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 29.59, up from the prior week’s 29.26, 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 66.31, up from the prior week’s 65.07.
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. 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: Stocks recorded solid gains for the week, lifting the S&P 500 index and the Nasdaq Composite Index to record highs. The Dow Jones Industrial Average rose 275 points to close at 21,080, a gain of 1.3%. The tech heavy Nasdaq Composite added over 2% by rising 126 points, closing at 6,210. By market cap, large caps again showed relative strength over smaller caps. The large cap S&P 500 index rose 1.4%, while the S&P 400 mid cap index and Russell 2000 small cap index added smaller gains, 0.9% and 1.1% respectively.
International Markets: Canada’s Toronto Stock Exchange fell for a fifth straight week by retreating -0.27%. In contrast, the United Kingdom’s FTSE rallied for its fifth straight week by rising 1%. On Europe’s mainland, France’s CAC 40 rose 0.23%, while German’s DAX pulled back -0.29%. Italy’s Milan FTSE ended the week down -1.6%. In Asia, major markets were green across the board. China’s Shanghai Stock Exchange rose for a second week, adding 0.63%, while Japan’s Nikkei rose half a percent. Hong Kong’s Hang Seng rose for a fourth straight week by rising 1.8%. As grouped by Morgan Stanley Capital International, emerging markets rose 1.4%, while developed markets fell -0.1%.
Commodities: Precious metals traded higher for a second week. Gold added 1.16% or $14.50 to close at $1,268.10 an ounce. Silver did even better, surging 3.1% and closing the week at $17.32 an ounce. However, the industrial metal copper (thought by some analysts to be an indicator of global economic health) retreated -0.6%. Oil retreated for the first time in three week, falling -1.7% to $49.80 per barrel for West Texas Intermediate crude.
U.S. Economic News: The number of Americans applying for new unemployment benefits continued to drop to levels not seen in almost 50 years — an indication that the U.S. labor market remains quite healthy after eight years of economic expansion. The Labor Department reported initial jobless claims rose 1,000 to 234,000 for the week ended May 20. The smoothed four-week average of new claims fell 5,750 to 235,250 to its lowest level since April 1973. New applications for benefits have remained under the 300,000 threshold for 116 straight weeks, its longest run since the early 1970’s. Continuing claims, the number of people already receiving benefits, rose by 24,000 to 1.92 million. Continuing claims have now remained under two million for six straight weeks—a feat that hasn’t occurred since 1973. The U.S. unemployment rate stands at 4.4%, while U.S. businesses continue to complain that they can’t find enough skilled workers for open positions.
Sales of newly constructed homes retreated in April following March’s strong pace. The Commerce Department reported new-home sales ran at a seasonally-adjusted annual rate of 569,000 last month. That missed analyst expectations of 610,000. Last month’s figures were down 11.4% from March, but remained 0.5% higher than the same time last year. In April, the median sales price for a new home was $309,200, down from $318,700. The slower sales pace also increased the months’ worth of inventory on the market. April’s inventory was 5.7 months’ worth of homes available, up from 4.9 months in March. Traditionally, the U.S. housing market has about 6 months’ worth of inventory available.
It was a similar story in existing home sales. Sales of previously-owned homes weakened in April after a strong first quarter. Existing home sales ran at a seasonally-adjusted 5.57 million annual rate, according to the National Association of Realtors (NAR). That was a decline of 2.3% from March’s sales pace, but 1.6% higher than the same time last year. Economists had estimated a 5.6 million annualized sales pace. Decreases were widespread, affecting every region except the Midwest (where sales were up 3.8%). In the Northeast, sales fell 2.7%, while in the South they were down 5%. The West was down 3.3%. Danielle Hale, the NAR’s managing director of research, attributed the weaker reading to the dwindling inventory of homes available for sale at reasonable prices. Inventory was down 9% compared to last April, and there is only a 4.2 months’ supply of homes available on the market. From listing to contract, homes were on the market for an average of just 29 days—the lowest since the NAR began tracking that metric in 2011. The median national sales price of existing homes was $244,800, a 6% increase from a year ago. It was the 62nd consecutive month of annualized price gains.
American factories were busier and job prospects better last month, driving up the Chicago Federal Reserve’s measure of national economic activity. The Chicago Fed’s national activity index rose 0.42 point to 0.49 last month to its highest reading since March 2014. The smoothed three-month average of the index, which offers a clearer picture of trends in economic activity, rose to 0.23, up from 0. The national activity index is a weighted average of 85 economic indicators, devised so that zero represents on-trend growth and a three-month average below -0.7 suggests a recession has begun. This latest reading is seen by analysts as adding to the prevailing opinion that the Federal Reserve will raise interest rates again at its policy meeting next month.
Orders for long-lasting goods meant to last at least three years, so-called “durable goods”, retreated in April for the first time in five months. Durable goods orders dropped -0.7% last month amid widespread weakness in heavy industry, according to the Commerce Department. Economists had expected a larger 1% decline. The decline followed four straight months of gains. Stripping out the volatile aircraft and military equipment orders, orders were flat for a second straight month. Stephen Stanley, chief economist at Amherst Pierpont Securities released an optimistic research note, writing “Surveys suggest that businesses are ecstatic about the change in tone in Washington and are prepared to unleash a flurry of pent-up investment, but they are holding off until there is more clarity on corporate tax reform and other elements of the new administration’s fiscal agenda.”
Research firm IHS Markit reported its manufacturing Purchasing Managers Index (PMI) fell 0.3 point to 52.5—still in expansion territory but an eight-month low. Manufacturers saw a surge that began at the end of last year and continued through early 2017 before easing up recently. However, on the services PMI side, Markit said its U.S. services index rose to a four-month high of 54 from 53.1. The services side of the economy makes up about 80% of the nation’s workforce in fields such as finance, retail, medical care, real estate, and travel. Chris Williamson, chief business economist at IHS Markit wrote, “May saw an encouraging upturn in service-sector growth to the fastest so far this year, buoyed by rising domestic demand. Manufacturers, on the other hand, reported the smallest rise in production since last September amid lackluster export sales.”
The Commerce Department released its latest update for first quarter GDP and it turns out the economy wasn’t as bad as it looked originally. The government raised its growth rate to 1.2% from the original 0.7%. The first quarter’s slowdown was largely blamed on a pullback in consumer spending and business inventory production—areas which appear to be stronger now. On a negative note, corporate profits declined for the first time in three quarters. Adjusted pre-tax profits fell at a 1.9% annual rate in the first quarter, but remain up 3.7% from the same time last year. Fixed business investment was also revised upward, from a 10.4% increase to 11.9%–largely due to more activity in the oil sector. Based on the improvement, analysts are expecting a stronger second quarter. Michael Pearce of Capital Economics wrote in a research note, “While business investment is likely to make a smaller contribution to growth in the second quarter, we still expect GDP growth to be between 2.5% and 3%.”
International Economic News: The Bank of Canada held its overnight interest rate unchanged at 0.5%, but hinted at its first rate hike in almost seven years in its statement. In its statement the bank said the global economy is gaining traction and there are signs business investment may be poised to pick up now that the collapse in oil prices has largely passed. “Growth will gradually strengthen and broaden over the projection horizon,” the bank said. The generally upbeat tone of the statement suggests that Bank of Canada Governor Stephen Poloz and his colleagues may be inching closer to an interest rate hike. Bank of Montreal chief economist Douglas Porter said in a note, “The main message is that the bank now clearly sees the balance leaning more to the side of raising rates, rather than cutting them.”
The United Kingdom’s economy slowed more than initially estimated in the first quarter, rising only 0.2% rather than the 0.3% originally reported. Growth in services, the largest part of the economy, and production were both revised down. The Office of National Statistics said in its statement, “UK GDP growth in quarter one 2017 has been revised down by 0.1 percentage points from the preliminary estimate, mainly due to broad-based downward revisions within the services sector.” The report from the Office for National Statistics also showed that exports fell 1.6% and net trade knocked 1.4% off GDP. Consumer spending weakened, with household activity adding the least to the economy since 2014.
New French President Emmanuel Macron and his Labor Minister Muriel Penicaud started their first round of meetings with France’s unions and business organizations in an attempt to find common ground in simplifying France’s burdensome labor rules and letting individual companies negotiate wages rather than follow industrywide agreements. France’s complex labor rules have frustrated French presidents for at least the last 20 years as the country’s powerful unions opposed previous efforts to reduce job protections for their members. Macron signaled during his campaign that making French labor markets more flexible will be central to his strategy for boosting growth.
German businesses reported stronger-than-expected activity in May. Research firm IHS Markit’s composite Purchasing Managers’ Index (PMI) rose 0.5 point to 57.3—its highest level in more than six years. The increase was driven by better than expected reports from the manufacturing sector. In addition, the Munich-based IFO institute described German business leaders’ sentiments as a “champagne mood”, lifting the widely-watched IFO Business Sentiment Index to an all-time high. IFO’s noted that moods in the manufacturing industry appear to be exuberant. “Many manufacturers are planning to ramp up production, and prices are expected to rise,” IFO said.
China’s credit rating was downgraded by Moody’s for the first time in almost three decades over fears that rising debts and slowing growth will weaken the world’s second largest economy. The agency lowered China’s sovereign rating one tick from Aa3 to A1, while the outlook was raised to stable from negative. Moody’s said the downgrade reflected expectations that “China’s financial strength will erode somewhat over the coming years, with economy-wide debt continuing to rise as potential growth slows”. The last time Moody’s cut China’s credit rating was in 1989, the year of the Tiananmen Square protests. Beijing was quick to respond with the finance ministry accusing Moody’s of overestimating the risks facing the economy.
In Japan, confidence among the country’s manufacturers retreated in May for the first time in nine months after hitting a ten-year high in April, according to a Reuters survey. In the poll, the sentiment index among manufacturers fell 2 points to 24, dragged down by weakness in food processing, precision machinery and chemical industries. The sentiment index for the services sector rose 2 points to 30, its best reading since the beginning of this year. Yuichiro Nagai, economist at Barclays Securities Japan noted, “Sentiment remained firm in both manufacturing and non-manufacturing. The dollar has risen since bottoming in mid-April and such a recovery in market conditions should underpin business sentiment.”
Finally: Have you ever heard of the “TSX Venture Exchange”? Most US investors have not, but it turns out to be the hottest investing venue in all of North America over the last 18 months. Headquartered in Calgary, Alberta with offices in Toronto, Vancouver, and Montreal the exchange is all electronic (like the NASDAQ in the US), so there is no “trading floor”. The TSX Venture Exchange is the home of many of Canada’s smaller resource companies, such as precious metals mining, uranium mining, smaller energy companies, and even high-tech startups. Oh yeah, and the TSX Venture Exchange Index is up 71% over the last 16 months, more than triple the S&P 500’s gain!
(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 11.50 from the prior week’s 13.75, while the average ranking of Offensive DIME sectors slipped to 14.50 from the prior week’s 14.00. The Defensive SHUT sectors slightly 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®