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 28.86, up from the prior week’s 28.60, 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 64.25, not much changed from the prior week’s 64.39.
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, unchanged from the prior week’s 24. 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: U.S. stocks ended higher following a week of choppy trading. The Nasdaq Composite outperformed the major indexes while disappointing earnings results from major Dow components weighed on the Dow. The Dow Jones Industrial Average recovered some of last week’s losses rising 94.5 points to close at 20,547, a gain of 0.5%. The tech-heavy Nasdaq Composite gained 105 points to close at 5,910, a gain of 1.8%. By market cap, small and mid-cap indexes recovered lost ground compared to large caps. The S&P 400 mid cap index gained 2.2% and the Russell 2000 small cap index added 2.6%, while the large cap S&P 500 index rose a much more modest 0.8%.
International Markets: Canada’s TSX gained half a percent, retracing most of last week’s decline. Across the Atlantic, the United Kingdom’s FTSE 100 had its second week of losses, falling over -2.9%. On Europe’s mainland, major markets ended the week down with fractional losses. France’s CAC 40 was off -0.2%, while Germany’s DAX fell -0.5%, and Italy’s Milan FTSE declined -0.2%. In Asia, major markets were mixed. China’s Shanghai Stock Exchange fell -2.2%, while Japan’s Nikkei rose 1.6%. Hong Kong’s Hang Seng ended down -0.9%. As grouped by Morgan Stanley Capital Indexes, developed markets were up 0.6%, while emerging markets managed a 0.4% gain.
Commodities: Oil plunged over -6.6%, taking out most of the last few weeks’ gains. The price of West Texas Intermediate crude oil fell -$3.56 to close at $49.62 a barrel. In precious metals, Gold barely managed a gain this week, rising $0.60 to $1289.10 an ounce. Silver diverged, however, and plunged -3.5% to end the week at $17.86 an ounce. The industrial metal copper, seen by some analysts as an indicator of worldwide economic health, weakened for a third straight week, falling -1.3%.
U.S. Economic News: The number of Americans collecting unemployment checks fell to a 17 year low this month, further evidence of a healthy jobs market. Continuing jobless claims, which counts those people already receiving benefits, fell by 49,000 to 1.98 million. This is only the second time in eight years that the number of people on unemployment has registered less than 2 million. The number of people applying for first-time unemployment benefits rose by 10,000 to 244,000 in the second week of April. The number of new applicants for unemployment benefits has remained below the 300,000 threshold for 111 straight weeks–its longest streak since the early 1970’s. Stephen Stanley, chief economist at Amherst Pierpont Securities, noted there is a “steady downtrend in place in the pace of layoffs.”
Sales of existing homes hit a 10-year high last month as homes continued to sell at a brisk pace. Existing home sales ran at a seasonally-adjusted annual rate of 5.71 million, a 4.4% increase over February according to the National Association of Realtors (NAR). That was the strongest selling pace since early 2007, and an increase of 5.9% over the same time last year. However, the supply of homes continued to be a limiting factor—supply was 6.6% lower compared to a year ago. Over 1.8 million homes were on the market the last day of March representing only a 3.8 month supply. Properties were on the market for an average of only 34 days. The national median sales price is now $236,400, a 6.8% gain over March of last year. By region, sales jumped 10.1% in the Northeast and 9.2% in the Midwest. In the South, sales were up 3.4%, while in the West sales fell 1.6%. First-time home buyers accounted for 32% of the market.
Sentiment among home builders weakened in April, pulling back slightly from last month’s 11-year high. The National Association of Home Builders (NAHB) housing market index (H MI) fell 3 points to 68. Readings above 50 indicate growth. In the details of the report, the measure of current sales conditions retreated slightly to 74, but has been over 70 for five consecutive months. NAHB Chief Economist Robert Dietz wrote, “The fact that the HMI measure of current sales conditions has been over 70 for five consecutive months shows that there is continued demand for new construction.”
Manufacturing in the New York area slowed in April as the euphoria following the election of President Donald Trump appeared to wane. The Empire State Manufacturing survey fell 11.2 points to 5.2 this month according to the Federal Reserve Bank of New York. Expectations were for a reading near 16. While any reading above zero indicates growth, a number of key metrics in the survey declined. New orders and shipments both fell suggesting more moderate growth going forward. In addition, the prices-paid index gained, possibly signaling rising inflationary pressures in the economy. On the labor front, hiring remained robust with the number-of -employees component rising 3.6 points to 12.4. The Empire State index is the first in a series of monthly regional Federal Reserve manufacturing surveys.
In the city of brotherly love, the Philadelphia Fed’s manufacturing index retreated slightly suggesting growth in the factory sector is slowing following the postelection surge in the Mid-Atlantic region, too. The Philly Fed’s manufacturing index fell 10.8 points to 22 in April after hitting a 33-year high of 43.3 in February. Economists’ had been expecting a reading of 25.5. In the details of the report, new orders fell 11.2 points to 27.4 and shipments fell 9.5 to 23.4, while two employment gauges turned higher. The number-of-employees gauge added 2.4 points to 19.9 and the average workweek subindex rose to 18.9, up 0.4. All readings above zero indicate growth.
Manufacturing output on a national level slowed in March, dragged down by weakness in the U.S. auto sector according to the Federal Reserve. Factory output fell 0.4%, its first decline since last August, as a result of a steep 3% decline in auto and auto parts production. However the decline was not all autos as ex-motor vehicles overall output was still down 0.2%. For the first quarter, factory output is up an annualized 2.7%–an improvement over last quarter’s 1.7% rise, but still “disappointing” according to Jim O’Sullivan, chief economist at High Frequency Economics. Josh Shapiro, chief economist at MFR Inc, said he expects “the underlying trend in reported output to gradually accelerate in the months ahead” based on recent Institute for Supply Management (ISM) survey data. Overall industrial production was up 0.5% with the gain due to an 8.6% rise in utilities output as colder weather returned following an unseasonably warmer first two months of the year.
The Federal Reserve’s Beige Book, a summary and analysis of economic activity and conditions prepared with input from each of the regional Federal Reserve banks, showed that wages are climbing but haven’t begun to have an effect on inflation just yet. The report found “a larger number of firms mentioned high turnover rates and more difficulty retaining workers.” A handful of districts reported that worker shortages and increased labor costs were restraining growth in construction, manufacturing, and transportation. The 12 Federal Reserve districts were equally split describing growth as either “modest” or “moderate”. Several Fed districts reported that uncertainty over tax and spending policies weighed on economic activity. The Cleveland Fed reported that customers appeared to be waiting “for more definitive proposals on tax and regulatory reform” from the Trump White House before moving ahead with projects. The report was a bit stronger than economists’ had expected based on other recent data releases.
International Economic News: The fastest growing country among the G-7 group is none other than our neighbor to the north—Canada. The energy-rich nation, which has struggled with falling crude oil prices the past two years, grew at an almost 4% rate in the first quarter, according to the Bank of Canada’s latest estimate. For all of 2017, the Canadian central bank is projecting a 2.6% growth rate, which would put the nation at the top of the G-7 growth scale. Senior Deputy Governor Carolyn Wilkins stated the Bank of Canada “welcomes the recent strength in economic data and wants to see more of it in order to be more confident that growth is on a solid footing.”
The International Monetary Fund (IMF), which had previously predicted dire consequences from the Brexit vote in the UK, belatedly raised its UK economic growth forecast to 2%. The group did admit that the performance of the economy following last year’s Brexit vote had been “stronger than expected.” In its half-yearly World Economic Outlook, the IMF said it now expects the British economy to expand 2% this year making it the second fastest growing major economy after the United States. In its release, the IMF stated that growth had “remained solid in the United Kingdom, where spending proved resilient in the aftermath of the June 2016 referendum in favor of leaving the European Union.” The IMF is also more optimistic about the global economy as a whole, expecting worldwide economic growth to increase 3.5% this year, and 3.6% next year.
On Europe’s mainland, French voters head to the polls this weekend in the first of multiple elections to choose a new President. The French presidential election could be a turning point for the existence of the shared euro international currency. Currently, two of the top presidential contenders, Marine Le Pen and leftist candidate Jean-Luc Melenchon both question the basic foundations of the euro—the independence of the European Central Bank and limits on its’ member governments’ budget deficits. Most market watchers are anticipating pro-euro candidate and former economy minister Emmanuel Macron to win. However, if the winner Sunday turns out to be National Front Candidate Marine Le Pen or, even worse, Le Pen and Melenchon as the top two finishers—well, world markets may be in for quite a surprise. Frank Engels, managing director at Union Investment, says an anti-European outcome would be a “major shock to equity markets,” while Athanasios Vamvakidis, foreign exchange strategist at Bank of America Merrill Lynch Global Research states “Markets are still underpricing the risks.”
In Germany, finance minister Wolfgang Schaeuble took to the airwaves to fiercely and crudely denounce accusations that Germany is an economic rogue state undermining the stability of the European Union as “Bullshit”. The minister was asked on CNBC about stories in the British media accusing Germany of caring only about its own profit and of ignoring its neighbors. “There are some writers even in the UK which write bullshit, with all due respect,” responded Schaeuble (showing very little due respect!). Matthew Lynn of the Telegraph had described Germany as “the biggest threat to the stability of the global economy right now.” The journalist had called out Germany’s trade surplus hitting record highs, while “hollowing out the industry” of its neighbors.
Analysts at the Fitch credit ratings agency moved its credit rating for Italy one notch closer to “junk” territory, downgrading Italy’s rating to “BBB” from “BBB+”. Fitch cited “weak economic growth” and the country’s “persistent track record of fiscal slippage” as reasons for the downgrade. Italy’s credit rating is now just two notches above speculative-grade. Fitch added that Italy has missed “successive targets” for its debt-to-gross domestic product ratio, which rose by 0.5% to 132.6% last year. Italy’s economy grew by 0.9% last year with Fitch expecting this year’s growth to match that tepid level. For 2018, Fitch expects growth to rise to 1%, “which would leave real GDP still more than 5% below the 2007 level.”
China, the world’s second largest economy, grew at an annualized rate of 6.9% in the first quarter, officials there said. The pace was a very slight acceleration following five consecutive quarters of 6.7 to 6.8% readings. The increase was attributed to the construction industry’s heavy use of steel (which had been expected to slow) along with investment in electronics factories as demand from overseas strengthened. However, of concern, the state-controlled banking sector has issued a flood of new mortgages, while the number of housing starts has risen even faster year to date. This will add even more inventory to the number of unsold homes at a time when policy makers are already concerned whether the easy availability of mortgages feeding a bubble.
Japanese construction companies are scrambling to hire workers for the surge in building projects ahead of the 2020 Tokyo Olympics. Unfortunately, the nation is already struggling with a declining workforce and the availability of labor is extremely tight. According to the website C4, a specialized job placement service for construction managers, there are over 2,000 employment offers for from major construction companies already. An executive of a mid-level construction company remarked, “We are finding it difficult to take orders for building condominiums other than those in central Tokyo within the Yamanote Line”, referring to a prized building area within the rapid-transit loop train line in the center of the capital. With both labor and materials costs rising, construction companies are becoming much more picky focusing on only highly profitable ventures.
Finally: Everyone has heard the term “Put your money where your mouth is”, often times in bar room banter when coaxing someone to back up their statements or opinions by putting some cash on the line. Schwab Chief Investment Strategist Liz Ann Sonders released a note this week with research showing that consumers are “saying” they have confidence in the economy going forward, but data such as retail sales figures aren’t matching that level of confidence – in other words, they aren’t “putting their money where their mouths are”. Wall Street analysts and economists collect various measures of data and most can be broken down into either of two groups—“hard” and “soft” data. Hard data are actual figures, retail sales, number of vehicles sold, etc. Soft data tends to be consumers or business managers opinions of the economy—e.g. consumer confidence data and purchasing manager surveys. Ms. Sonders notes that, for example, the Conference Board’s “soft” consumer confidence data hit its highest level in 17 years last month, but on the other hand “hard” data like retail sales fell for a second straight month in March.
(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 8.00 from the prior week’s 9.75, while the average ranking of Offensive DIME sectors fell to 15.5 from the prior week’s 13.5. The Defensive SHUT sectors again expanded their 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®