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 29.26, down slightly from the prior week’s 29.38, 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 65.07, down from the prior week’s 66.92.
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 28. 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: A market plunge midweek was almost completely reversed by a rally on Friday in a volatile week of trading. On Wednesday, the Dow and the S&P 500 fell the most since September, while the Nasdaq declined the most since the Brexit vote last June. Analysts attributed the declines to allegations that President Trump had requested (now ex-) FBI Director James Comey to drop his investigation into possible ties between former Trump campaign officials and the Russian government. For the week, the Dow Jones Industrial Average gave up 91 points, or -0.4%, to end the week at 20,804. The tech-heavy Nasdaq Composite fell -0.6% to close at 6083. By market cap, both the S&P 500 large cap and S&P 400 mid cap indexes finished down -0.4%, while the small cap Russell 2000 index declined -1.1%.
International Markets: In international markets, Canada’s TSX fell -0.5%, its third consecutive down week. The United Kingdom’s FTSE enjoyed its fourth straight week of gains by rising 0.5%. On Europe’s mainland, France’s CAC 40 fell -1.5%, Germany’s DAX fell -1%, and Italy’s Milan FTSE was essentially unchanged. In Asia, China’s Shanghai Composite rebounded 0.2% after five straight weeks of losses, while Japan’s Nikkei fell -1.5% after four weeks of gains. As grouped by Morgan Stanley Capital International, emerging markets were off -0.2%, while developed markets gained 1.3%.
Commodities: Precious metals were a safe harbor from the volatility of the week. Gold gained 2.1%, or $25.90, ending the week at $1253.60 an ounce. Silver, likewise, enjoyed a 2.4% gain, closing at $16.80 an ounce. The industrial metal copper, seen by some analysts as an indicator of worldwide economic health, rose 2.28%. Oil had its second week of gains. West Texas Intermediate crude oil rose 5.92% to end the week at $50.67 a barrel.
U.S. Economic News: The number of Americans who filed for new unemployment benefits fell by 4,000 to 232,000, according to the Labor Department. That’s the second-lowest weekly reading since the economic recovery began 8 years ago. In addition, the number of people already receiving benefits, so-called “continuing claims”, fell by 22,000 last week to 1.9 million – its lowest level since 1988. The U.S. economy has been creating jobs at a rapid pace over the last six years, adding almost twice as many jobs as necessary to absorb the number of new entrants into the labor force. Applications for unemployment benefits have registered less than 300,000 for 115 straight weeks—its longest run since the early 1970’s. The smoothed four-week moving average of jobless claims fell slightly to 240,750.
Construction of new homes fell for a second consecutive month in April as housing starts fell 2.6% to a seasonally adjusted annual rate of 1.17 million units. The weakness entirely found in a big drop in construction of apartments, a volatile sector. The Commerce Department reported that builders broke ground on more single-family homes, an increase of 0.4% to an annualized 835,000 homes. Construction of multi-family units, such as apartments, however, dropped 9.2% to a rate of 337,000 units. By region, the decline was led by a 37.3% plunge in activity in the Northeast, followed by a 9.1% drop in the South. The Midwest saw a 41.1% rise, while the west saw just a 5.4% increase. Applications for builder permits, used by analysts as an indication of future activity, fell 2.5% – its second decline in the past three months.
Sentiment among the nation’s home builders rebounded this month, rising 2 points to its second-highest level since the recession. The National Association of Home Builders (NAHB) index stands at 70; economists had forecast an unchanged reading of 68. U.S. homebuilders are expecting stronger sales, but mortgage applications for newly built homes don’t necessarily support that hope. In its release, the NAHB mentioned more expensive lots, more expensive building material costs, and higher labor costs as significant headwinds for builders. Of the index’s three components, sales expectations over the next six months saw the biggest gain, rising 4 points to 79. That is the highest level since June 2005 (near the last market top). Current sales conditions also rose 2 points to 76. The components measuring buyer traffic, however, fell 1 point to 51.
Manufacturing in the New York-area fell into negative territory this month for the first time this year according to the New York Fed. The Empire State Manufacturing survey retreated 6.2 points to -1 in May, far below March’s reading of 16.4. Economists had expected a reading of 7. Readings below 0 indicate worsening conditions. In the details, the new-orders index dropped 11.4 points to -4.4, its lowest level in a year, while unfilled orders slumped 16.1 points to -3.7. The figures suggest that factory activity may be leveling off. Ian Shepherdson, chief economist at Pantheon Macroeconomics, said the index’s decline was “disappointing, but not disastrous.” “The big picture in the industrial economy remains one of gradual recovery in the wake of the gentle upturn in capital spending in the oil sector,” he said.
In contrast to the New York survey, manufacturing in the Mid-Atlantic region showed unexpected strength, said the Philadelphia Fed. Their manufacturing index jumped 16.8 points in May to 38.8, well above economist forecasts of 19.6. It marked the tenth month of positive readings for the index, where any positive reading indicates improving conditions. In the details, the new-orders index fell 2 points to 25.4, while shipments jumped 15.7 points 39.1. On a negative note, expectations of future activity decreased further to 25.4, down 2 points from April’s reading.
The Federal Reserve said that nationally, industrial production rose 1% last month, its biggest gain since February 2014. In the details, factory production rose 1%, mine production added 1.2%, and utility output increased 0.7%. Compared with the same time last year, production was up 2.2%. The strong dollar has weighed on manufacturing the last two years. Analysts received the report with cautious optimism. Paul Ashworth, chief U.S. economist at Capital Economics said it was still questionable whether the good performance could be sustained given both the apparent slowdown in China and the weakening Empire State manufacturing index.
International Economic News: About 23% of Canadian chief executives, chief financial officers, and chief operating officers cite U.S. protectionism as their top economic concern, according to the most recent CPA Canada Business Monitor survey. That protectionism was the number one concern is especially notable considering that the survey was administered March 30 to April 18, before Trump had criticized Canada’s dairy industry or slapped tariffs on Canadian lumber shipments. Oil prices came in second, with 17% of the vote, in the Business Monitor list of 10 challenges facing the Canadian economy. Uncertainty surrounding the Canadian economy and the state of the U.S. economy were tied for third with 14%. Despite these concerns, executives were less worried about the economy than they were this time a year ago.
United Kingdom retail sales volumes handily beat expectations by rising 2.3% last month compared to the 1.4% decline in March, according to the Office for National Statistics. Expectations had been for only a 1% gain. Consumer spending, the mainstay of economic growth in the U.K., appeared to be holding up in the face of rapidly increasing food and fuel costs. Inflation accelerated at its fastest pace since September of 2013 last month and workers saw their real earnings fall for the first time in over two years. The news sent sterling above $1.30 for the first time since last fall on the conjecture that the strong figures suggest the possibility of an earlier than expected interest rate hike from the Bank of England.
In France, new President-elect Emmanuel Macron has unveiled his new cabinet. France’s youngest ever President pledged to rebuild the country’s economy and listen to its citizens as he invoked the national motto; “liberty, equality, fraternity”. Macron’s first international trip as president is scheduled for Monday: a meeting with German Chancellor Angela Merkel in Berlin. Macron is the first French president who doesn’t originate from one of the country’s two mainstream parties. His “Republic on the Move” party is considered progressive but with a practicality linked to his pro-business worldview. In his inauguration speech, Macron said he will do everything that is necessary to fight terrorism and authoritarianism and to resolve the world’s migration crisis. He also listed “the excesses of capitalism in the world” (without identifying any particular ones) and climate change among his future challenges.
German investor sentiment improved further this month to reach its highest in almost two years. The Mannheim-based ZEW research institute said its monthly survey showed its economic sentiment index rose to 20.6, a gain of 1.1 points. Investors’ assessment of the economy’s current conditions added 3.8 points to 83.9. ZEW President Achim Wambach said in the release, “The German economy is in good shape, and the prospects for the euro zone as a whole are gradually improving, further strengthening the economic environment for German exports.”
In Italy, despite EU sanctions against Moscow, trading between Russia and Italy remains high according to Russian President Putin. The Russian President met with Italian Prime Minister Paolo Gentiloni this week in the Black Sea resort of Sochi. The Italian Prime Minister said that Italian companies have always had faith in the Russian market, and added that trade ties between the two nations are improving. Italian journalist Gennaro Sangiuliano explained that Rome hopes that it might play a decisive role in restoring ties between Russia and the EU. “By reuniting Russia with the EU, Italy could have restored its weight in the international geopolitical arena,” he said.
An array of Chinese economic data sparked concerns of a consumer-led slowdown in the world’s second-largest economy. The most disappointing of the data was the industrial production report. Industrial production slowed 1.1% from March, slowing the year-over-year expansion to 6.5% in April. Retail sales also slowed, falling to 10.7% year-over-year growth from March’s 10.9%. Finally, urban investment grew an annualized 8.9% in April, down from March’s 9.2% rate. The weaker April data comes on the heels of other signs that China’s massive economic engine is losing steam after achieving 6.9% growth in the first quarter. Industrial metal prices have fallen in recent weeks, auto sales declined at twice the pace in April as in March, and inventory restocking has slowed. Macquarie Securities head of China Economics, Larry Hu, said, “All the data sends the same message: The economy slowed down meaningfully in April.”
Japan’s economy grew in the first quarter at its fastest pace in a year to mark the longest stretch of expansion in a decade. Stronger global demand, especially for tech-related items, and an improvement in household spending helped gross domestic product beat forecasts and rise 2.2%, according to Japan’s Cabinet Office. Kyohei Morita, chief economist at Credit Agricole said, “The economy is enjoying comfortable growth driven by both domestic and external demand. Consumer spending remains relatively soft and it has room to improve. But the economy passed the grade both in terms of the pace of growth and the quality of the expansion.” Japan’s economic growth in the first quarter outpaced an annualized 1.8% expansion in the euro zone and a 0.7% increase in the United States.
Finally: In the midst of Wednesday’s market plunge numerous financial websites weighed in on whether it was time to “buy the dip” or “throw in the towel”. One writer, Wolf Richter (editor-in-chief of the Wolf Street Blog), advised readers that according to one indicator they would strongly want to consider the latter. The Hagerty Market Index tracks the prices of cars— not just any cars, but very expensive classic collectible cars. Hagerty is the leading insurer of classic collectible cars, and is thus intimately knowledgeable of their values. According to Richter, the reason the Hagerty Index is important is that classic car prices often move similarly to – and sometimes lead – prices of other assets such as equities and real estate. Richter writes “The global asset class of collector cars … is quietly but persistently and very unenjoyably experiencing a downturn that parallels and in some aspects already exceeds the one during the financial crisis.” The Hagerty index peaked and then dropped in April 2008, a few months before U.S. stocks suffered the biggest crash in decades, suggesting it could be an early indicator of what may be in store for other asset classes. At the present time, the Hagerty Index is down about 10% over the last year and about 15% from its peak in September, 2015.
(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 13.75 from the prior week’s 12.50, while the average ranking of Offensive DIME sectors rose slightly to 14.00 from the prior week’s 14.25. The Defensive SHUT sectors are ranked higher than the Offensive DIME sectors but by only the thinnest of margins. 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®