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 29.02, up from the prior week’s 28.88, 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 69.22 down from the prior week’s 69.81.
In the intermediate and Shorter-term picture:
The Shorter-term (weeks to months) Indicator (see Fig. 4) turned negative on March 24th. The indicator ended the week at 24, down from the prior week’s 25. Separately, the Intermediate-term Quarterly Trend Indicator – based on domestic and international stock trend status at the start of each quarter – was positive entering April, indicating positive prospects for equities in the second 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 negative. Therefore, with two of three indicators positive, the U.S. equity markets are rated as Neutral.
In the markets:
U.S. markets: Stocks rose for the week, closing out the first quarter of 2017 with solid gains. The major indexes all rebounded from the previous week’s declines, but the tech-heavy Nasdaq Composite index was the only one to recoup its entire decline. The Dow Jones Industrial Average rose 66 points to 20,663. The Nasdaq Composite rose 1.4% to 5,911. Smaller stocks showed relative strength over large caps. The S&P 500 large cap index gained 0.8%, while the small cap Russell 2000 and S&P 400 mid cap indexes rose 2.3% and 1.5%, respectively.
International markets: Canada’s TSX rose 0.68%, while the United Kingdom’s FTSE fell slightly, down -0.19%. On the mainland, France’s CAC 40 and Germany’s DAX both added 2%, while Italy’s Milan FTSE rose 1.5%. Major Asian markets finished down. China’s Shanghai Composite fell -1.4%, while Japan’s Nikkei declined -1.8%. Hong Kong’ Hang Seng finished down -1%. As defined by Morgan Stanley Capital International, emerging markets as a group fell ‑1.1%, while developed markets as a group added 0.24%.
Commodities: Gold rose $2.70 ending the week at $1,251.20 an ounce. Silver rose as well, adding 2.86% to close at $18.26 an ounce. Oil broke above $50 per barrel, rising 5.5% to close at $50.60. Overall, the Commodities Research Bureau (CRB) index rose 1.3% for the week.
March summary: U.S. Markets were mixed for the month of March. The Dow Jones Industrial Average fell 149 points, losing -0.7%, while the Nasdaq Composite gained 1.5%. By market cap, both the large cap S&P 500 and small cap Russell 2000 were essentially flat, down -0.04% and -0.05%, while the S&P 400 mid cap index lost half a percent. In contrast to lackluster U.S. results, international markets showed good strength in March. Both the MSCI Emerging Markets Index and MSCI Developed Markets index did very well, rising 3.7% and 3.2%, respectively.
First Quarter summary: Most of the major U.S. indexes showed solid gains for the first quarter. The Nasdaq Composite led the way by rising 9.8%. By market cap, stocks with large capitalizations performed the best. The large cap S&P 500 and Dow Jones Industrial Average added 5.5% and 4.6%, respectively. Smaller-cap indices were also positive, but less so than their large cap brethren: the mid cap S&P 400 rose 3.6%, and the small cap Russell 2000 tacked on 2.1%. International indexes rebounded with a vengeance following a weak fourth quarter of 2016, and handily beat the U.S. benchmarks. The MSCI Emerging Markets index surged 12.5%, while the MSCI Developed Markets index soared 7.9%. Among sectors, Energy was the worst for the quarter, slipping -6.64%, while Technology was the best, roaring ahead by 10.66%.
U.S. Economic news: The Labor Department reported the number of Americans who applied for new unemployment benefits last week fell by 3,000 to 258,000—a 17-year low. New jobless claims have remained under the 300,000 level for 108 straight weeks, the second longest streak since the early 1970’s. Economists had expected initial jobless claims to total 247,000. The smoothed four-week average of initial claims rose 7,750 to 245,250. Although still low, that is its highest reading for 2017. Continuing claims, the number of people already receiving benefits, rose 65,000 to 2.1 million.
Home prices surged to their highest level in nearly three years as demand remains hot, particularly in the West. The S&P/Case-Shiller 20-city home price index rose 5.7% in the three-month period ending in January compared to the same time a year earlier. The index was a gain of 0.2% from its 5.5% annual increase in December. On a monthly scale, the 20-city index added 0.2% for the month or 0.9% when seasonally-adjusted. The national index, which includes all housing markets, rose 5.9% for the year, a 31-month high. Western metro areas, in particular Seattle, Portland, Denver, and San Francisco, continued to see the largest price increases.
Pending home sales, the number of homes that are under contract but haven’t yet closed, surged last month to its second-highest level in more than a decade. Pending home sales rose 5.5% in February according to the National Association of Realtors (NAR). The NAR attributed the reading to the rising stock market and steady jobs market, as well as warm weather and fears from home buyers of rising interest rates. The NAR forecasts a 2.3% rise in existing-home sales and a 4% rise in median home prices for this year.
Confidence among American consumers soared to its highest level in over 16 years, according to the Conference Board. The board reported its consumer confidence index jumped a huge 9.5 points to 125.6 in March, blowing past expectations of 114.1. Consumer confidence has continued to improve since the election of President Trump on expectations of lower taxes and more infrastructure spending. The only fly in the ointment is that confidence has not yet been impacted by the inability (so far) of congressional Republicans to enact any of the President’s ambitions – the cutoff for responses to the survey was March 16, just before Republicans were forced to abandon their efforts to replace Obamacare. In the report, both the present situation and the expectations indexes improved in March. Even better, the gains were widespread among almost all regional and income groups. Only those with household incomes below $15,000 were less confident now than they were before the election.
In the Windy City, a reading of economic activity inched higher this month to end the strongest quarter in more than 2 years. The Chicago Purchasing Managers’ Index (PMI) rose 0.3 point to a very solid 57.7 on a scale where any reading above 50 indicates improvement. Out of the five components measured, four showed improvement with only employment falling into contraction.
The Commerce Department reported that the U.S. economy’s Gross Domestic Product (GDP) grew at a 2.1% pace in the final quarter of last year, further evidence that the economy entered 2017 on a stronger footing than the previous year. GDP, the official tally for the overall economy, was revised up 0.2% from its 1.9% annual rate according to the Commerce Department. Consumer spending, which accounts for more than two-thirds of U.S. economic activity, was revised up 0.5% to 3.5% while most other figures were little changed. Economists had expected 2.0% growth in the fourth quarter. In addition to the upward revision, the report revealed a key measure of profits at U.S. companies increased for the third time in four quarters. Adjusted pretax corporate profits rose at a 0.5% annual rate in the final quarter of last year, after an almost 6% gain in the third. Profit figures are adjusted for depreciation and the value of inventories. Profits improved drastically starting in the second half of last year and have climbed over 9.3% over the past year.
While Fed officials might be happy, most consumers won’t be: the rate of inflation in consumer goods and services surpassed 2% in February for the first time in almost 5 years. The rate of inflation, as measured by the government’s Personal Consumption Expenditure (PCE) index, is now above the Federal Reserve’s long-term target of 2%. The increase opens the door for further rate hikes by the central bank. Some of the increase in inflation has been driven by a rebound in oil prices, but the cost of other staples such as housing, medical care, and financial services has been increasing even more rapidly. Stripping out the volatile food and energy components, the so-called core rate of inflation rose 0.2% last month, and is up 1.8% over the past year.
International economic news: To the north, the Canadian economy grew at an annualized 2.3% rate in January, according to Statistics Canada. For the month, Canadian GDP grew by 0.6%, double the expectations of 0.3%. Manufacturing had the strongest performance, expanding by 1.9%, but there was widespread growth across both goods and services production. Wholesale trade, the retail sector, construction, mining, and oil and gas were all on the upswing. Excluding October, Canadian GDP has risen every month since June 2016. BMO economist Doug Porter said he was revising his estimates for Canadian GDP growth in the first quarter to a 3.5% annualized rate, up from 2.7%, and predicted annual growth in 2017 could come in at 2.5%. “Given the rip-roaring start to the quarter and the nice hand-off from late last year, even tiny gains in the next two months will yield quarterly growth of well over three per cent,” he wrote in a note to clients.
Across the Atlantic, the EU is using the future of Gibraltar as a bargaining chip for the upcoming Brexit negotiations. The EU is backing Spain in its centuries-old dispute with the UK over the future of the British overseas territory. After lobbying from Spain, the EU’s opening negotiating position for Brexit talks presents the British government with the choice of reaching agreement with the Spaniards about Gibraltar’s future or risk pushing “the rock” outside any EU-UK trade deal. “The union will stick up for its members and that means Spain over the UK now,” a senior EU official said. Residents of Gibraltar, which Spain has sought to reclaim almost since it was ceded to Britain in 1713, voted 96% to remain in the EU. Spain is arguing that any agreement would require its blessing, because unlike Northern Ireland that is part of the UK, Gibraltar is a colony with a “disputed status”.
In France, far-right National Front presidential front candidate Marine Le Pen took the podium in Lille, France and proclaimed, “The European Union will die!” eliciting a round of raucous applause. “The time has come to defeat the globalists.” In late April and early May, voters in France will decide the future path of the country that has struggled with high unemployment, a huge influx of migrants, and frequent terrorist attacks. Their vote will also, in large part, determine the immediate future of the EU, a troubled institution that might be saved or destroyed by the same nation that spearheaded its creation. Of the five candidates for French presidency, two advocate abandoning the EU, two are harshly critical, and one argues for the EU.
German unemployment fell to a record low as Germany, Europe’s largest economy, continued to power ahead. The number of unemployed workers fell 30,000 to 2.6 million in March as the unemployment rate dropped 0.1% to 5.8% according to the Federal Labor Agency. Andreas Rees, economist at UniCredit Bank AG in Frankfurt stated, “It’s not only the jobless number but also the growth in the number of workers employed that has been strengthening over the last few months.” The number of employed people in Germany strengthened in February and was about 600,000 higher than a year ago.
In Asia, China’s factory activity ticked up again last month to its highest level in five years according to the latest official survey. The Chinese Federation of Logistics and Purchasing’s PMI climbed for a second month to 51.8, its strongest level since April 2012. Production and new orders were key drivers of the latest growth. High-tech manufacturing saw rapid growth, while conditions in traditional industrial production also improved. Chinese manufacturing and trade with the U.S. will be on the agenda when U.S. President Donald Trump meets with Chinese counterpart Xi Jinping on April 6-7 in Florida. Trump, who accused China of unfair trade practices during his campaign, tweeted Thursday that the meeting would be “very difficult.”
In Japan, the unemployment rate hit a 22-year low of 2.8% last month, offering a positive sign for the country’s economy. The country’s job availability, the ratio of job offers to job seekers, remained unchanged at 1.43—the best level since July 1991 according to Labor Ministry data. It means that 143 positions were available for every 100 applicants. The job market remains tight with labor shortages prevalent in nonmanufacturing sectors such as medical and nursing care. Of concern, however, consumers remained reluctant to spend more as household spending fell 3.8% from a year earlier. Consumers cut spending on food items, clothes, transportation and communications, and entertainment.
Finally: While the U.S. Civil War officially ended in 1865, a trio of researchers from the Washington D.C.-based think tank Center for Economic and Policy Research (CEPR) released a paper asserting that the United States still remains a nation of two countries. The authors wrote, “For the 117 million U.S. adults in the bottom half of the income distribution, growth has been nonexistent for a generation, while at the top of the ladder it has been extraordinarily strong.” The researchers discovered that for the working class, income has actually dropped. In fact, none of the growth from 1980 to 2014 went to the bottom 50%, the study pointed out. Only 32% went to the middle class, while the top 10% reaped 68% of the growth. A full 36% went to the 1% alone. The authors concluded “An economy that fails to deliver growth for half of its people for an entire generation is bound to generate discontent with the status quo and a rejection of establishment politics.” Sounds like exactly the kind of discontent and rejection we’ve seen! Here’s the rather dramatic chart from the CEPR.
(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 12.56 from the prior week’s 10.25, while the average ranking of Offensive DIME sectors rose to 15.5 from the prior week’s 16.25. The Defensive SHUT sectors still lead the Offensive DIME sectors, but by a smaller margin than last week. 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®