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 29.88, up from the prior week’s 29.59, 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 68.81, up from the prior week’s 66.31.
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 21, down from the prior week’s 21 (despite the market’s weekly advance). 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 rallied for a second week as three of the major U.S. benchmarks reached new highs. Gains were broad-based as the Dow Jones Industrial Average gained 126 points to close at 21,206, an increase of 0.6% and a new record high. The Nasdaq Composite rallied 1.54%, or 95.6 points, to close at 6,305–also a new record. The S&P 500 large cap index lagged its smaller cap brethren but managed a gain of 0.96% to also reach a new record close of 2,439. Rounding out the market caps, the small cap Russell 2000 had a strong week, vaulting 1.67%, while the mid cap S&P 400 rose a respectable 1.38%. The smaller-cap benchmarks remained just below the records they set earlier in the year.
International Markets: Canada’s TSX had its first positive week in six, rising just a modest 0.17%. In Europe, the United Kingdom’s FTSE finished flat bringing to an end a streak of five consecutive weeks of gains. On Europe’s mainland, France’s CAC 40 rose 0.13%, while Germany’s DAX retraced two weeks of losses by rising 1.75%. Italy’s Milan FTSE had its third week of losses falling -1.3%. In Asia, China’s Shanghai Composite retreated -0.15%, while Japan’s Nikkei rallied 2.5%. Hong Kong’s Hang Seng index rallied a fourth straight week, adding 1.1%. As grouped by Morgan Stanley Capital Indexes, developed markets rallied 1.77%, while emerging markets managed only a tiny 0.05% gain.
Commodities: Energy continued to be pressured as oil slumped a sizeable -4.3% to $47.66 a barrel for West Texas Intermediate crude. In precious metals, Gold, which is traditionally seen as a defensive investment in times of economic uncertainty, uncharacteristically rallied alongside the stock market for its fourth straight week of gains by rising 0.95% to $1,280.20 an ounce. Silver rallied in tandem with gold, gaining 1.17% to close at $17.52 an ounce. Copper, viewed by some as an indicator of worldwide economic health, managed just a 0.33% gain.
May Summary: May’s results were mixed, despite the headlines announcing frequent “new highs”. Tech stocks in the Nasdaq lead U.S. results, with a solid gain of +2.50%. The S&P 500 gained +1.16%, and the Dow managed a +0.33% rise. But the S&P Mid Cap 400 lost -0.64% and the Small Cap Russell 2000 sank -2.16%. International indices were quite strong, with Developed Markets (as defined by the MSCI Developed Market index) roaring ahead by +3.54% while Emerging Markets (as defined by the MSCI Emerging Market index) did almost as well with a robust gain of +2.85%.
U.S. Economic News: The Labor Department reported that the U.S. added 138,000 new jobs in May. Spring hiring was weaker than initially reported. The unemployment rate fell to 4.3%, touching its lowest level since 2001, but the decline was actually due to more people leaving the labor force than an actual increase in jobs found. The broader “U6” measure of unemployment fell to 8.4% last month, closing in on its’ pre-crisis low of 7.9%. This measure of unemployment reflects those who can only find part-time work and the underemployed. In the details, professional white-collar firms, health-care providers, restaurants, and energy producers led the way in hiring. However, traditional retailers, weighed down by internet rivals, lost jobs for a fourth straight month. Ted Wieseman, economist at Morgan Stanley noted, “Business complaints of labor shortages have become increasingly widespread.”
The number of Americans seeking first-time unemployment benefits last week rose to a five-week high of 248,000. The Labor Department reported that initial jobless claims rose by 13,000 for the week ended May 27. The less-volatile smoothed four-week average of new claims rose a lesser 2,500 to 238,000. New applications for benefits have registered less than 300,000 for 117 straight weeks, the longest streak since the early 1970’s. Continuing claims, the number of people already receiving benefits, fell by 9,000 to 1.92 million. Continuing claims have remained under 2 million for seven consecutive weeks. That last occurred in 1973-74.
The ongoing increase in home prices picked up speed last month, accelerating to its highest rate in nearly three years. The S&P/Case-Shiller 20-city Q1 index rose 5.9%, compared to the same period last year. It was a tick higher than economists expected, and was the strongest year-over-year price gain since July 2014. The broader national index was up 5.8% year-over-year, its highest increase in almost three years. The strongest price increases were in Seattle, Portland, Dallas, and Denver. Case-Shiller noted in their release that even in the metro areas with the lowest annual appreciation rates, prices still rose at about double the rate of inflation. While the broader national index regained its bubble-era peak last year, the narrower 20-city index still remains 5.4% below its July 2006 high.
Confidence among consumer fell last month for the second month in a row as Americans may have lowered their expectations going forward following the huge burst of optimism at the beginning of the year. The Conference Board said its consumer confidence index retreated 1.5 points to 117.9 in May. At the beginning of the year, consumer confidence hit its highest level in more than 16 years on hopes that the economy would get a jolt from the pro-business Trump administration. Expectations may be tempered due to the biggest proposals by the White House—replacing Obamacare, cutting taxes, and increased spending on public works have so far languished in Congress.
Inflation, as measured by the Personal Consumption Expenditures Index, rebounded 0.2% in April, reversing March’s 0.2% drop. Over the past year, the PCE price index increased 1.7%. Excluding the often-volatile food and energy categories, the so-called core PCE price index also rose 0.2% to an annualized 1.5% growth rate. The Federal Reserve has established a target of 2% inflation in its monetary policy. Even with the slowdown in inflation, the Federal Reserve is still widely expected to raise interest rates soon, possibly as early as mid-June.
The Federal Reserve’s Beige Book, a gathering of anecdotal information on current economic conditions from each Federal Reserve Bank in its district, said the economy expanded at a “modest to moderate” pace through late May, but that growth weakened in some regions, raising questions about whether the central bank will postpone its anticipated mid-June rate hike. The latest Beige Book was less optimistic than the Fed’s previous survey. While most districts were strong, the Fed said that the economies in Boston, Chicago, and New York were weaker than the previous survey. Jennifer Lee, senior economist at BMO Capital Markets, said, “The U.S. continues to grow but there appears to be some slowing taking place.” Labor shortages also appear to be taking their toll. In the Chicago region, businesses said “the labor market was tight and it was difficult to fill positions at any skill level.”
Manufacturing continued to strengthen in May according to the latest data from the Institute for Supply Management (ISM). Their Purchasing Managers Index (PMI) for manufacturers rose 0.1 to 54.9. Of the eighteen industries surveyed, fifteen reported growth in May. The subcomponents of the PMI were also strong. New-orders rose 2 points to 59.5, while the prices component dropped 8 points to 60.5. Timothy Fiore, chair of ISM’s business survey committee, said in a statement, “Comments from the panel generally reflect stable to growing business conditions, with new orders, employment and inventories of raw materials all growing in May compared to April.”
International Economic News: Statistics Canada reported that Canada’s GDP grew at an impressive 3.7% annual pace—the best in the developed world. The increase was driven by consumer spending, a rebound in business investment, and the housing market, said the national statistics agency. Bank of Montreal chief economist Doug Porter said it was “a pretty impressive result. We’ve now had three quarters in a row of quite solid activity in Canada, so this is not a flash in the pan by any means. It does look like the economy is moving beyond the oil shock.” As hot as GDP was, it was still slightly below expectations. In addition, the International Monetary Fund released a report this week stating that Canada had regained momentum but risks were significant, most notably due to Canada’s hot housing market and rising household debt.
The United Kingdom, on the other hand, is now the worst-performing advanced economy in the world. Of the G7 group of advanced economies, Britain is now at the bottom with just 0.2% growth in the first three months of the year—a reading it shares with Italy. Before the Brexit vote, just under a year ago, the UK economy had been outperforming Germany, Japan, and the U.S. The U.K. economy had initially held up better than expected immediately following the vote, defying many mainstream economists, financial institutions, and media outlets that had predicted an apocalyptic outcome. However, some signs of deterioration have begun to appear. Inflation jumped a large 2.7%, primarily due to a dramatic slump in the value of the pound that has raised the price of imports.
Across the Channel in France, it appears that French President Emmanuel Macron took power at just the right time, just as the economy turned upward. France’s economy grew by 0.4% in the first quarter of the year, 0.1% stronger than initially expected. In addition, private sector surveys show business activity is growing at its fastest pace in seven years. The strength in businesses is transferring to consumers as French consumer confidence also climbed to its highest level in a decade, according to the national statistics agency INSEE. Economist Christian Schulz at Citi wrote in a note, “After a slightly higher first quarter, we look for real GDP growth to accelerate to an annualised rate of around 2pc in the rest of 2017, with upside risks to our baseline in the second half of 2017. If our forecast turns out to be right, real GDP growth of 1.5pc would be the highest since 2011.”
A new study by Germany’s IFO Institute simulated the effects of eight different Brexit scenarios on Germany and the EU economy. What it found was even the “worst case” Brexit scenario would be bearable for both. Germany’s Economy Minister Brigitte Zypries said “even in the most adverse case,” Brexit would be “bearable for the EU economy and in particular for the German economy.” While Zypries said Germany would seek the “best results” from talks, the remarks sent an ominous message to British negotiators for the upcoming Brexit talks. The study simulated the effects of eight different Brexit scenarios. In the most positive scenario, a comprehensive free trade deal between all parties predicted a long-term output loss from a pre-Brexit trajectory of 0.1% for the EU and 0.6% for the U.K. The worst-case scenario showed the U.K. economy losing -1.7% of economic output, while German and EU GDP would lose -0.2% and -0.3%, respectively.
In Asia, China’s factory activity contracted last month for the first time in almost a year. Private market research firm Caixin reported its Purchasing Managers Index (PMI) came in at 49.6 for May, down from 50.3 in April. All its major indicators deteriorated over the month, pushing the index below the crucial 50 point barrier, which indicates contraction. Caixin’s PMI primarily focuses on smaller companies, while Chinese government PMI figures focus on larger (and largely state-owned) factories. Caixin analyst Zhengsheng Zhong said “China’s manufacturing sector has come under greater pressure in May and the economy is clearly on a downward trajectory.” Zhong added that manufacturers have stopped actively replenishing fresh supplies as goods in stock have started to pile up. The day before, official figures from the Chinese government showed their PMI at 51.2, slightly beating forecasts of 51.
In Japan, the main stock index surged to an 18-month high this week, breaking the 20,000 level for the first time in more than a year. Shares have surged on the back of stronger economic growth and improved corporate profits in both Japan and the U.S. But analysts worry that company earnings have improved primarily due to tax cuts rather than improved bottom lines. In addition, Japan’s ultralow jobless rate means that employers are scrambling to find workers amid the tightest labor market in decades. Government figures showed the jobless rate at 2.8% for April—the lowest since 1994. The ratio of job offers to job seekers was 1.48, in essence 148 positions available for every 100 job hunters.
Finally: This week online retailer Amazon closed above $1000 a share for the first time in its history as Americans more and more become accustomed to the convenience of shopping at home and having a package show up at their door two days later. More than a few people have described the experience as a “Christmas every day” phenomenon where boxes filled with items they had forgotten they had ordered appear on their doorsteps day after day. Amidst this new shopping experience, brick-and-mortar store chains by the dozens have sunk into bankruptcy as consumers no longer walk their aisles.
But from the wreckage of retail, one firm has emerged by managing to grow, not shrink, and prosper, not wilt: Dollar General. Dollar General has not only survived, but is also seeing amazing growth. According to Bank of America data, of the nearly 7,800 net new stores opened since 2008, a whopping 76%, or 5,936 were Dollar General stores! Catering to the unglamorous low end of retail has been exactly the right thing to do.
(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 slightly to 11.25 from the prior week’s 11.50, while the average ranking of Offensive DIME sectors rose to 14.00 from the prior week’s 14.50. The Defensive SHUT sectors retained 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®