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 29.68, essentially unchanged from last week’s 29.66, 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 65.72, down from the prior week’s 67.83.
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, up 1 from the prior week’s 23. 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: Major U.S. indexes all finished in the green for the holiday-shortened week—but just barely. While the larger-cap benchmarks recorded modest gains, the smaller indexes managed to close just barely positive. The Dow Jones Industrial Average rose 64 points to close at 21,414, a gain of 0.3%. The technology-heavy Nasdaq Composite added 0.2%, ending the week at 6,153. The market cap indexes were all a tiny bit positive: the large cap S&P 500 rose 0.07% while the mid cap S&P 400 gained 0.04% and the small cap Russell 2000 added 0.03%.
International Markets: Canada’s TSX fell for a second week, declining just over 1%. In Europe, major markets were all in the green. The United Kingdom’s FTSE rebounded half a percent after five straight weeks of declines. On Europe’s mainland, France’s CAC 40 rose 0.48%, along with Germany’s DAX which rose 0.52%. Italy’s Milan FTSE surged over 2.09%. Asian markets were mixed. China’s Shanghai Composite gained 0.8%, while Japan’s Nikkei was off -0.5%. Hong Kong’s Hang Seng reversed last week’s rise falling -1.6%. As grouped by Morgan Stanley Capital Indexes, developed markets as a group and emerging markets as a group both ended the week down -0.6%.
Commodities: Precious metals retreated for a fourth consecutive week. Gold fell $32.60 to $1,209.70 an ounce, a loss of -2.6%. Silver plunged over 7.2% to end the week at $15.43 an ounce. In energy, oil retraced most of last week’s rise falling -3.9% to $44.23 per barrel of West Texas Intermediate crude oil. Copper, seen by some as an indicator of world economic health, also retraced most of last week’s gain by falling -2.3%.
U.S. Economic News: The number of Americans who applied for new unemployment benefits rose slightly the last month of June, but remained near its lowest level in years. The Labor Department reported initial jobless claims increased 4,000 to a seasonally-adjusted 248,000. Initial claims count the newly unemployed who apply for benefits after losing their jobs. New applications for benefits have been under the 300,000 threshold for 122 straight weeks, its longest stretch since the early 1970’s. Below the 300,000 level is traditionally considered a “healthy” jobs market. The four-week moving average claims, used by analysts to smooth the weekly volatility, rose a meager 750 to 243,000. The U.S. has added over a million jobs during its eight year recovery. Continuing claims, the number of people already receiving benefits, totaled less than 2 million for the 12th straight week—its longest streak since 1973. On Friday, the Labor Department announced that the U.S. created 222,000 new jobs last month and that hiring was stronger during the spring than previously reported. The unemployment rate rose a slight 0.1% to 4.4% as more people entered the labor force in search of work. Economists had predicted an increase of only 180,000 nonfarm jobs.
The nation’s manufacturers are growing at their fastest pace in almost three years, according to the latest data from the Institute for Supply Management (ISM). The ISM manufacturing index rose 2.9 points to 57.8 last month to its highest reading since mid-2014. Analysts attributed the rise to improving economic conditions both at home and abroad. In the details of the report, 15 out of 18 industries tracked by ISM were expanding their operations. New orders and production both experienced sharp gains and employment plans hit the second highest level since 2011.
The ISM nonmanufacturing (or “services”) index rose 0.5 point to 57.4 in June. Consensus forecasts were for a reading of 56.5. The improvement in services bodes well for the overall economy as the service sector makes up roughly 70% of the U.S. economy. Of the 17 industries tracked, ISM’s index showed improvement in 16. Using past relationships with GDP, June’s reading historically corresponds to an annualized growth rate of 3.3%.
Spending on construction in May was essentially unchanged when compared to the upwardly revised April data, the Commerce Department reported. Outlays for all construction projects were at a seasonally-adjusted $1.23 trillion, about 1% higher than in April. Economists’ had forecast a 0.3% decline for May. Overall, the spending data tends to be very volatile and analysts traditionally report having difficulty using the data for actionable investment decisions—still, total construction spending for the first five months of this year are up 6.1% over the same period last year. Ian Shepherdson, chief economist at Pantheon Macroeconomics states, “Overall, construction is set to make a modest contribution to Q2 GDP growth via the housing and public components, but we hope for much better in the second half as developers respond to significantly stronger home sales.”
The Federal Reserve released the minutes from its June 13-14 Federal Open Market Committee meeting revealing that “several” members were in favor of starting the reduction of its $4.5 trillion balance sheet within a “couple of months”. The statement only indicated that the process would start this year, without indication of the extent. In addition, members were divided between those comfortable with the unemployment rate and those concerned about a “substantial and sustained unemployment undershooting” that could trigger inflation or financial instability. The minutes also showed concern among members that financial conditions have remained loose even as the Fed has embarked on an interest rate hiking cycle.
The trade deficit fell 2.3% in May, primarily due to fewer imports of cellphones and other consumer goods. The deficit stood at $46.5 billion in May, down $1.1 billion from April according to the Commerce Department. Economists had forecast a $46.3 billion gap. Exports continued to improve. The U.S. shipped $192 billion worth of goods and services to other countries, a 0.4% increase. Exports hit their highest level in more than two years. Imports fell a slight 0.1% to $238.5 billion. For the first five months of 2017, the U.S. deficit was 13% higher than the same time last year. In the details, the deficit with Mexico rose to $7.3 billion, its highest level in a decade. Imports from Canada, our biggest trading partner, were at a two-year high. With China, the trade gap widened to $31.6 billion, while with Germany the deficit declined.
International Economic News: Trade data from Statistics Canada showed that both exports and imports hit record highs in May. Imports rose 2.4% on the month and have increased for six consecutive months. Imports of motor vehicles and parts rose strongly and aircraft imports jumped pushing overall imports higher. The Bank of Canada has become more optimistic in its outlook for economic growth, but concerns have lingered over the outlook for exports. Total exports increased 1.3% for the month to a record high $48.7 billion. The overall growth in trade volumes should reinforce confidence in Canada’s economic strength in anticipation of an interest rate decision on July 12th. Markets are increasingly expecting a hike to come soon as the economy recovers from the prolonged shock caused by low oil prices.
The UK economy suffered a blow as the latest trade data came in weaker than expected. In the three months to May, Britain’s trade deficit widened to 8.9 billion pounds, up 2 billion pounds from the previous quarter. The widening deficit was primarily due to the increase in the import of cars, aircraft, ships, oil, and electrical machinery from non-EU countries, the Office for National Statistics reported. The concomitant drop in services exports also contributed to the fall. The news was unwelcome to Bank of England policymakers who had hoped that an improvement in exports and investment would compensate for the fall in consumer spending in recent months. Separately, UK manufacturing output fell 0.2% in May, cancelling out April’s rise and missed forecasts for a modest rise.
Across the Channel in France, Chinese President Xi Jinping and French President Emmanuel Macron agreed to promote bilateral relations and cooperation. The Chinese state news agency quoted Xi as saying, “The Chinese side is willing to make concerted efforts with the French side to continue to view the bilateral relations from a strategic height and a long-term perspective, and work for a better development of our ties.” Both China and France are permanent members of the UN Security Council. Xi proposed that the two countries increase high-level exchanges and consider each other’s core interests and major concerns based on the principles of mutual respect, trust, understanding and accommodation. In addition, Russian President Vladimir Putin noted an improvement of economic ties with France at his meeting with Macron. “Despite all difficulties, the economic ties (between Russia and France – TASS) are improving, and the trade turnover is on the rise,” Putin said. “We expect the Russian-French council for economic, financial, industrial and trade issues to work hard,” he added.
In Germany, tens of thousands of people turned out for large protests against the G-20 meetings in Hamburg. The G-20 (or Group of Twenty) is an international forum for the governments and central bank governors of the world’s 20 largest economies. Peaceful protests Saturday were bracketed by violent rioting Friday and Saturday nights. Cars, barricades, and trash cans were set on fire, stores were looted, and rioters threw bottles and stones at police. The meeting of the world’s most powerful leaders has drawn a wide range of protestors to the city, ranging from economic equality groups, socialists, anarchists and communists to climate activists. German Chancellor Angela Merkel has taken considerable heat over hosting the meetings in Hamburg, Germany’s second largest city.
A trade report published this week suggests that Chinese trade with North Korea was up 15% during the first five months of the year. The news provoked a tweet from U.S. President Donald Trump remarking, “So much for China working with us – but we had to give it a try!” Trump has repeatedly indicated that he wants Chinese President Xi to sanction North Korea or stop trading with the country entirely for its continued ballistic missile testing and provocations. China is by far North Korea’s most significant trading partner. Customs data show total trade in the first five months of this year rose 15 percent from a year earlier, driven by North Korea’s purchases of Chinese oil and consumer goods. China bought more iron ore but suspended purchases of coal, a key North Korean export. Total trade between the two countries for the first five months of the year was just over $2.1 billion—a tiny percent of China’s massive total world trade volume.
Confidence among Japan’s biggest manufacturers rose for the third consecutive quarter to its best level in more than three years according to a key Bank of Japan survey. The survey, known as the Bank of Japan’s Tankan report, is a quarterly survey of more than 10,000 companies. The key index rose 5 points to 17—its highest since the first quarter of 2014. Marcel Thieliant, senior Japan economist at Capital Economics said, “The jump in the Tankan’s headline index for large manufacturers suggests that economic activity accelerated last quarter. Capacity shortages have intensified and manufacturers are reporting the smallest declines in output prices since 2008.” The Tankan survey is the broadest indicator of how the Japanese economy is faring.
Finally: It’s been a bad couple of weeks for the cable news outfit CNN. Multiple accusations of airing “fake news” stories (with several editors, reporters and producers fired as a result), veiled threats to individual Reddit.com users, and a couple of embarrassing undercover videos from Project Veritas that showed CNN producers themselves admitting their own news is “mostly bull—-“ are just a few of the gaffes, unforced errors and outright falsehoods that have dogged CNN of late. In response, viewers seem to be voting with their feet. According to Adweek.com, for the final week of June CNN’s primetime shows even managed to draw fewer viewers than decades-old reruns of “Yogi Bear”, “Full House” and “Friends”. The chart below tracks the steep decline in viewership among the coveted 25-54 demographic group.
(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 15.00 from the prior week’s 11.50, while the average ranking of Offensive DIME sectors rose to 17.00 from the prior week’s 18.75. The Offensive DIME sectors sharply reduced the lead of the Defensive SHUT sectors had. Note: these are “ranks”, not “scores”, so smaller numbers are higher ranks and larger numbers are lower ranks.
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