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 29.38, down slightly from the prior week’s 29.48, 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 66.92, down from the prior week’s 67.34.
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, down 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 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 indicators positive and one negative, the U.S. equity markets are rated as Neutral.
In the markets:
U.S. Markets: Most of the major U.S. benchmarks ended the week lower. The Nasdaq Composite was the only index to record a gain and touch a new high. Another notable development was this week’s decline of the Chicago Board of Exchange’s Volatility Index, or VIX, to its lowest level since 1993. The VIX is often referred to as the “fear index”, as it traditionally moves inverse to stock prices. The Dow Jones Industrial Average retreated half a percent, or 110 points, to close at 20,896. The tech-heavy Nasdaq Composite had its fourth straight week of gains, rising 0.3% to close at 6,121. By market cap, the large cap S&P 500 retreated -0.3%, while the mid cap S&P 400 and small cap Russell 2000 indexes fell -1.1% and -1.0%, respectively.
International Markets: Canada’s Toronto Stock Exchange Index fell a third straight week, losing -0.3%. Major European markets were mixed. The United Kingdom’s FTSE rose 1.9%, while on the mainland France’s CAC 40 fell half a percent. Germany’s DAX rose for a third week, adding 0.4% as did Italy’s Milan FTSE which also added 0.4%. Markets were mixed in Asia as well. China’s Shanghai Composite Index fell 0.6%, while Japan’s Nikkei surged a robust 2.3% – its fourth straight week of solid gains. As a group, emerging markets (as measured by the MSCI Emerging Markets Index) gained 2.6%, while developed markets (as measured by the MSCI Developed Markets Index) lost 0.5%
Commodities: Oil managed to close up following three straight weeks of losses. West Texas Intermediate crude oil climbed 3.5% to close at $47.84 a barrel. Gold was essentially flat, rising just 80 cents to $1,227.70 an ounce. Silver also held steady after three weeks of losses, rising 0.79% to close at $16.40 an ounce. The industrial metal copper, viewed by analysts as an indicator of worldwide economic health because of its ubiquitous use, fell by a slight -0.18%.
U.S. Economic News: The number of people collecting unemployment benefits fell to its lowest level in over 28 years last week, further evidence of the robust labor market. Initial claims fell by 2,000 to a seasonally-adjusted 236,000 for the week ended May 6, according to the Labor Department. Claims have now been below the key 300,000 threshold that analysts view as a healthy job market for 114 straight weeks. Economists had expected claims to rise by 12,000. The four-week moving average of claims, used by some analysts to smooth the week-to-week volatility, rose by 500 to 243,500. With the unemployment rate at 4.4%, Federal Reserve officials believe the labor market is close to full employment. With the jobless rate so low, Fed officials have stated they need to raise interest rates to prevent the economy from overheating. Stephen Stanley, chief economist at Amherst Pierpont Securities stated, “The labor market continues to tighten, and the Fed had better do the same.” Continuing claims, the number of people already receiving benefits, fell 61,000 to 1.91 million the previous week. That is the lowest number of continuing claims since November 1988.
The Labor Department’s “JOLTS” report – Job Openings and Labor Turnover Survey – drifted sideways in March as the momentum in the labor market appeared to wane. The Labor Department reported 5.74 million job openings, matching February’s number while the number of hires and separations were also little changed at 5.3 million and 5.1 million, respectively. Job openings had previously risen to a seven-month high in February, increasing 118,000 positions to a seasonally adjusted 5.7 million. Professional and business services openings led the way with an increase of 126,000, other services increased 55,000, and state and local government education gained 27,000. The number of “quits”, the number of people who voluntarily left their jobs for presumably better pay, ticked up 2.6% in March. That number is closely watched by analysts as it signals more worker confidence in the labor market.
Sentiment among small-business owners fell for the third straight month last month as business owners voiced concerns about Washington’s inaction on taxes, surging health care insurance costs, and other financial issues. The National Federation of Independent Business (NFIB) monthly sentiment gauge retreated 0.2 point to 104.5, but that still exceeded economists’ forecast of a 103.8 reading. Analysts point out that although the gauge retreated, it’s following December’s surge that was the highest in the 40-year history of the survey. In the details of the report, five of the ten index components gained, three declined, and two remained unchanged. Business owners once again reported that the inability to find qualified workers is their “single most important business problem.” Healthcare also continues to be a major concern. NFIB said in its release, “Obamacare has crushed small businesses.”
Consumer sentiment improved last week as Americans turned more bullish on their income expectations. The University of Michigan’s confidence gauge rose 0.7 point to 97.7, beating expectations by half a point. Richard Curtin, chief survey economist wrote, “Consumer sentiment remained on the high plateau established following Trump’s election, with the early May figure nearly identical with the December to May average of 97.4.” Compared to April a year ago, the University of Michigan’s Consumer Sentiment Index rose 8 points to 97. The monthly survey measures 500 consumers’ attitudes towards topics such as personal finances, inflation, unemployment, government policies and interest rates.
Sales at U.S. retailers rose 0.4% in April and were up 4.5% compared to the same time a year earlier, according to the Commerce Department. Sales have risen three out of the last four months so far this year. Stripping out motor vehicle and fuel sales, sales were up 0.3%. Sales at gas stations were over 12% higher last month than a year ago, reflecting the higher year-over-year cost of oil. Economists had expected an increase of 0.5%. Sales were bifurcated between online and offline. Brick and mortar retailers such as Sears and Macy’s continue to struggle as shoppers move more and more to online purchasing. Online retail sales were up 10.7% from the same time last year, while sales at department stores were down 5.2%. Online retail sales were up 1.4% last month.
The Treasury Department reported the federal government ran a budget surplus of over $182 billion in April, an increase of $76 billion over the same month last year. That was the largest surplus for an April since the record set in 2001. Total receipts were $455.6 billion, while spending was $273 billion. April is traditionally a surplus month since the government receives tax payments from individuals before the mid-April tax deadline. In addition, receipts were boosted by a change in corporate tax filing deadlines that moved the deadline to mid-April from mid-March. For the first seven months of the year, the government is running a deficit of $344.4 billion, down 2.4% from the same time last year. The Congressional Budget Office estimated that the federal government would run a budget deficit of $559 billion for fiscal 2017, a slight decrease from last year’s $585.6 billion.
International Economic News: In Canada, as trade relations with the U.S. become more tumultuous with protectionist talk from the Trump administration and U.S. tariffs on Canadian softwood lumber, Canada may want to “seize” the opportunity to export more products to China, the new ambassador to China said. John McCallum spoke to a Chinese delegation meeting with business leaders in Alberta said, “With trouble on the U.S. front in that sector, it’s more natural for Canada to turn to China as a partial recipient of Canadian forest products.” While stressing that the United States will always be Canada’s foremost trading partner, Mr. McCallum said the nation is trying to diversify its trade.
Across the Atlantic in the United Kingdom, Bank of England governor Mark Carney warned of a potential consumer spending squeeze as inflation rises and real household wages fall. Mr. Carney said this year will be “a more challenging time for British households” as “wages won’t keep up with prices.” The bank trimmed U.K. economic growth forecasts from 2% to 1.9% and held interest rates at 0.25%. The bank also raised its forecast for inflation this year to 2.8%, up 0.4% from February. The estimates were based on the assumption that “the adjustment to the United Kingdom’s new relationship with the European Union is smooth”. Lucy O’Carroll, chief economist at Aberdeen Asset Management, said: “The Bank of England is stuck between a rock and hard place. It has to base its forecasts on a view of the Brexit deal but, with so little to go on at present, it’s not an easy judgement.”
New French president Emmanuel Macron may be the first French president in over a decade to inherit an economic tailwind. Business confidence in the euro region’s second largest economy is improving and an indicator of private-sector activity shows solid economic growth. Emmanuel Macron, a former investment banker, is promising to overhaul the labor market, simplify the tax and pension systems, and pare back the regulations that he says hamper innovations. The Bank of France’s manufacturing sentiment index rose to 104 in April, its highest level since May of 2011, while the nation’s composite Purchasing Manager’s Index jumped to a six-year high. Martin Malone, global macro strategist at Mint Partners in London said, “We’re getting a currency tailwind, a cost of capital tailwind, and a catch-up trade in jobs and consumption.”
The German economy grew strongly in the first quarter of the year driven by investment and consumption, official data show. First quarter GDP growth was 0.6%, an increase of 0.2% over the fourth quarter of 2016’s 0.4% rise. According to German statistics authority Destatis, household and state spending were strong, while firms invested heavily in construction and equipment. In addition, exports increased faster than imports. Germany has the largest economy in the Eurozone, and its economic outperformance has frequently led to friction between it and its economic partners. In February, the European Commission said Germany’s current account surplus, which measures the balance of goods, services and investments into and out of the country, was too big and that cutting that surplus would benefit the whole Eurozone.
In Italy, a spokesperson for the Italian minister said U.S. Treasury Secretary Steven Mnuchin met with Italian Finance Minister Pier Carlo Padoan characterizing the meeting as the start of what will become a good relationship between Italy and the Trump administration. The two shared ideas and information on the soundness of the Italian banking system which continues to be saddled with troubled loans. Italy’s economy is also dealing with rising unemployment.
China and the U.S. have agreed to take action by mid-July to increase trade between the two nations. The 10-point trade deal will open the Chinese market to U.S. credit ratings agencies and credit card companies and China will also lift its ban on U.S. beef imports. In return, Chinese cooked chicken will be allowed into the U.S. market and Chinese banks can enter the U.S. market. China agreed to issue guidelines that would allow U.S.-owned card payment services “to begin the licensing process” in an area where China’s UnionPay system has had a near monopoly. U.S. Commerce Secretary Wilbur Ross said the deal should reduce China’s trade surplus with the U.S. by the end of this year.
The Japanese economy is expected to expand for a fifth straight quarter, led by resurgence in consumer spending and solid offshore demand. Analysts project the economy will continue to expand as exports rise, while capital spending is expected to recover, driven by strong corporate earnings and growing business confidence. In a poll of analysts, the economy was expected to expand at an annualized 1.7% in the first quarter—its fastest rate since a 2.2% rise in the second quarter of 2016. Hidenobu Tokuda, senior economist at Mizuho Research Institute said, “The economy in fiscal 2017 is expected to continue to pick up with the tailwinds of the global economic recovery and a weak yen.”
Finally: Late in the cycle of the housing boom in 2007, analysts and hedge fund managers at prescient firms such as Scion Capital and FrontPoint Partners became aware of a strange new phenomenon in home mortgages that were being “securitized” into mortgage-backed securities (MBS). What they found was that so-called NINJA applicants, which stands for “No Income No Job and No Assets”, were becoming a larger and larger component of MBS’s but were nonetheless being labeled as safe investments by the ratings agencies. Well, as Mark Twain is believed to have said, “History doesn’t repeat itself but it often rhymes.” In research from Point Predictive, a startup firm that helps lenders discover bogus borrowers, the firm reveals that “borrower fraud in U.S. auto loans is surging, and may approach levels seen in mortgages during the last decade’s housing bubble.” As many as 1% of U.S. car loan applications include some type of material representation, Point Predictive says. Frank McKenna, chief fraud strategist at the firm, said “We see an extraordinary amount of parallels between the auto and mortgage industries, in terms of the rising levels of hidden fraud.” As of right now, it remains to be seen if this revelation in the auto loan sector will have the same impact on the overall economy as it did for the housing market.
(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 12.5 from the prior week’s 14.25, while the average ranking of Offensive DIME sectors fell to 14.25 from the prior week’s 13.75. The Defensive SHUT sectors have taken the 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®