The very big picture:
In the “decades” timeframe, the current Secular Bull Market could turn out to be among the shorter Secular Bull markets on record. This is because of the long-term valuation of the market which, after only eight years, has reached the upper end of its normal range.
The long-term valuation of the market is commonly measured by the Cyclically Adjusted Price to Earnings ratio, or “CAPE”, which smooths out shorter-term earnings swings in order to get a longer-term assessment of market valuation. A CAPE level of 30 is considered to be the upper end of the normal range, and the level at which further PE-ratio expansion comes to a halt (meaning that increases in market prices only occur in a general response to earnings increases, instead of rising “just because”).
Of course, a “mania” could come along and drive prices higher – much higher, even – and for some years to come. Manias occur when valuation no longer seems to matter, and caution is thrown completely to the wind as buyers rush in to buy first and ask questions later. Two manias in the last century – the 1920’s “Roaring Twenties” and the 1990’s “Tech Bubble” – show that the sky is the limit when common sense is overcome by a blind desire to buy. But, of course, the piper must be paid and the following decade or two are spent in Secular Bear Markets, giving most or all of the mania gains back.
See Fig. 1 for the 100-year view of Secular Bulls and Bears. The CAPE is now at 31.49, up from last week’s 31.42, and 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 in the 0% – 3%/yr. range. (see Fig. 2).
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 76.67, up from the prior week’s 74.80.
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 28, 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 October, indicating positive prospects for equities in the fourth 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 Q4, 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: Most of the major U.S. indexes ended the week higher and powered further into record territory. The broad-based S&P 500 Index recorded its seventh consecutive weekly gain, its longest run in almost three years, while the technology-heavy Nasdaq Composite was the best of the bunch powered by better-than-expected earnings reports from Microsoft, Amazon, Alphabet (Google), and Intel. The Dow Jones Industrial Average added 105 points to close at 23,434, a gain of 0.45%. The Nasdaq Composite rose 72 points to close at 6,701, a gain of 1.09%. By market cap, midcaps barely outperformed both large caps and small caps. The S&P 400 mid cap index gained 0.26%, while the large cap S&P 500 added 0.23%. However, the small cap Russell 2000 fell ‑0.06%.
International Markets: Canada’s TSX, like the S&P 500, also had its seventh straight week of gains, rising 0.6%. In Europe, the United Kingdom’s FTSE ended down -0.24%, but on the mainland results were uniformly positive: France’s CAC 40 surged 2.27%, Germany’s DAX rose 1.74%, and Italy’s Milan FTSE gained 1.42%. In Asia, China’s Shanghai Composite rose 1.13%, while Japan’s Nikkei powered ahead 2.57%. As grouped by Morgan Stanley Capital International, developed markets retreated -0.2%, and emerging markets which fell -0.3%.
Commodities: Precious metals had their second week of losses with Gold retreating -0.68%, ending the week at $1,271.80 an ounce, while silver dropped almost 2% to close at $16.75. In energy, oil rallied for a third straight week, rising almost 4% to $53.90 per barrel of West Texas Intermediate crude oil. The industrial metal copper, used by many analysts as a gauge of worldwide economic health, retreated almost 2% this week after reaching its highest level in almost three years.
U.S. Economic News: The number of newly unemployed people rose last week, returning to levels seen before hurricanes hit both Florida and Texas. According to the Labor Department, initial jobless claims rose by 10,000 to 233,000. The reading was less than the 235,000 forecast by economists and well below the key 300,000 threshold analysts use to indicate a healthy jobs market. The less-volatile monthly average of new claims fell by 10,000 to 239,500—its lowest level since late August. John Ryding, chief economist at RDQ Economics in New York said, “Firms remain unwilling to release labor. The labor market is very tight.” Continuing claims, which counts the number of people already receiving unemployment benefits, fell by 3,000 to 1.90 million—their lowest level since December 1973. That number is reported with a one-week delay.
Sales of newly-constructed homes surged last month to their highest pace in almost ten years as demand remained strong. The Commerce Department reported that new home sales ran at a 667,000 annual pace last month, up 18.9% from August, and a 17% increase from the same time last year. Economists had only expected a 555,000 annual rate. In the details of the report, every region of the United States saw growth. The median sales price was $319,700, compared to $314,700 a year ago. At the current sales rate, there is a five month supply of homes available on the market. Amherst Pierpont Securities’ chief economist Stephen Stanley said that the report was “shockingly strong” and he noted the bulk of the new homes were not yet started at the time of purchase, meaning homebuyers were purchasing “built-to-order” homes—another sign of strong demand.
An index measuring the number of contracts to buy a home, but not yet closed, remained unchanged last month, but the big news was that August’s reading was revised down. The National Association of Realtors Pending Home Sales index fell to its lowest level in almost three years as high prices and limited supply weighed on home sales. Pending home sales have fallen on an annualized basis now for five out of the last six months, and realtors aren’t expecting much improvement unless the supply issue eases. The pending home sales index is down 3.5% from the same time last year. Lawrence Yun, chief economist for the NAR stated, “Demand exceeds supply in most markets, which is keeping price growth high and essentially eliminating any savings buyers would realize from the decline in mortgage rates from earlier this year.”
According to the Commerce Department, new orders for goods expected to last longer than three years (‘durable goods’), rose 2.2% last month. The reading beat economists’ forecasts of 1.5%. Core capital-goods orders, which are durable goods orders minus defense equipment and aircraft, rose by 1.3%. This number is seen by analysts as a more accurate measure of domestic economic health. Core capital goods orders have climbed 7.8% over the past year, their fastest growth rate in five years. American manufacturers have rebounded this year, aided by strong demand at home and the best global economy in years. Sales, profits, and hiring are all up. Andrew Hunter of Capital Economics wrote in a note, “Overall, business equipment investment appears to be going from strength to strength, providing further reason to believe that the economy will continue to grow at a healthy pace in the fourth quarter as well.”
Sentiment among the nation’s consumers rose to a 13-year high this month, according to the University of Michigan. The University of Michigan’s final reading of consumer sentiment was 100.7 this month, a five point increase from September’s reading. The average of all readings in 2017 has been the highest since the year 2000. In the details of the report, consumers’ views of current conditions and future expectations rose by a strong 4.3% and 7.2%, respectively. Overall the strong jobs market, booming stock market, and rising home prices are all contributing to a more optimistic consumer.
The Commerce Department, in its third quarter Gross Domestic Product (GDP) “advance estimate” report, said the U.S. economy maintained its brisk pace of growth in the third quarter, shrugging off a decline in construction and weaker consumer spending following hurricanes Harvey and Irma. According to the Commerce Department, GDP increased at a 3.0% annual rate in the third quarter, a slight 0.1% drop from the second quarter but well above most expectations. The increase was attributed mostly to an increase in inventory investment and a smaller trade deficit. The third quarter advance estimate is based on source data that is usually incomplete and subject to further revision. It will be followed by a second estimate released in November. After a slow start to the year, GDP has now printed at or greater than 3% for two quarters in a row. This is the first time that’s happened since 2014.
International Economic News: The Bank of Canada indicated that it’s in no hurry to try to cool an economy that is very close to running up against capacity constraints. Bank of Canada policymakers led by Governor Stephen Poloz left the benchmark overnight interest rate at 1% this week, following consecutive hikes at the bank’s last two policy meetings in July and September. The central bank stated they would remain “cautious” before considering future hikes. Following a jump in the Canadian dollar earlier this year, the Bank of Canada is trying to curb expectations for accelerated rate increases. In addition to the stronger Loonie (which is negative for exports), the bank was concerned about growing risks with renegotiating the North American Free Trade Agreement.
Across the Atlantic, faster growth in the United Kingdom puts a possible rate hike back on the table. According to the Office for National Statistics, Britain’s economy grew more than forecast in the third quarter, rising 0.4% and beating estimates by 0.1%. With inflation running at its fastest rate in more than five years, the Bank of England governor Mark Carney has stated that tightening may be needed “within months”. Economists and traders are expecting the bank to raise interest rates for the first time in a decade at its next policy meeting on November 2. Some analysts have warned that a rate hike could be a policy mistake, given the United Kingdom’s relatively tepid growth and all the uncertainty surrounding the impacts of the Brexit decision. However, in Mr. Carney’s assessment, Brexit has crimped the United Kingdom’s potential growth, therefore lowering the level of expansion the economy can achieve without overheating.
On Europe’s mainland, French President Emmanuel Macron is facing renewed criticism over his measures to cut France’s contentious wealth tax and institute a flat rate on dividends after it emerged that the very wealthy would benefit from the tax breaks. According to estimates from the finance ministry, under the new tax breaks France’s top 100 wealthiest households will see their tax bill reduced by 582,380 euro on average. The top 1,000 richest families will save an average of 172,220 euros each year. Overall, the top 1% of France’s families will receive about 44% of the tax breaks. The tax breaks are part of a pro-business first budget designed to attract foreign investment, bring back French expatriates, and revitalize the Eurozone’s second-largest economy. The tax cuts have been used by Mr. Macron’s political opponents as further evidence that he is the “president of the rich”. A recent survey shows only 42% of French people back Macron’s policies, the lowest level yet and 20 points lower than his approval following his election in May.
In Germany, a monthly survey of the business climate hit its highest level ever this month, beating analysts’ forecasts and suggested continued strong performance for Europe’s largest economy. The Munich-based Ifo Institute reported its German business climate index reached 116.7 this month, rebounding strongly from its reading in September. The index is based on a survey of roughly 7,000 firms across Germany. Ifo President Clemens Fuest said in the release, “Germany’s economy is powering ahead…companies are very optimistic about the months ahead.” Analysts surveyed had predicted a fall in the Ifo reading after a complicated election outcome that left Chancellor Angela Merkel with the task of building a four-party governing coalition in Berlin.
In Italy, credit ratings agency Standard & Poor’s unexpectedly nudged up Italy’s rating one notch to BBB with a stable outlook, citing the country’s firming economic recovery and rising private-sector investment and employment. It was the first such increase by S&P for at least three decades. Matteo Renzi, who heads the ruling Democratic Party said, “After years, finally, S&P has raised Italy’s rating. The work is paying off.” S&P’s move came as Italy’s political parties are preparing for national elections in March 2018. So far, Renzi’s PD party is trailing in the polls behind the anti-establishment 5-star Movement and a resurgent center group. S&P is predicting economic growth of 1.4% this year and 1.3% next year.
In Asia, ratings agency Moody’s said in a report released this week that the further consolidation of power in China under President Xi Jinping could help the country achieve its economic rebalancing and reform goals. China announced its new leadership lineup after a week of closed-door meetings and what was conspicuously not present was an heir-apparent under the current Chinese president. The absence was viewed as an indication that Xi was not ceding any of his authority anytime soon. Moody’s remarked that they “believe this consolidation could increase the alignment of incentives between the central leadership and other officials, and thus could advance the process of economic reform and rebalancing.”
In Japan, the government maintained its moderately optimistic view on economic growth this month, due to increased consumer spending and capital expenditures. In addition, according to the report, exports and industrial output will continue to drive growth in the world’s third-largest economy. The Cabinet Office maintained its view that consumption is “picking up moderately”. The Cabinet Office report comes one week before a Bank of Japan policy meeting at which the central bank will update its forecasts of consumer prices. Currently the BOJ predicts consumer inflation will hit its 2% target by March 2020, but many analysts feel that this is a bit too ambitious. Despite four years of massive quantitative easing, core consumer prices are believed to have risen only 0.8% over the last year—less than half the BOJ’s inflation target.
Finally: What is the number one financial regret of Americans? According to personal finance website Nerd Wallet, it turns out that roughly 71% of Americans express regret about their ability to manage their money. First on the list was not planning early enough (48%), followed by too much spending on non-essentials (39%), credit-card debt (33%), and not having a budget (32%). While baby boomers led in the way in the “not planning early enough” category, Generation X and millennials were tied in regretting spending on non-essentials.
(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 slipped modestly to 20.50 from 20.25, while the average ranking of Offensive DIME sectors rose to 10.75 from the prior week’s 12.75. The Offensive DIME sectors expanded their lead over the Defensive SHUT 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®