closing at 5,861. Market analysts noted that this week marked the eighth anniversary of the bull market that began in March, 2009. By market capitalization, the LargeCap S&P 500 fell -0.44%, while the MidCap S&P 400 retreated -1.6%, and the SmallCap Russell 2000 ended down over -2%.
Canada’s TSX reversed last week’s gain, falling -0.65%. In Europe, the United Kingdom’s FTSE retreated from last week’s all-time high by falling -0.4%. On the European mainland, France’s CAC 40 and Italy’s Milan FTSE were essentially flat, while Germany’s DAX retreated half a percent. In Asia, China’s Shanghai Composite fell for a second week, down -0.2%, while Japan’s Nikkei rose for a third straight week, up +0.7%. As grouped by Morgan Stanley Capital International, developed markets were up a second week by +0.2%, while emerging markets fell a third consecutive week, losing half a percent.
In commodities, precious metals were down for second week. Gold was off by -2%, or $25.10 to end the week at $1,201.40 an ounce. Silver, traditionally more volatile than gold, fell -4.6% to $16.92 an ounce. The industrial metal copper, viewed by some as an indicator of worldwide economic health, retreated -3.8%. Oil has been in a 3-month consolidation, but broke out to the downside this week, plunging -9% on heavy volume to close at $48.49 per barrel of West Texas Intermediate crude oil.
In U.S. economic news, the U.S. created 235,000 jobs last month and the unemployment rate was 4.7% for President Donald Trump’s first full month in office. Leading the way was construction with 58,000 new jobs. Manufacturing also posted strong gains, adding 28,000. Economists were only expecting 190,000 new jobs. The results come as analysts expect renewed economic growth from President Trump’s push for tax cuts, less regulation, and higher domestic spending. The total number of Americans employed surged 447,000 to 152.5 million—its highest reading ever. Tony Bedikian, head of global markets for Citizens’ Bank stated, “Hard to see any negative signs in this report. This should put the Fed strongly on the table for next week’s potential tightening.”
The private sector recorded its third-best showing for jobs creation since the Great Recession according to data from payrolls processor ADP. ADP reported that 298,000 new private-sector jobs were added last month, the highest in nearly three years. The details of the report were also strong. Well-paying fields like construction, professional services, and business services each added 66,000 jobs, while education, health, and leisure and hospitality each added another 40,000. Importantly, manufacturing – which has lagged the economic recovery – added 32,000 jobs.
New orders for U.S.-made goods climbed 1.2% in January, according to the Commerce Department. Factory orders have now increased 6 out of the last 7 months, and suggest the recovery in the manufacturing sector continues to gain momentum. Orders were up 5.5% from the same time last year. Manufacturing accounts for roughly 12% of the U.S. economy.
The Federal Reserve reported that corporate debt grew by the slowest percentage in six years in the final quarter of last year. Analysts believe that companies are taking a more cautious stance as the Federal Reserve prepares to raise interest rates. Corporate debt grew at a seasonally adjusted annual rate of 0.8% in the last quarter of 2016. Cash levels remained roughly the same at $2.08 trillion. Overall, household and non-profit net worth rose $2.04 trillion to $92.8 trillion. Most of that gain came from stock market gains as corporate equities added $728 billion in market valuation.
The increase in labor productivity among American firms and employees remained unchanged at 1.3% in the final quarter of last year, making 2016 the worst performing year since 2011. Output, which is the amount of goods and services produced, increased 0.2% to 2.4%. Productivity increases when output rises faster than hours recorded on the job. The most significant aspect of the latest report is the big increase in productivity among manufacturers. The government revised the gain up 1.3% to 2%. Rising productivity is the key to a more vibrant economy, as it allows companies to earn bigger profits and invest more while paying better salaries to workers.
The U.S. trade deficit surged to a five-year high in January, rising 9.6% to $48.5 billion in January. The wider deficit was driven by a 2.3% increase in imports of oil, foreign-made cars, and consumer goods like mobile phones from China and other countries. The rising cost of oil also boosted the value of U.S. imports. U.S. exports rose a lesser 0.6% to $192.1 billion. Exports of cars and trucks, oil, and soybeans all rose sharply. Both imports and exports rose to their highest levels since December of 2014, evidence that global trade is picking up. A close aide to President Trump, economist Peter Navarro, argued in a major address this week that a high trade deficit poses large risks economically and undermines national security.
In international news, the Paris-based thinktank Organization for Economic Cooperation and Development (OECD) reported Canada’s economy is expected to grow by 2.4% this year, matching the U.S. rate of growth. That’s an increase of 0.3% over the group’s last growth estimate. The group said Canada’s economy will be supported this year by export growth, a better market for commodities, and government spending initiatives. However, once again it was concerned with the rapid increase in Canadian home prices. “As past experience has shown, a rapid rise of house prices can be a precursor of an economic downturn,” it wrote. The OECD works with the governments of 35 member countries to collect data and analyze trends around the world.
In addition, the OECD raised its forecast for the United Kingdom as well, its second upgrade in just four months. The OECD, which had previously (and very mistakenly) predicted a collapse of the UK’s economy if it voted to leave the EU, upgraded the UK’s growth forecast to 1.6%, up 0.4% from November’s estimate. Chancellor Philip Hammond of the United Kingdom remarked that the economy was performing “extremely well” in the wake of the Brexit vote. However, those that were expecting an increase in government spending in the Chancellor’s new budget will be disappointed. The Chancellor stated that the Treasury’s priority is “making sure that our economy is resilient, that we’ve got reserves in the tank”.
Across the Channel in France, French companies created the most jobs last year since the global financial crisis. Data from the nation’s statistics office Insee suggest the next French president set to take office will inherit an economy showing modest signs of recovery. A total of 187,200 jobs were created in the non-farm private sector in 2016—the highest annual figure since 2007. The final quarter of the year produced over 64,000 jobs. Philippe Waechter, chief economist at Natixis, a French investment bank, said the rise was “in line with improving sentiment among business leaders who are anticipating an increase in activity.”
In Germany, the nation referred to as the “powerhouse” of Europe may be showing some signs of weakening. Carl Weinberg, chief economist at High Frequency Economics notes, “The crack in Germany’s economy has become most evident in consumer spending. Retail sales volumes have slowed consistently since growth rates peaked in mid-2015. They have crashed in the last six monthly reports.” In addition, other data showed German industrial new orders dropped by 7.4% in January from December. This plunge in factory orders was the biggest monthly fall since 2009 and described by analysts as a “horrendous reading”. The ministry downplayed the negative implications of the readings. In a statement alongside the data, it said “The weak start to the year should be manageable. Business confidence in manufacturing is significantly brighter than the long-term average, so that a revival in manufacturing can still be expected.”
In Asia, China plans to create 11 million new jobs for urban residents this year, despite the slowdown of economic growth. Chinese Prime Minister Li Keqiang delivered the government’s job creation goal at the opening meeting of the National People’s Congress and also promised to keep the registered urban unemployment rate at or below 4.5%. Zheng Gongcheng, professor with Renmin University of China said the medium-to-high speed growth and considerable economic aggregate provide the country the basis to stabilize and expand employment. Data showed that the service industry now accounts for 51.6% of China’s GDP and that the sector will continue to create more jobs.
In Japan, economic growth was revised upward for the last quarter of 2016. Gross domestic product expanded on a 1.2% annualized basis from the previous quarter according to data released from the Cabinet Office. The increase was the fourth consecutive quarter of expansion, its longest run in more than three years. Of concern, however, is that the increase was almost entirely due to exports, while domestic growth has remained soft. Private consumption remained unchanged at 0% in the final quarter of last year. Hiroaki Muto, chief economist at Tokai Tokyo Research said “The strength in investment isn’t coming from strong domestic demand, it’s basically foreign demand. Production of exports is picking up, which pushes up business spending.”
Finally, as the market takes a pause from its recent string of new highs, the question investors are pondering is whether it will it resume its march higher, or perhaps turn negative. According to the American Association of Individual Investors, bearishness among regular folks has just climbed to its highest level in over a year and second-highest in four years. But before considering rotating into “safe haven” investments, investors might instead consider that analysts actually view this as a contrarian indicator. In other words, sophisticated professional investors actually are more optimistic the gloomier the regular folks get. According to financial blogger Jani Ziedins, “When the market isn’t doing what the crowd expects, that means it is getting ready to do the opposite.” While not ready to predict a move higher, Mr. Ziedins suggests that is “far more likely” than an imminent collapse.
(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 to 14.25 from the prior week’s 16.75, while the average ranking of Offensive DIME sectors rose to 16.00 from the prior week’s 17.50. The Defensive SHUT sectors widened their new lead over the Offensive DIME 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®