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 30.29, up from last week’s 30.23, 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 71.96, up from the prior week’s 70.65.
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 22, down sharply 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: Most U.S. indexes ended the week modestly lower, although the Dow Jones Industrial Average recorded a solid gain. The week got off to a slow start with trading volumes on Monday among the lowest of the year. Activity picked up later in the week as Thursday was the busiest day for second quarter earnings releases with over 70 S&P 500 companies reporting results. For the week, the Dow Jones Industrial Average rose 262 points to close at 22,092, a gain of 1.2%. The tech-heavy Nasdaq Composite, however, fell -0.36% to close at 6,351. By market cap, large caps outperformed the small cap indexes. The large cap S&P 500 index managed a 0.19% gain, while the S&P 400 mid cap index and the Russell 2000 small cap index both suffered their second week of losses, falling -0.62% and -1.19% respectively.
International Markets: Canada’s TSX rebounded from last week’s slight decline rising 0.85%. Across the Atlantic, major European markets had a strong week. The United Kingdom’s FTSE had a strong week, reversing last week’s drop and rising 1.95%. On Europe’s mainland, France’s CAC 40 rose 1.4%, Germany’s DAX gained 1.1%, and Italy’s Milan FTSE had a second week of gains rising 2.3%. In Asia, China’s Shanghai Composite scored its seventh consecutive week of gains rising 0.27%. Japan’s Nikkei finished effectively flat, down just -0.04%. Hong Kong’s Hang Seng had its fourth consecutive week of gains, rising 2.16%. As grouped by Morgan Stanley Capital Indexes, developed markets rose a fourth consecutive week, up 1%, while emerging markets ended up 0.46%.
Commodities: Precious metals lost their luster as the price for an ounce of gold retreated -$10.70 to $1264.60, a decline of -0.84%. Silver was sympathetically down a more significant -2.65%, ending the week at $16.25 an ounce. In energy, the price of oil traded in a narrow range following last week’s surge. Oil retreated -0.26% to $49.58 per barrel of West Texas Intermediate crude oil. The price of copper, also known as “Dr. Copper” by some analysts for its use as an indicator of global economic health, also traded in a narrow range following a big surge last week, closing with a gain of 0.35%.
U.S. Economic News: The U.S. created an impressive 209,000 new jobs in July, keeping the unemployment rate at a 16-year low of 4.3%, according to the Bureau of Labor Statistics. Economists were expecting only a net 183,000 new jobs created. The more encompassing U-6 unemployment rate (which includes discouraged workers and the underemployed) remained unchanged at 8.6%. The number of employed Americans hit a new high of 153.5 million, lifting the employment-to-population ratio up to 60.2%. Analysts universally praised the report. David Berson, chief economist at Nationwide stated, “This is an unambiguously positive jobs report, as it suggests that consumers will have the wherewithal to increase spending (with solid job gains and faster wage growth) and that inflation may be slowly pushed higher by tighter labor and product markets.” Professional firms, health-care providers, and restaurants accounted for the bulk of the new jobs. In the details, however, one ugly fact was revealed: job creation was largely from part-time jobs, which gained 393,000 positions. Full-time positions actually fell by 54,000.
An indicator of future home sales rebounded last month after three months of declines. The National Association of Realtors (NAR) pending home sales index rose 1.5% to 110.2, whereas economists had expected only a 0.9% increase. The index forecasts future sales by tracking real estate transactions in which a contract has been signed but the deal has not yet closed. By region, only the Midwest saw a decline, where pending sales fell 0.5% for the month. In the Northeast pending sales rose 0.7%, while in the South pending sales rose 2.1%. Sales in the West rose 2.9%. In its statement, the NAR repeated concerns about the dwindling supply of affordable homes. NAR Chief Economist Lawrence Yun wrote, “The first half of 2017 ended with a nearly identical number of contract signings as one year ago, even as the economy added 2.2 million net new jobs.” Yun is forecasting a 2.6% increase in sales of previously owned homes this year compared to last year.
Americans increased their spending in June by just 0.1%, slowing to its weakest performance in seven months according to the Commerce Department. Analysts watch consumer spending closely because it accounts for 70% of economic activity in the United States. Andrew Hunter, economist with Capital Economics said that the new report showed that consumer spending has lost some momentum at the end of the second quarter “which isn’t a particularly promising sign going into the third quarter.” In the details, the reduction in income growth was attributed to declines in dividend and interest payments, and other investment income. The category for wages and salaries actually rose a respectable 0.4% in June, reflecting the solid employment growth during the month.
Manufacturing slowed slightly last month but still remained near “exceptionally strong” levels according to the Institute for Supply Management (ISM) manufacturing index. The index fell 1.5 points to 56.3 last month after reaching a three-year high in June. Although new orders, production, and plans for employment all retreated they remained near the levels typically seen during periods of stable economic growth. Of the 18 industries surveyed, 15 reported growth last month. In the report, an executive at a manufacturer of computers and electronics enthusiastically stated, “We are having huge sales numbers, and backlog is growing.”
The news wasn’t as good in the services sector. The ISM non-manufacturing index fell 3.5 points to an 11-month low of 53.9 in July. Gauges for production, new orders, employment, deliveries, inventories, order backlogs, and new-export orders all weakened. Anthony Nieves, chair of the ISM survey committee, said “The non-manufacturing sector did not sustain the previous rate of growth and cooled-off in July.” Still, fifteen of the 17 non-manufacturing industries surveyed reported growth in July. Two industries—”management of companies & support services” and “agriculture, forestry, fishing and hunting,” reported contraction.
Spending on construction projects slowed in June, led by a drop in spending on public projects. The Commerce Department reported construction spending fell 1.3% to a seasonally-adjusted annual rate of $1.21 trillion missing economists’ forecasts for a 0.4% increase. Compared to a year ago, spending was up 1.6% in June, while for the first half of the year spending was up 4.8% compared to the same time in 2016. Construction spending on residential projects fell for the third straight month, declining 0.2%. However, government spending fell 5.4%, its biggest drop since a 6% decline in March 2002. The decline raised concerns among analysts that construction may not provide as much support for the overall economy as was expected for the second half of the year.
International Economic News: Canada’s unemployment rate dropped to its lowest level since October 2008, falling to 6.3%. Canada’s job market posted its eighth consecutive month of job growth last month; the economy created 10,900 net new jobs in July, preceded by gains of 45,300 and 54,500 the previous two months, according to Statistics Canada. Avery Shenfeld, chief economist at CIBC Capital Markets released a note stating, “We can forgive the economy for taking a bit of a breather on job gains in July, given how torrid the pace has been in the prior two months.” Canada’s gain was fueled by the addition of 35,100 new full-time jobs, offset by the loss of 24,300 part-time positions. Compared to the same time last year, the number of jobs created in Canada has increased by 388,000.
Irish Prime Minister Leo Varadkar stated he wants free movement of people, goods, and services between the UK and Ireland after Brexit. Speaking on his first official visit to Northern Ireland, Mr. Varadkar said “I do not want an economic border”, and that it was time to talk “meaningfully” about a solution that would “work for all of us.” Acknowledging the advocates of a so-called “hard Brexit”, the prime minister said that the onus for the proposals for trade and commerce is on the UK. “They have already had 14 months to do so, which should have been ample time to come with detailed proposals. But if they cannot, and I believe they cannot, then we can start to talk meaningfully about solutions that might work for all of us,” he said.
On Europe’s mainland, the newly-elected French President Emmanuel Macron has sparked some tension with Italy over the sale of the large French shipyard STX. Rome had agreed to buy a majority stake in the venture, but President Emmanuel Macron wants shared control. Under former French President Francois Hollande, France has agreed to sell a controlling stake in STX to Italy’s Fincantieri, a firm owned by the Italian government. The agreement, in principle, said that Fincantieri would acquire 66.66% of the share capital of STX France. But Macron decided to review the deal, and subsequently announced that he was ready to cancel the agreement and temporarily nationalize the shipyard. The shipyard, in the western port of Saint-Nazaire, has turned out some of the world’s biggest cruise liners and – importantly – also builds warships.
In Germany, industrial orders rose twice as much as expected as strengthening domestic demand offset weaker foreign demand data from the Economy Ministry showed. German factories posted a 1% increase in contracts in June after orders for German-made goods rose by 1.1% the previous month. Forecasts were for only a half percent rise. Nordea economist Holger Sandte said, “The order numbers are another mosaic tile in what is a very positive picture of the economy.” In the details of the report, domestic demand increased by 5.1%, while foreign orders dropped by 2%. The orders data follows a number of reports that continue to underline the strength of the German economy seven weeks before its national election in which Chancellor Angela Merkel will be seeking her fourth term.
The Italian national statistical office ISTAT said that the economy is benefitting from the improvement in the industry sector and strong labor market dynamics have driven consumer and business confidence higher. In its monthly report, ISTAT said its leading indicator continued on a positive trend suggesting favorable economic conditions in the coming months. Industrial production grew by 0.2% in the second quarter compared to the previous quarter, with the biggest gains posted in durable consumer goods (3.8%) and capital goods (2.1%), ISTAT said. The agency said that in “a context of world trade expansion” and consolidating Eurozone growth, the Italian economy is “powering ahead on a growing industrial sector and falling unemployment.”
In Asia, analysts expect China to report a string of economic reports showing steady growth. Although good news for China, analysts expect the reports have the potential to trigger increased trade friction with the United States. China is expected to report another strong month of exports for July according to a poll of analysts. China’s exports are seen rising 10.9% year-over-year, while imports are expected to increase 16.6%. China’s trade surplus was at $46.08 billion last month, the second highest reading of the year. However, what may spark some discord with Washington is that the trade surplus with the United States actually rose 6.5% in the first half of the year to $117.5 billion. Yang Zhao, chief China economist at Nomura said, “We see a bumpy road ahead for the trade relationship between the two countries.”
Japanese Finance Minister Taro Aso said that Japan hope to hold economic talks with Washington this fall stating that he hopes to conduct rough preparations with Vice President Pence in September and hold formal talks in October. Aso and Pence have led a U.S.-Japan economic dialog which has discussed trade, investment, and economic policies of both countries. The upcoming talks will almost assuredly include the issue of safeguard tariffs that Japan has imposed on frozen beef from the United States. Aso said, “I must continue a dialogue aimed at helping economic development in the Asia-Pacific region. I must continue to carry out economic and fiscal management.”
Finally: An old Wall Street saying goes something like “When the soldiers leave the field of battle, the generals are soon to follow.” The meaning is that when the few stock market leaders are all alone, and most other stocks have already turned down…the few leaders are likely to follow as well. Mid Cap and Small Cap stocks have broken down recently, and now the important Transports sector has diverged sharply from the Dow Jones Industrials. A venerable market theorem, “The Dow Theory”, raises red flags when the Dow Industrials and the Transports diverge significantly. They recently have, as illustrated by the chart below.
(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 14.00 from the prior week’s 15.75, while the average ranking of Offensive DIME sectors fell to 17.25 from the prior week’s 15.75. The Defensive SHUT sectors have regained 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®