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 30.31, up from last week’s 29.90, 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 65.08, up from the prior week’s 63.69.
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 13, 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 internal disagreement expressed by two indicators positive and one negative, the U.S. equity markets are rated as Neutral.
In the markets:
U.S. Markets: Stock market gains later in the week helped offset a weak start and ultimately moved indexes higher despite relatively light trading in advance of the Labor Day holiday weekend. The advance brought the large-cap indexes and the tech-heavy Nasdaq close to their all-time highs, while the smaller-cap indexes remained a bit below. The Dow Jones Industrial Average rose 173 points to close at 21,987, a gain of 0.8%. The Nasdaq surged 2.7%, or 169 points to end the week at 6,435. By market cap, the small cap Russell 2000 index surged 2.6% (offsetting a portion of a very weak month), while the mid cap S&P 400 index gained 1.7%, and the large cap S&P 500 added 1.4%.
International Markets: Canada’s TSX rose 0.9%. Across the Atlantic, the United Kingdom’s FTSE added a half percent, while on Europe’s mainland major markets were mixed. France’s CAC 40 rose 0.4%, but Germany’s DAX fell -0.2%. Italy’s Milan FTSE added 0.5%. In Asia, China’s Shanghai Composite added 1.1%, Japan’s Nikkei rose 1.2% and Hong Kong’s Hang Seng rose a lesser 0.4%. As grouped by Morgan Stanley Capital Indexes, both developed markets and emerging markets gained, 0.4% and 0.5%, respectively.
Commodities: Precious metals were bid higher with Gold rising 2.5% to $1330.40 an ounce, alongside Silver, which surged 4.5%. Energy remained under pressure, with crude oil retreating -1.2% to $47.29 a barrel. The industrial metal Copper had a strong week, rising 2%.
August Summary: For the month of August, the Dow Jones Industrial Average gained 0.3% and the Nasdaq Composite added 1.3%. The large-cap S&P 500 remained essentially flat, up just 0.1%, while the mid cap S&P 400 fell -1.7% and the small cap Russell 2000 lost -1.4%. Canada’s TSX gained 0.5%. European markets were mixed, with the UK’s FTSE rising 0.8%, France’s CAC falling -0.2%, and Germany’s DAX declining -0.5%. In Asia, China’s Shanghai Composite rose 2.7%, while Japan’s Nikkei fell -1.4%. As grouped by Morgan Stanley Capital Indexes, developed markets were flat (-0.04%) in August, while emerging markets gained 2.4%. Copper surged 8.2% and Gold and Silver rose 4.4% and 6.7%, respectively. Oil, however, ended the month in the red, losing -3.3%.
U.S. Economic News: The number of people who applied for new unemployment benefits last week rose by just 1,000 to 236,000, according to the Labor Department. Initial jobless claims remained near their post-recession lows, and far below the 300,000 threshold analysts use to indicate a healthy jobs market. The less-volatile four-week moving average of new claims, which offers a more stable picture of layoff trends, fell by 1,250 to 236,750. That reading is the second lowest level recorded since the middle of 2009. New applications for benefits have remained less than 300,000 for 130 consecutive weeks, its longest streak since the early 1970’s. The U.S. has created 17 million jobs since 2010, supporting an economic expansion that’s now in its ninth year.
The U.S. added 156,000 new jobs in August, missing economists’ expectations but still enough to keep the economy growing. Economists had expected an increase of 170,000. The unemployment rate rose a tick to 4.4%, as more workers entered the job market, while wages increased by 3 cents to an average $26.39 an hour. The government cut its estimate of jobs created in the prior month of July by 20,000 to 189,000.
Private-sector job growth surged last month, according to payroll processor ADP. Employers added a seasonally-adjusted 237,000 jobs in August—a healthy increase from the 178,000 jobs reported in July. In the details, large companies added 115,000 people, while medium-sized businesses and small businesses added 74,000 and 48,000 people, respectively. Almost all the job gains came from the service sector which totaled 204,000 jobs. A significant contributor appears to be warehouse functions for online retailers and distributors, such as Amazon. Over 56,000 jobs were added in the trade/transportation/utilities category, which includes such warehouse work. In the goods producing sector, construction added 18,000 jobs, manufacturing added 16,000 jobs, but mining lost 1000 jobs.
Home prices across the nation rose in June, again, as strong demand continued to support the market. The S&P/Case-Shiller 20-city home price index rose a seasonally-adjusted 5.7% in the three-month period ending in June compared to the same time last year. The 5.7% increase matched the 5.7% gain seen the previous month. Of the 20 cities surveyed, 9 had a stronger annual increase in June from May with cities in the West garnering many of the top spots again. Of note, home prices in Seattle have rocketed over 13% the past year, while the prices of homes in Portland have surged over 8%. Overall, the national index was up 5.8% compared to the same time last year, a 0.1% increase from May’s number. The national price index has now exceeded its 2006 housing bubble peak, while the 20-city index remains just 2.9% away.
Pending home sales – measuring homes that are under contract but have not yet closed – fell for the fourth time in the last five months in July, according to the National Association of Realtors (NAR). Pending home sales were down -0.8% in July and down -1.3% from year-ago levels. Lawrence Yun, the NAR’s chief economist attributed the decline to low inventory, stating “The pace of new listings is not catching up with what’s being sold at an astonishingly fast pace.” Yun noted that inventory was down 9% from the same time last year.
Confidence among American consumers continued to strengthen last month, according to the Conference Board. The board’s Consumer Confidence Index rose 2.9 points to 122.9 in August, reaching its second-highest level since late 2000. Economists said consumers are feeling more secure with rising home prices, a healthy jobs market, and stocks close to record highs. The reading is a positive sign for consumer spending going into the fourth quarter. Household spending has contributed a significant portion of GDP growth in the first half of the year. In the details, the present situation index – a measure of respondents’ views of current conditions – jumped to a high of 151.2 in August from 145.4. The future-expectations index added a point, and consumers’ assessment of the labor market was also optimistic. Those stating that jobs were “plentiful” rose 2.2% to 35.4%, while those stating jobs were “hard to get” fell to just 17.3%, its lowest level since 2001.
As confidence among Americans rose, so did their spending. The Commerce Department reported that consumer spending rose 0.3% in July. Helped by higher incomes and tame inflation, households are in their best financial shape in years. Inflation has remained under control, according to the Personal Consumption Expenditures (PCE) index, the Federal Reserve’s preferred inflation measure. The PCE index rose just 0.1%. The 12-month rate of inflation remained unchanged at 1.4% in July. With inflation remaining below the Federal Reserve’s 2% target, analysts are starting to question whether the Fed will raise rates for a third time this year. Some senior Fed officials have stated the central bank should raise interest rates more slowly if inflation remains muted.
U.S. Gross Domestic Product (GDP) rose at a 3% rate in the second quarter, up 0.4% from its initial reading, according to the Commerce Department. Increases in consumer spending and business investment contributed to the economy’s strongest growth in more than two years. The economy grew at a 1.2% rate in the first quarter. A slower first quarter followed by an improved second quarter has occurred twice in the past three years. Consumer spending rose 3.3% in the second quarter, beating estimates by 1.4%. Business investment rose 0.6%, up from a 0.4% estimate.
In U.S. manufacturing, the Institute for Supply Management’s Purchasing Managers’ Index (PMI) surged to a six-year high in August, exceeding analysts’ expectations. ISM said its index climbed to 58.8, an increase of 2.5 points over July. That’s the highest reading since April 2011. In the details, it was a very strong report. The new-orders index slipped by just 0.1 points to 60.3, while the employment index jumped by 4.7 points to 59.9. Ian Shepherdson, chief economist at Pantheon Macroeconomics stated in a note to clients, “The report paints a picture of a robust recovery in the industrial sector immediately before Hurricane Harvey.” Readings above 50 indicate improving conditions.
International Economic News: Canada’s economy blew away forecasts by growing at an annual rate of 4.5% in the second quarter, according to Statistics Canada. Household spending and energy exports were the main drivers of the increase. In the details of the report, exports expanded 2.3% in the second quarter, a significant increase over the 0.4% gain in the first quarter. Household consumption rose at an annualized 4.6% pace in the second quarter, following a 4.8% gain in the first quarter. The solid growth numbers have analysts widely expecting that the Bank of Canada will raise its benchmark interest rate in the coming weeks. According to National Bank senior economist Krishen Rangasamy, it solidified those rate-hike predictions and has some analysts suggesting a rate hike could come as early as next week.
Referring to the United Kingdom’s economy, Japan’s Prime Minister Shinzo Abe told business leaders in Tokyo he has “trust” and “full-confidence” in the post-Brexit UK. The comments come as a huge boost to the United Kingdom as it continues its negotiations to leave the European Union. Speaking alongside the UK’s Theresa May at a business conference in Tokyo, Shinzo Abe told the leaders of Japan’s biggest firms he is convinced the U.K. will remain a compelling place to do business after Brexit. Theresa May told the business group she was ‘determined to seize the opportunity’ to build trade relations with “old friends and new allies” as Britain leaves the EU.
On Europe’s mainland, French President Emmanuel Macron and German Chancellor Angela Merkel joined together stating they are ready to press ahead with deeper European integration, promising a tighter euro zone at the core of the European Union. French President Emmanuel Macron said he wanted to strengthen Europe’s union and pledging to announce proposals after Germany’s election on September 24th. Speaking to an assembly of French ambassadors in Paris, Macron promised “concrete steps in around 10 areas.” Likewise, Merkel endorsed the idea of a European Monetary Fund and said she could imagine creating a combined European finance and economy ministry.
The number of Italians employed full-time has risen above 23 million for the first time since 2008, boosting hopes that the recovery in the Eurozone’s third-largest economy is finally gathering steam. Italy’s statistical agency ISTAT said that employment increased in July by 59,000 lifting employment to the same level as it was prior to the financial crisis. In addition, economic confidence in Italy is at its highest level in almost 10 years. The country’s overall index of economic sentiment increased from 105.6 to 107 in August – its highest level since November 2007.
In Asia, China reported that its official manufacturing Purchasing Managers’ Index (PMI) for August came in at 51.7, exceeding analysts’ expectations by 0.4 point. China’s manufacturing sector has been posting solid growth of late, primarily due to infrastructure spending and a recovery in exports. However, on the services side, China’s services PMI fell 1.1 points to 53.4 – the lowest reading since May 2016. This is a concern because while China has traditionally been a more manufacturing-oriented economy, its policymakers are attempting to shift it to a more services-based economy like those in the West.
Japanese companies curbed their rates of investment in plants and equipment in the second quarter, suggesting the government may revise down its initial estimate of economic growth. Data from Japan’s Finance Ministry showed that capital expenditures rose 1.5% from the second quarter of last year, a substantial -3% decline from the 4.5% increase seen in the first quarter. A decline in spending by auto makers and manufacturing equipment makers was responsible for most of the loss. Excluding software, capital expenditures fell 2.8% from the previous quarter. The preliminary estimate showed Japan’s economy grew by an annualized 4% in the second quarter. Given the new data, analysts believe this could be revised down to around 3%.
Finally: Using data from a comprehensive employment report from the University of Oxford, Henrik Lindberg, chief technology officer at Swedish financial technology company Zimpler developed a chart depicting which jobs were most likely to be taken over by robots. According to his data, the first jobs to be performed by robots will be those working as retail clerks, fast food workers, and secretaries. He doesn’t say exactly when it will happen, but he expects that within 10 to 20 years, about 50% of jobs in existence today will transition to automation. Lindberg believes that occupations which will remain in demand are those that require the human characteristics of compassion, understanding, and moral judgement, such as nurses, teachers, and police officers.
(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 remained unchanged from the prior week at 9.00, while the average ranking of Offensive DIME sectors rose to 15.50 from the prior week’s 16.50. The Defensive SHUT’s lead over the Offensive DIME sectors narrowed a bit. 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®