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 30.12, down from last week’s 30.31, 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 64.35, down from the prior week’s 65.08.
In the intermediate and Shorter-term picture:
The Shorter-term (weeks to months) Indicator (see Fig. 4) turned positive on September 7th. The indicator ended the week at 14, up from the prior week’s 13. 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 positive. Therefore, with internal agreement expressed by all three indicators being positive, the U.S. equity markets are rated as Positive.
In the markets:
U.S. Markets: Major U.S. indexes recorded modest losses in the holiday-shortened week. Mid-cap shares were particularly weak and ended the week down the furthest from their recent highs, about -4.3% from their record highs set earlier this summer. The Dow Jones Industrial Average fell by -189 points last week to close at 21,797, a loss of -0.86%. The technology-heavy NASDAQ Composite gave up some of last week’s strong gains, retreating ‑1.17% to 6,360. All major market cap indexes finished in the red, with smaller indexes falling further than their large cap brethren. The S&P 500 large cap index ended down -0.61%, while the mid cap S&P 400 and small cap Russell 2000 indexes finished down, -1.08% and -1%, respectively.
International Markets: Canada’s TSX reverse last week’s gain and fell -1.36%. In Europe, the United Kingdom’s FTSE ended down -0.8%, while on the mainland major markets were mixed. France’s CAC40 index fell by -0.19%, Germany’s DAX gained 1.3%, and Italy’s Milan FTSE gave up some of last week’s half percent gain, falling by -0.37%. All major Asian markets were down for the week. China’s Shanghai Composite was barely down with just a ‑0.06% decline, Japan’s Nikkei declined ‑2.1% and Hong Kong’s Hang Seng finished down -1%. As grouped by Morgan Stanley Capital International, emerging markets ended the week down -0.60%, while developed markets gained 0.78%.
Commodities: Precious metals continued their ascent. Gold rose for the third week in a row, climbing $20.80 to close at $1,351.20 an ounce, a gain of 1.56%. Silver, likewise, ended the week with a healthy gain, rising by 1.7% to close at $18.12. The industrial metal copper, seen by some analysts as an indicator of world economic health, ended the week with a loss of -2.45%. Energy managed to break a 6-week string of losses by gaining 0.4% to close at $47.48 a barrel for West Texas Intermediate crude oil.
U.S. Economic News: New claims for unemployment benefits jumped 62,000 to 298,000 last week as the impact of Hurricane Harvey in Texas left many Americans unable to work, according to the Labor Department. Many businesses were closed after Harvey flooded the city of Houston and left many people out of work. The increase in initial claims was the largest since November of 2012. New claims are at their highest levels since the spring of 2015, but they still remain below the key 300,000 threshold that analysts use to indicate a healthy jobs market. The four-week moving average of new claims, smoothed to iron-out the weekly volatility, rose by 13,500 to 250,250. Continuing claims, which counts the number of people already receiving benefits, fell by 5,000 to 1.94 million.
Orders for U.S.-made manufactured goods fell 3.3% in July amid a drop off in spending on transportation equipment, according to the Commerce Department. The decline in factory goods orders was its biggest drop since August 2014. July’s data essentially reversed June’s 3.2% increase. Orders for transportation equipment plunged 19.2% due to a 70% plunge in civilian aircraft orders. Boeing reported that it received only 22 aircraft orders in July, down from 184 in the prior month. Motor vehicle orders retreated by 0.9%. Motor vehicle production has weakened in recent months as sales declines are leaving more dealerships with excess inventory. Orders for non-defense capital goods ex-aircraft were up 1% for the month.
The vast majority of companies in fields such as retail, medical care, and food service grew last month, according to the latest data from the Institute for Supply Management (ISM). ISM’s non-manufacturing index rose 1.4 points to 55.3 in August, its 92nd consecutive month of expansionary numbers (greater than 50). 15 out of 18 industries reported growth for the month and the majority of survey respondents were optimistic about business conditions moving forward. The business activity/production index rose to 57.5 from 55.9, while the new orders component rose 2 points. The employment index also increased to 56.2 from 53.6.
The Commerce Department reported that the US trade deficit for the United States rose slightly in July, edging up $200 million to $43.7 billion in June. The trade deficit for the year is almost 10% higher than at the same time last year. Economists note that while the Trump administration is aiming to rework key trade deals like NAFTA, the trade deficit is likely to persist as the U.S. no longer produces popular consumer items like cellphones. Imports fell 0.2% to $238.1 billion as imports of crude oil, autos, and pharmaceutical goods all dropped. Exports dipped further, 0.3% to $194.4 billion amid declines in shipments of cars, trucks, and household goods.
A collection of anecdotes about the economy gathered from all of the Federal Reserve’s districts, known as the Federal Reserve’s Beige Book, expressed concerns about a prolonged slowdown in the auto industry. In Cleveland, production at auto assembly plants was down more than 16% year-to-date compared to the same time last year. In Chicago, one survey respondent reported auto suppliers were no longer searching for space to build new factories. Several districts reported concerns of falling auto sales and rising inventories. Despite the weak auto sector, the overall economy continued on a “modest to moderate” growth pace in August with little indication of inflation, per the report. Employment growth slowed in some districts as labor market conditions were still described as “tight” with many firms reporting that they had to turn down business because they could not find the necessary workers.
International Economic News: The Bank of Canada raised its benchmark interest rate a quarter percentage point to 1% this week, igniting a cascade of rate increases across Canada’s “Big 5” banks. Bank of Montreal, CIBC, Royal Bank of Canada, TD Bank, and Scotiabank all announced they are raising their prime lending rate to 3.2%, increasing rates by the same amount as the Bank of Canada. Bank of Canada Governor Stephen Poloz and his central bank colleagues acknowledged they have been surprised at the strength of the economy, which surged ahead at an annual pace of 4.5% in the second quarter, leading the Group of Seven countries. In its release the central bank stated, “Recent economic data have been stronger than expected, supporting the bank’s view that growth in Canada is becoming more broadly based and self-sustaining. The level of GDP is now higher than the bank had expected.”
In the United Kingdom, a variety of reports said the economy had a mixed start to the third quarter. Manufacturing rose 0.5% in July—its first increase this year, boosted by a rebound in auto production. However, construction shrank for the fourth consecutive month following a plunge in new orders, falling a larger-than-expected -0.9%, according to the UK statistics office. In addition, the British Chamber of Commerce stated that Britain is locked into a “low growth trajectory” that will see GDP growth next year. The BCC said a squeeze on household budgets and the failure of exporters to capitalize on the low pound meant the United Kingdom was “treading water”.
Across the Channel in France, French President Emmanuel Macron said in Athens this week that if the European Union isn’t overhauled, it will crumble. Macron’s comments came during a tour of European capitals organizing support for changes he believes are needed to protect Europe and the Eurozone from further economic or debt crises. Mr. Macron said he would propose to European leaders a plan in coming weeks for greater economic and social convergence in Europe. Macron is pushing for the Eurozone to have a new structure to create its own a budget, parliament and executive. “In Europe, today, sovereignty, democracy and trust are in danger,” Mr. Macron said.
In Germany, almost 27 years since reunification, the economy in the ex-Communist East still lags far behind the West German states, the government said. The economic disparity could lead to social divisions and the risk of those in the East becoming “radicalized”, said a government report. The government’s annual report found record-high employment, increased job security, and rising real wages are powering Germany’s economy forward. However, the gap in economic strength between the East and West remains substantial. GDP per head in East Germany still lags that of the west by 27%, and the unemployment rate is 8.5% – far above the national average of 5.7%. Support for the anti-immigrant Alternative for Germany (AfD) party is particularly strong in the East where it’s a common belief that refugees are overrunning the country and siphoning away resources and jobs from Germans.
Italy’s Lake Como was the site for an annual gathering last weekend of some of the world’s wealthiest and most influential people, called the Ambrosetti Forum. Among topics discussed was how to convince investors that Italian banks have overcome the threat of “systemic risk” and can again become attractive investments. Davide Serra, chief executive officer of Algebris Investments, said in an interview, “We are very positive on Italian banks.” London-based Algebris, has committed about 20% of its portfolio to Italian bank equity and credit. Chief Executive Officer of UniCredit SpA, Italy’s biggest bank, Jean Pierre Mustier said Italy has very strong fundamentals and its healthy economic growth is pushed by exports, consumers, and investments. “The core banking activity in Italy is actually quite profitable,” he said.
Chinese import/export data pointed to strong domestic demand as imports to China beat expectations last month, but exports eased. For the month of August, China reported exports were up 5.5% from the same time a year ago, while imports surged 13.3%. Analysts had expected a somewhat higher 6% rise in Chinese exports. Louis Kuijs, head of Asia economics at Oxford Economics said, “The strong import data suggests that domestic demand may be more resilient than expected in the second half.” But the weaker reading in exports may suggest that global demand is waning. The country’s surplus with the U.S. rose to $26.23 billion from $25.2 billion in July. Trade between the two countries is closely-watched amid current tensions over trade practices.
Japanese economic growth in the second quarter was revised down to a much less impressive 2.5% annualized growth rate from the whopping 4.0% growth rate originally reported. Economists were quick to point out that while the actual result was lower than the median forecast of 2.9%, the economy still managed to post a sixth straight quarter of expansion. Yoshiki Shinke, chief economist at Dai-ichi Life Research Institute stated, “It’s indeed a big revision, but growth in the economy and capital expenditure is still pretty fast. There’s no need to be pessimistic about Japan’s economy. Given strong corporate profits and improving business sentiment, capital expenditure will remain firm.” Also, he pointed out, Japan’s GDP data tends to experience big revisions due to the way the Cabinet Office estimates capital expenditure, consumption and inventory in the preliminary reading.
Finally: After consolidating for much of the year, Gold has recently broken out of a trading range to the upside, back to levels not seen since the summer of 2016. Analyst Chris Kimble at Kimble Charting took it a step further and looked at the Gold to Dollar ratio in the chart below. The Gold/Dollar ratio has recently broken above both its resistance level, and a multiyear downward trend line. In the past, Gold/Dollar strength has been positive for precious metals and miners, Kimble notes.
(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 9.25 from the prior week’s 9.00, while the average ranking of Offensive DIME sectors was unchanged at 15.50. The Defensive SHUT’s lead over the Offensive DIME sectors continued, but has 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®