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 30.26, up from last week’s 30.10, 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 69.41, up from the prior week’s 67.48.
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 26, up 1 from the prior week’s 25. 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. market indexes recorded modest gains for the week with almost all indexes hitting new highs save for the Dow Jones Industrial Average. The Dow Jones Industrial Average shed 57 points to close at 21,580, a decline of -0.27%. However, the Nasdaq Composite continued to build on last week’s sharp gain by rising 1.19% to close at 6,387. By market cap, larger stocks barely edged out smaller stocks with the large cap S&P 500 index gaining 0.54% for the week, while the mid cap S&P 400 and small cap Russell 2000 each returned 0.49%.
International Markets: Canada’s TSX was essentially flat, rising just 0.05%. In Europe, the United Kingdom’s FTSE 100 gained a percent, while on the mainland France’s CAC 40 and Germany’s DAX retreated -2.25% and -3.1%, respectively. In Asia, China’s Shanghai Composite added 0.48%, while Japan’s Nikkei fell a slight -0.09% and Hong Kong’s Hang Seng rose 1.2%. As grouped by Morgan Stanley Capital Indexes, developed markets gained 0.35% last week, while emerging markets rose 0.48%.
Commodities: Precious metals built on last week’s gain with Gold rising an additional $27.40 to $1254.90 an ounce, a gain of 2.23%. Silver likewise rose, up 3.29% to close at $16.46 an ounce. Energy gave up some of last week’s gain. West Texas Intermediate crude oil fell -1.65% to close at $45.77 a barrel. Copper rose for a second week. The industrial metal, tracked by some analysts as a gauge of worldwide economic health, rose 1.17% – its second week of gains.
U.S. Economic News: The number of Americans applying for initial unemployment benefits fell by 15,000 last week to nearly a 44-year low of 233,000. The number remained below the key 300,000 threshold that analysts use to indicate a healthy jobs market. New applications for unemployment benefits have been under the 300,000 level for 124 consecutive weeks—its longest streak since the early 1970’s. The four week average of new claims, used to smooth out the weekly volatility, also remained at an extremely low level. The four week average fell by 2,250 to 243,750. The number of people that have been already collecting unemployment benefits rose by 28,000 to 1.98 million people. These so-called continuing claims have been under 2 million for 15 consecutive weeks, an event that last occurred in 1973. Continuing claims are reported with a one week delay.
Sentiment among the nation’s home builders diminished this month as rising costs for materials continued to take their toll. The National Association of Home Builders monthly confidence gauge fell two points to 64, whereas economists had expected an increase of one point. Notably, the index now stands at its lowest level since before the election. Then-candidate Donald Trump had addressed the trade group, pledging to roll back regulations, but has yet to deliver. In the details, every component of the sentiment index declined. Both the readings for current conditions and expectations for the coming six months fell two points to 70 and 73, respectively. Prospective buyer traffic also dipped a point to 48. In its release, the NAHB stated, “Our members are telling us they are growing increasingly concerned over rising material prices, particularly lumber. This is hurting housing affordability even as consumer interest in the new-home market remains strong.”
Despite the decline in sentiment, homebuilders broke ground on more homes in June and figures from the prior month were also revised upward. The Commerce Department reported housing starts rose 8.3% to a seasonally-adjusted 1.22 million annualized rate. Housing starts are up 2.1% for the year. The number of applications for building permits, an indicator of future building activity, rose 7.4% for the month to a pace of 1.25 million. For the year, permits are up 5.1%. The report was welcome news as many analysts had noted that labor shortages, land shortages, regulations, and rising lumber costs have all weighed on new construction.
A reading of manufacturing activity in the New York-region weakened in July following June’s two year high, according to the New York Federal Reserve. In its latest release, the New York Fed’s Empire State manufacturing index fell 10 points to a seasonally-adjusted reading of 9.8. The decline was worse than expected—forecasts were for a reading of 15. Readings for new orders, shipments, inventories, delivery times, and number of employees all decelerated. Nonetheless, the Empire State index has been positive for six out of the first seven months of 2017. Any reading above zero signals expansion.
In the city of brotherly love, manufacturers reported solid but slowing growth according to the latest report from the Philadelphia Federal Reserve. The Philadelphia Fed’s manufacturing survey fell 8.1 points to 19.5 this month. The result missed economists’ expectations for a reading of 22. The indexes for activity, new orders, shipments, employment, and work hours all remained positive, but weakened from earlier readings. Of note, the index for new orders plummeted to just 2.1 from a reading of 25.9 in June. Joshua Shapiro, chief U.S. economist at MFR Inc. released a research note stating, “The preponderance of recent survey data point to improving conditions in the manufacturing sector, and we expect the underlying trend of reported output to gradually accelerate in the months ahead. However, an ongoing inventory adjustment in the automotive sector will likely dampen headline factory output data over the near term.”
While the United States receives an enormous amount of goods from foreign countries, the latest Import Price index report from the Bureau of Labor Statistics shows that they are not bringing inflation along with them. The price of imported goods fell last month for the third time in four months, dropping 0.2%. The decline was largely due to the lower costs of imported oil. Annualized, the rate of import inflation slowed to 1.5%, a substantial retreat from January’s five-year high of 4.7% annualized. The decline is supported by other measures that track wholesale and consumer prices in the U.S., including the Federal Reserve’s preferred inflation gauge, the Personal Consumption Expenditures (PCE) index, which has also tapered off in recent months. Stripping out energy, however, import prices actually rose a slight 0.1% last month. Over the past 12 months, ex-energy, the cost of imports have risen 1%.
International Economic News: In Canada, readings for core consumer prices and retail sales came in hotter than expected, signaling that overall inflation may rise enough to warrant another rate increase this year. Statistics Canada reported the average of the central bank’s three core inflation measures rose to 1.4% last month, a rise of 0.1% from May. Canadian retail sales came in double economists’ forecasts for May with a 0.6% increase. Fred Demers, chief Canada macro strategist at TD Securities said, “Seeing the core measures trend up, that’s quite comforting for the Central bank. The retail gain also puts the economy on track for another quarter of growth at faster than a 3 percent annualized pace, meaning another rate increase in October is a very likely scenario.”
According to research firm Price Waterhouse Cooper’s (PwC) UK Economic Outlook, the UK economy is on course for an even deeper slowdown as consumer spending and business investment continue to suffer from the uncertainty surrounding the upcoming Brexit negotiations. According to PwC, Britain’s GDP is expected to drop to 1.5% growth this year and 1.4% in 2018. Consumer spending has been a key driver of the UK economy, but higher inflation and sluggish wage growth have weighed on household spending. PwC’s chief economist John Hawksworth said Brexit uncertainty has also restrained business investment as firms have held off large capital expenditure plans. In addition, CNBC is reporting that British finance minister Philip Hammond told the board of U.S. investment bank Goldman Sachs that he was pushing for a “lengthy transition period” after Britain leaves the European Union to help banks prepare for Brexit and ease concerns of a “cliff-edge” exit from the bloc.
In France, Economy Minister Bruno Le Maire kicked off Brexit negotiations on a less than amicable note by proclaiming “We want our money back.” Le Maire said that Britain must pay what it owes to the European Union and that it is a non-negotiable prerequisite for Brexit talks. The EU wants London to accept a bill to cover its share of European Union spending commitments that were made while Britain was a member—an amount which Le Maire said could be up to 100 billion euros ($115 billion). EU diplomats have warned that chief negotiator Michel Barnier is prepared to “stall” talks unless the U.K. presents proposals for calculating the U.K.’s financial obligations to the bloc.
The German economy is humming and set for solid growth despite external concerns such as the outcome of Brexit negotiations or U.S. President Donald Trump’s trade policies the German Finance Ministry stated this week. In its monthly report the ministry said, “The current picture of economic indicators suggests that the economic upswing continued vigorously in the second quarter.” Gross domestic product (GDP) likely expanded in the second quarter at a similar rate as the first quarter when the economy grew by 0.6%. The International Monetary Fund also raised its growth forecast for the German economy. It now expects the German economy to expand by 1.8% in 2017 and by 1.6% in 2018 in real terms.
In Asia, Chinese economic growth topped lofty expectations yet again last quarter with GDP expanding 6.9% from a year earlier. The figure was the tenth consecutive GDP report where the year-over-year growth rate met or exceeded economists’ forecasts—a remarkable run of stability compared to other major economies over the same period (or,perhaps, a remarkable run of “managed” numbers, as some suspect). For the second quarter, China’s National Bureau of Statistics (NBS) reported that the economy grew by a seasonally-adjusted 1.7%, in line with expectations and a 0.4% increase over the first quarter. The NBS said in its release, “Generally speaking, the national economy has maintained the momentum of steady and sound development in the first half of 2017, laying a solid foundation for achieving the annual target and better performance.” The Chinese government previously stated that it is aiming for a minimum growth rate of 6.5% this year, a result that looks more than achievable given the strength seen in the first half of the year.
Japan’s exports rose for a seventh consecutive month, led by shipments of cars and electronics. Ministry of Finance data showed that June exports grew 9.7% year-over-year, a 0.2% increase over economists’ expectations. Over the first half of the year, Japan logged a 1.04 trillion yen ($9.3 billion) trade surplus as exports surged to Asia. In the details of the report, exports to China increased 19.5% from a year earlier. Shipments to the U.S. rose 7.1%, while exports to the E.U. were up 9.6%. Toru Suehiro, senior market economist at Mizuho Securities said, “The world economy has been in its expansion phase and Japan has been benefiting from increased exports.”
Finally: “Hooray for the 1%” isn’t a cheer leaving most American’s lips, let alone anything they want to hear. But according to a recently released study by the Tax Foundation, most Americans would be surprised to learn that the richest percent of Americans pay over 39% of all Federal Income Tax! In absolute dollars, out of the $1.37 trillion collected from taxpayers, the richest 1% were responsible for over $542 billion of that amount. In fact, the richest 1% pay almost double the amount the next highest bracket pays: those with earnings in the top 2% to 5%, pay 20.5% of all Federal Income Tax. Surprising to most, the bottom 50% of all taxpayers pay just 2.8% of total taxes. Note that each section of this graphic excludes the next (e.g., the top 5% excludes the top 1%, etc).
(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 rose to 15.75 from the prior week’s 16.25, while the average ranking of Offensive DIME sectors fell to 15.75 from the prior week’s 15.50. The Offensive DIME sectors and Defensive SHUT sectors are now tied in rank. 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®