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 29.66, down slightly from the prior week’s 29.87, 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 67.83, down from the prior week’s 70.27.
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 23, 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 July, indicating positive prospects for equities in the third 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 Q3, 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: The major U.S. benchmarks finished the week mixed after a volatile span with unusually high trading volumes for this time of year. As was the case last week, the technology-heavy Nasdaq Composite experienced the widest swings, this time to the downside. The Dow Jones Industrial Average fell 45 points ending the week at 21,349, a decline of -0.21%. The Nasdaq Composite declined over 124 points to close at 6,140, a loss of -1.99%. The Nasdaq 100 Index, with higher concentrations of tech high-flyers, fell even further – down -2.69%. By market cap, large caps lagged their smaller cap brethren. The large cap S&P 500 fell -0.61%, while the S&P 400 mid cap index managed a gain of 0.15%, and the small cap Russell 2000 eked out a 0.04% gain.
International Markets: Canada’s TSX fell -0.9% this week. In Europe, major markets finished the week in the red. The United Kingdom’s FTSE 100 index fell -1.5%, while on Europe’s mainland, France’s CAC 40 and Germany’s DAX fell -2.76% and -3.21%, respectively. Italy’s Milan FTSE ended down -1.2% as well. In Asia, major markets were mixed. China’s Shanghai Composite rose 1.09%, while Japan’s Nikkei retreated -0.49% and Hong Kong’s Hang Seng rose 0.37%. As grouped by Morgan Stanley Capital Indexes, developed markets were up 0.09%, while emerging markets declined -0.27%.
Commodities: Gold retreated a fourth straight week by falling -1.12%, to $1,242.30 an ounce. Silver likewise ended the week down, retreating -0.12%. Oil rebounded after five weeks of losses, surging a substantial 7.04%. West Texas Intermediate crude oil closed at $46.04 a barrel. Copper, also known as “Dr. Copper” by some analysts for its reputed ability to forecast world economic growth, rose for a second straight week, gaining 3.32%.
June Summary: The small cap Russell 2000 led the other domestic indexes with a 3.3% rise in June. The Dow Jones Industrial Average managed a 1.62% rise followed by the S&P 400 mid cap index which added 1.45%. The S&P 500 rose a much more modest 0.48%. On the other hand, the Nasdaq Composite and Nasdaq 100 index finished the month in the red, falling -0.94% and -2.45% respectively as many tech high-fliers lost altitude. Major markets in Asia were in the green for June. China’s Shanghai Composite led international markets by gaining 2.4%, followed by Japan’s Nikkei and Hong Kong’s Hang Seng which rose 1.95% and 0.41% respectively. In Europe, all major markets finished June in the red. The United Kingdom’s FTSE retreated -2.76% while Italy’s Milan FTSE fell -0.71%, Germany’s DAX gave up -2.3%, and France’s CAC 40 fell -3.08%. As grouped by Morgan Stanley Capital Indexes, developed markets retreated -1.3% in June, while emerging markets gained 0.46%. Copper rose 5.08% in June, while oil fell for its fourth straight month, down -4.72%. Precious metal were also weaker, with Gold falling -2.6% and Silver falling -4.48% in the month.
Second Quarter Summary: The Dow Jones Industrial Average added 3.3% in Q2, and the Nasdaq Composite gained 3.87%. By market cap, the large cap S&P 500 rose 2.57%, the mid cap S&P 400 added 1.57%, and the small cap Russell 2000 gained 2.12%. International markets were considerably less positive. Canada’s TSX retreated -2.35%, the United Kingdom’s FTSE fell -0.14%, France’s CAC 40 finished down a miniscule -0.04%, Germany’s DAX rose 0.1%, and Italy’s Milan FTSE gained 0.45%. In Asia, China’s Shanghai Composite fell -0.93%, while Japan’s Nikkei surged 5.95%. Emerging markets outpaced developed markets by rising 5.08% versus 4.67%.
U.S. Economic News: The number of Americans applying for new unemployment benefits rose slightly last week but remained comfortably below the threshold analysts use to indicate a “healthy” jobs market. The Labor Department reported initial jobless claims in the week ending June 24 rose by just 2,000 to a seasonally-adjusted 244,000. New applications for benefits have been under 300,000 for 121 consecutive weeks—the longest run since the early 1970’s. The smoothed four-week average of new claims fell by 2,750 to 242,250. Analysts use the smoothed average to iron out the week-to-week volatility. In addition, the number of people already receiving benefits registered fewer than 2 million for the 11th straight week. The last time the number of so-called continuing claims were consistently under 2 million was in 1973.
Home prices pulled back slightly but remained strong according to the S&P CoreLogic Case-Shiller U.S. National Home Price Index. The S&P/Case-Shiller 20-city index rose 5.7% in the three-month period ending in April compared to the same period a year ago—a slight decrease from the 5.9% annual increase in March. Economists had expected a reading of 5.9%. Despite the slight deceleration, prices continued to reflect healthy demand. Only one of the metro areas in the 20-city index saw a monthly decline, Cleveland, while in Seattle prices surged 2.6%. Seattle also led the annual gain, with a 12.6% gain over a year ago. Portland, Dallas, and Denver were close behind. Nationally, the index retreated slightly to a 5.5% annual growth rate in April from 5.6% in March.
Pending home sales – the number of homes under contract, but not yet closed – declined for a third-straight month in May. The National Association of Realtors (NAR) pending home sales index slid 0.8% to 108.5, while April’s reading was revised lower. Analysts view the reading as another sign that the housing market may be cooling off – or the market is being artificially constrained by there being simply too few homes to sell. The index was down 1.7% from the same time last year. No region saw an increase in May. In the Northeast, the index fell 0.8%, while in the South it slid 1.2%. In the West, pending home sales fell 1.3%, while in the Midwest the index was unchanged. Currently, only the index for the Northeast is higher than its level a year ago. The NAR again attributed the decline to a dwindling supply of available homes. In its release, the group’s chief economist Lawrence Yun wrote, “Buyer interest is solid, but there is just not enough supply to satisfy demand. Prospective buyers are being sidelined by both limited choices and home prices that are climbing too fast.”
The Commerce Department reported real GDP rose 1.4% in the first three months of the year, growing twice as fast as the government initially reported. The improved reading stems mostly from stronger exports and an increase in consumer spending on healthcare and financial services. Consumer spending was by far the biggest influence on GDP, revised up 0.5% to 1.1%. Most of the increase was due to higher spending on professional services: doctor visits, hospital stays, investment advice, and insurance. In addition, export growth grew 7%, an increase of 1.2% over the initial report. In the details, most of the other key figures in the GDP report—business investment, inventories, government spending, and inflation were little changed.
Orders for items expected to last three years or longer, so-called “durable goods”, fell in May for the second month in a row, registering its biggest drop in six months. The Commerce Department reported that durable-goods orders slipped 1.1% last month following a similar decline in April. Economists had only expected a -0.8% decrease. The consecutive declines come as businesses continue to anxiously await tax, health care, and regulatory relief promised by President Trump during his campaign. In the details of the report, orders for aircraft sank nearly 12% last month, while orders for new autos rose 1.3%. Stripping out aircraft and autos, so-called “orders ex-transportation” rose 0.1%, their fourth gain out of the last five. Non-defense capital goods orders excluding aircraft, or “core” capital-goods orders fell 0.2%, marking their first decline of the year. Blerina Uruci, an economist with Barclays noted, “We see the core data as consistent with soft business investment in the second quarter.”
Confidence among American consumers continued to rise, according to the Conference Board’s latest consumer confidence index reading. The index rose to 118.9 in May, an increase of 1.3 points from April. The increase exceeded economists’ forecast of a reading of 116. In the details of the report, the “present situation” index, which tracks how consumers view the current health of the economy, rose to a nearly 16-year high of 146.3. However, consumers don’t think the economy will be much different six months from now. The “expectations” index fell to 100.6 from 102.3. Lynn Franco, director of economic indicators at the Board stated, “Overall, consumers anticipate the economy will continue expanding in the months ahead, but they do not foresee the pace of growth accelerating.”
As far as spending, American consumers barely increased their outlays and chose instead to save more money, according to the Commerce Department. Consumer spending rose just 0.1% last month after back-to-back gains in April and March. The slight increase took place against the backdrop of slowing inflation. The Federal Reserve’s preferred inflation gauge, the PCE (personal consumption expenditures) index fell 0.1%, marking its second decline in three months. In addition, the 12-month rate of inflation fell to 1.4% in May, falling from 1.7% the previous month. The Federal Reserve has been quoted as targeting an inflation growth rate of 2%. Instead of spending the money from reduced inflation, Americans chose to save it instead. The savings rate jumped to an eight-month high of 5.5%.
International Economic News: The governor of the Bank of Canada said it looked like the low interest rates implemented in 2015 have “done their job”, but stopped short of giving an indication of future moves by the central bank. The Canadian economy continues to recover from the consecutive shocks of the financial crisis of 2008 and the sudden decline in oil prices in 2014. Statistics Canada reported the Canadian economy grew 0.2% in April compared with an increase of 0.5% in March. Service-producing industries gained 0.3%, while goods-producing industries were essentially unchanged. In an interview, Bank of Canada Governor Stephen Poloz stated the Canadian economy will likely moderate in the coming months but still remain “above potential.”
In the United Kingdom, the Office for National Statistics reported the U.K. economy grew just 0.2% in the first quarter of the year, making it the worst performing major economy in the world and the European Union. GDP had been originally estimated at 0.3% but was revised down. According to the data, business services and construction supported growth, while consumer-driven industries such as retail and accommodation weighed. Consumers in Britain have suffered a sharp loss in confidence due to rising inflation and weakening wage growth. Research firm GfK reported its latest measure of consumer confidence sank to -10, 3 points weaker than its median forecast.
French President Emmanuel Macron took the first step toward major labor market reforms, a task that none of his predecessors from across the political spectrum were willing to undertake. Macron’s cabinet approved a broad outline of changes to the labor code and is asking parliament for the authority to negotiate the details with unions and business groups. The government plans to introduce the new framework by decree, to avoid getting impeded by debates and numerous amendments. Finance Minister Bruno Le Maire said, “The labor-market reform is the mother of all reforms, both from an economic and social point of view. While the context is favorable, we must not waste a minute.” The French economy just recorded its strongest six-month period of growth since 2010. With his political capital at a high, Macron is anxious to show France’s European partners that he can deliver on the long-overdue labor reforms.
German Chancellor Angela Merkel stated in a speech to parliament that the future of Germany and the EU lies in a French and German-led Europe. The Chancellor made it abundantly clear that her nation is pivoting away from a US and United Kingdom dominated world. In the speech, she stated that Germany and France will take a greater role in leading the European Union, and Europe must take a greater role in leading the world. Merkel spoke specifically of France and that she had talked to French President Emmanuel Macro about a “medium-term plan for deepening the EU and the euro zone.” She also added that German and French interests were “connected in the closest possible way.” The German chancellor argued that the EU was recovering from its economic crisis, with all 27 remaining members recording growth and lower unemployment. The UK, Merkel suggested, was no longer at the center of European plans.
In China, despite challenges facing the world’s second largest economy, views were predominantly optimistic at the World Economic Forum meeting in Dalian. Premier Li Keqiang delivered the opening speech, touting the idea of a Chinese economy driven by innovation. China has been characterized as being an economic “copycat”, with its strength due to manufacturing the ideas and innovations of other nations. China needs to “eliminate barriers” to foreign investment and create jobs to spur growth in the country, Premier Li Keqiang said. The premier also made it clear that Beijing was aware of risks facing growth, and asserted the authorities were equipped to handle them. Helen Zhu, managing director and head of China equities at Blackrock, noted that China’s growth momentum remains strong.
Japanese industrial output fell at its fastest pace at any time since the devastating earthquake of March 2011. In addition, inventories hit their highest in almost a year, suggesting that the nation’s tepid economic recovery may stall. A decline in household spending also weighed on the economy putting Japan’s 2% inflation target farther out of reach. Hiroaki Muto, an economist at Tokai Tokyo Research Center stated, “Production looks like it will enter a period of stagnation. If production is weak, consumer spending is unlikely to strengthen. The BOJ may have to lower its consumer price forecasts.”
Finally: While past week marked the end of the first half of the year, what can we expect as we enter the second half? Chris Verrone, technical analyst at Strategas Research Partners, released a note pointing out that stocks are “approaching the more difficult stretch of the calendar.” Verrone pointed out that the average performance of both the S&P 500 and Nasdaq 100 over the last 30 years typically trade lower during the upcoming 4-month period —a slight adjustment to the “Sell in May and Go Away” Wall Street adage of old. While equities have risen about 9% the first half of the year, “defensive” assets such as gold and bond prices have also climbed. This suggests to Mr. Verrone that a significant number of investors are skeptical of the eight-year bull market. Other analysts shared similar research. Robert Sluymer, technical analyst with Fundstrat Global Advisors wrote in a note, “Our monthly cycle data continues to support a more cautious technical outlook heading through the summer into the fall.”
(sources: all index return data from Yahoo Finance; Reuters, Barron’s, Wall St Journal, Bloomberg.com, ft.com, guggenheimpartners.com, zerohedge.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 11.50 from the prior week’s 9.00, while the average ranking of Offensive DIME sectors fell to 18.75 from the prior week’s 17.25. The Defensive SHUT sectors maintained 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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