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 29.29, up from the prior week’s 28.86, 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 65.67, up from the prior week’s 64.25.
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 28, up smartly 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: A sharp rally early in the week brought both the Nasdaq Composite and small-cap Russell 2000 indexes to record highs, with the Nasdaq breaking through the 6,000 threshold for the first time. It’s been more than 17 years since the index first crossed the 5,000 level. For the week, the Dow Jones Industrial Average rose 392 points to close at 20,940, a gain of 1.9%. The tech-heavy Nasdaq Composite added 137 points to end the week at 6,047, a 2.3% rise. Large caps and small caps bested mid caps with the large cap S&P 500 and Russell 2000 indexes each rising 1.5%, while the mid cap S&P 400 index rose 0.9%. For the month of April, the Dow Jones Industrial Average gained 1.3% and the Nasdaq Composite rose 2.3%. Other major U.S. market indices saw gains as well, with the Russell 2000 adding 1%, while the S&P 500 gained 0.9% and the S&P 400 rose 0.8%.
International Markets: Canada’s TSX retreated -0.2% while across the Atlantic the United Kingdom’s FTSE gained 1.3%. On Europe’s mainland, France’s CAC 40 surged 4.1%, along with Germany’s DAX and Italy’s Milan FTSE which added 3.2% and 4.4%, respectively. In Asia, China’s Shanghai Composite fell for a third straight week, down -0.6%. Japan’s Nikkei rallied 3.1%, while Hong Kong’s Hang Seng index gained 2.4%. As grouped by Morgan Stanley Capital Indexes, developed markets surged almost 3%, while emerging markets ended up 2%. For the month of April, Canada’s TSX managed a 0.2% gain, while the United Kingdom’s FTSE fell -1.6%. France’s CAC 40 added 2.8%, Germany’s DAX rose 1%, and Italy’s Milan FTSE gained 0.6%. In Asia, China’s Shanghai Composite gave up -2.1%, while Japan’s Nikkei gained 1.5%. Hong Kong’s Hang Seng rose 2.1%.
Commodities: Precious metals weakened after several weeks of gains. Gold retreated -1.6%, falling $20.80 to end the week at $1,268.30 an ounce. Silver had a second difficult week, falling -3.3%, or -$0.59, to close at $17.26 an ounce. Energy was also weaker for a second week, falling -0.58% to close at $49.33 a barrel for West Texas Intermediate crude oil. The industrial metal copper, used by some as a barometer of worldwide economic growth, gained 2.76% after three weeks of losses.
U.S. Economic News: The number of Americans who applied for initial unemployment benefits rose to a one-month high last week, though the increase appeared largely due to the state of New York. The Labor Department reported that initial claims for unemployment rose 14,000 to 257,000. Still, nationwide layoffs remain extremely low. Applications for unemployment benefits have numbered less than 300,000 for 112 straight weeks—the longest stretch since the early 1970’s. The less-volatile 4-week moving average of claims was little changed at 242,250. Since 2011, the economy has added more than 2 million jobs, pushing the unemployment rate down to a post-recession low of 4.5%.
Home prices rose at the fastest rate in almost three years as the red hot housing market showed no sign of slowing down. The S&P Case-Shiller 20-city home price index rose 5.9% in the three-month period ending in February compared to the same time last year. In addition, on an annual basis, home prices rose 5.7% over January’s annual increase. The 20-city index rose 0.4% on the month, or 0.7% when seasonally adjusted. A few months ago the national index regained its highs last seen during the housing bubble in 2007. That index is up 5.8% for the year, a 32-month high. The largest price increases continue to be in the Pacific Northwest. In Seattle, home prices are up 12.2% from this time last year, while in Portland home prices are up 9.7%. Dallas replaced Denver in the top three with an 8.8% increase.
Sales of newly-constructed homes soared to an eight-month high last month as the housing recovery continued to gain ground. The Commerce Department reported sales of new single-family homes last month were at a seasonally-adjusted annual rate of 621,000. That is 5.8% higher than February’s reading and a gain of 15.6% over the same time last year. March’s reading was the second-highest since early 2008 and handily beat the median economist forecast of 580,000. The median sales price for a new home was $315,000—an increase of 7.5% from February. At the current rate of sales, there is a 5.2 months’ supply of homes on the market.
A gauge of pending home sales slipped last month as tight inventory continued to price many buyers out of the market. The National Association of Realtors’ Pending Home Sales index fell -0.8% to 111.4, a decline -0.3% worse than economists’ expected. The index forecasts future actual sales by tracking real estate transactions in which a contract has been signed but not yet closed. Regionally, activity was mixed. In the Northeast, Midwest, and West contract signings were down -2.9%, -1.2%, and -2.9%, respectively. In the South, signings rose 1.2%. Compared to the same time last year, the indexes are higher in the Northeast and South, but lower in the West and Midwest. According to the NAR, properties are currently on the market for an average of only 34 days.
In the first quarter, the U.S. economy grew at its slowest pace in 3 years, according to the Commerce Department. Gross Domestic Product increased at a mere 0.7% annual pace in the first three months of the year, down from an annualized 2.1% and 3.5% in the two quarters of the last half of last year. Economists had been expecting a 0.9% growth rate. The weakness stemmed from the smallest increase in consumer spending since the end of 2009, largely due to fewer sales at car dealers. Spending rose just 0.3%–a sharp slowdown from last quarter’s 3.5% gain. Also contributing to the weak reading, the government reduced its spending while businesses scaled back production. However, many analysts believe the drop in spending is temporary. They cite statistics showing household finances are in their best shape in years amid the record stock market gains, strong labor market, and rising wages. Paul Ashworth of Capital Economics stated consumer spending “will rebound in the second quarter.”
Hiring on a national level retreated last month according to the Chicago Federal Reserve’s National Activity Index. The Chicago Fed’s index eased to 0.08 last month from 0.27 in February. The index’s three-month moving average, used by analysts to smooth out volatility, fell to 0.03 from 0.16. The index’s average reading remained positive for the fourth consecutive month. The index is a weighted composite of 85 separate economic indicators designed so that zero represents trend growth. Of the 85 indicators, 48 made a positive contribution while 37 were negative. In addition, over 50% of the indicators registered a net deterioration on the month. Analysts noted that the indexes employment-related indicators contributed just 0.02 to the index in March, falling 0.18 point from February.
Confidence among American consumers dipped slightly earlier this month, but Americans are still more optimistic than they were before the election. The Conference Board reported its Consumer Confidence Index fell 4.6 points from last month’s 16 year high to 120.3. Americans were slightly less optimistic about the current environment and their expectations for the next six months, according to the report. Still, confidence is sharply higher compared to the period leading up to the election last November. Michael Pierce, U.S. economist at Capital Economics said, “The details of the index are still consistent with a strong labor market and economy.”
New orders for goods expected to last at least 3 years, so-called durable goods, rose less than expected last month, but still managed its third consecutive gain. The Commerce Department reported overall durable goods orders rose 0.7% last month supported by new bookings for aircraft. In March, orders for commercial aircraft rose 0.7%, while orders of military planes surged 26%. Core capital-goods orders, which remove spending on big-ticket items like defense equipment and aircraft, rose 0.2% last month and are up 3% over the past year. Businesses have been slowly increasing spending since last fall, a positive sign for the economy.
International Economic News: The National Bank of Canada stated the Canadian economy is likely to see a “limited impact” as a result of the tariffs announced by the Trump administration on Canadian softwood lumber. National Bank Senior Economist Krishen Rangasamy said if Canadian lumber exports to the States were stopped completely, the net effect on Canada’s GDP would be half a percentage point. CIBC Capital Markets Chief Economist Avery Shenfeld echoed the National Bank’s views on the limited impact of the tariff. “It is likely that the reaction today is on fear that the lumber duties are the tip of the iceberg, showing that despite cozy talk between Trudeau and Trump, the U.S. is willing to flex its muscles to show a protectionist ‘win,’” he wrote.
Britain’s economy slowed considerably during the first quarter of the year as higher inflation bit into the wallets of consumers, official figures show. Economic growth slowed to 0.3% for the first quarter, missing estimates by 0.1% according to the Office for National Statistics. The economy has been surprisingly resilient given last summer’s vote to exit the European Union. Britain was the second strongest-growing nation in the Group of Seven the previous year, but now consumers are cutting back as prices rise due to a depreciating pound and higher energy costs. Britain’s previously struggling manufacturing sector was actually the best performing part of the economy in the first quarter.
In France, far-right Presidential candidate Marine Le Pen and centrist candidate Emmanuel Macron are set to face off in an election on May 7. Both candidates have very different views on how to manage the French economy, with far-reaching potential consequences. Macron, a former investment banker at Rothschild & Cie Banque, worked as the Minister of Economy, Industry and Digital Affairs under former French president Francois Hollande. Le Pen represents a radical departure from traditional French politics. She advocates for a strong French identity and economic nationalism that would mean new trade barriers and the country’s exit from the Eurozone. Le Pen has proposed dropping the euro and switching to a “nouveau franc” of lower value to make French exports more competitive. Macron has promised to cut corporate tax rates to 25% from 33%. Macron supports free trade and campaigned in favor of CETA, the EU’s new free trade agreement with Canada.
In Germany, economists from the Bundesbank in Frankfurt wrote that Germany’s aging population will undermine potential economic growth by the middle of next decade as more of the baby boomer generation heads for retirement. The German central bank reported that based on current trends, the number of people of working age in 2025 will be the same as in 2016, meaning that potential growth will fall to “significantly below 1%” from the near 1.25% seen from 2011 to 2016. Germany has become the continent’s economic powerhouse recently, recording 1.9% growth in 2016. “According to the forecasts, growth in the medium term will largely be supported by developments in productivity,” the experts add, with an increase in the next few years before a slowdown to levels last seen in the 2000s.
China’s economy got off to a strong start in the first quarter with a greater-than-expected GDP growth rate of 6.9% year over year. Nomura Securities described the first quarter data point as “resilient growth momentum” in a research note. Based on the data, the International Monetary Fund upgraded its forecast for China’s economic growth in 2017 to 6.6%, and 2018 to 6.2% – additions of 0.1% and 0.2%, respectively. Furthermore, the global growth rate forecast for 2017 was also raised by the IMF to 3.5%, a gain of 0.1%. Xu Hongcai, economist at the China Center for International Economic Exchanges said, “Given the stable growth, China can put greater emphasis on supply-side structural reform and prevention of financial risks.”
In Japan, the Bank of Japan (BOJ) raised several of its economic forecasts at a policy meeting this week, but kept its rate policy steady as was widely expected. The BOJ raised its real gross domestic product (GDP) growth forecast for 2017-18 fiscal year to 1.6%, an increase of 0.1% over January’s forecast. The Bank now sees the economy ‘expanding’ rather than just ‘recovering’. Marcel Thieliant, senior Japan economist at Capital Economics said in a note, “We believe that the bank remains too optimistic about inflation. The main reason is that wage growth remains tepid despite a tight labor market.” Thieliant said he expected monetary policy to remain unchanged for “the foreseeable future.” The BOJ had set its target yield for the benchmark 10-year Japanese government bond at around zero percent, and it has been willing to intervene to keep the benchmark yield in line with its target.
Finally: Sunday marked President Trump’s 100th day in office. Markets are higher with many indexes hitting all-time highs, businesses seem happy to have a pro-business President, and everything is awesome–or is it? Real, so-called ‘hard’, economic data may be collapsing. The Atlanta Fed produces a “real-time” gauge of GDP called “GDPNow”, which is based on ‘hard data only’ (i.e., no projections or guesses about the future or measures of sentiment – known as ‘soft data’). As the weak first quarter GDP print showed, optimism and sentiment alone can’t lift the real economy. The following chart shows the current level of divergence between two economic indexes–the New York Fed’s GDP estimate, called the NOWCAST index (which includes loads of soft data), and the Atlanta Fed’s GDPNOW index (which contains none).
(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 sharply to 15.25 from the prior week’s 8.00, while the average ranking of Offensive DIME sectors rose to 13 from the prior week’s 15.5. The Defensive SHUT sectors lost 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®