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 31.11, up from last week’s 30.83, 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 just 3%/yr. (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 70.90, up from the prior week’s 68.87.
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, up 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 October, indicating positive prospects for equities in the fourth quarter of 2017.
Timeframe summary:
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: Stocks maintained their winning streak for most of the week, resulting in most of the major indexes setting new record highs. The large cap S&P 500 index had eight consecutive daily gains before retreating a bit on Friday—its longest winning streak since 2013. The Dow Jones Industrial Average recorded its fourth consecutive week of gains, rising 368 points or 1.65% to close at 22,773. The technology-heavy Nasdaq Composite had its second week of gains, rising 1.45% and ending the week at 6,590. By market cap, the smaller cap indexes showed a modest relative strength over large caps with the mid cap S&P 400 and Russell 2000 rising 1.25% and 1.3%, respectively, while the large cap S&P 500 added 1.2%.
International Markets: Canada’s Toronto Stock Exchange had its fourth week of gains, rising 0.6%. In Europe, the United Kingdom’s FTSE rose 2%, France’s CAC 40 gained 0.56%, Germany’s DAX rose 0.99%, but Italy’s Milan FTSE retreated -1.3%. In Asia, China’s Shanghai Composite slipped a slight -0.11%, while Japan’s Nikkei scored a fourth week of gains by rising 1.6%. Hong Kong’s Hang Seng surged 3.3% following last week’s down week. As grouped by Morgan Stanley Capital International, developed markets were essentially flat, off just -0.07%, while emerging markets added a strong 1.83%.
Commodities: Precious metals continued to lose their luster. Gold fell for a fourth straight week, falling -0.77% to $1274.90 an ounce. Silver, while generally trading in tandem with gold, nonetheless managed to finish positively gaining 0.68% to close at $16.79. In energy, the price of West Texas Intermediate crude oil retraced most of the last three weeks of gains, retreating -4.6% to $49.29 per barrel. Copper, seen by some analysts as an indicator of world economic health, notched its second week of gains by rising 2.5%.
U.S. Economic News: The number of applications for new unemployment benefits fell by 12,000 to 260,000 last week, returning to levels last seen prior to the disruptions caused by Hurricanes Harvey and Irma. The less-volatile four-week moving average of initial claims declined by 9,500 to 268,250. Both numbers remain under the key 300,000 threshold analysts use to indicate a healthy jobs market. Continuing claims, which counts the number of people already collecting unemployment benefits, fell slightly to 1.94 million. That number is reported with a one-week delay.
The Bureau of Labor Statistics’ Non-Farm Payrolls (NFP) report said that the economy lost 33,000 jobs last month, the first decline in seven years. The NFP attributed the cause to the widespread workplace disruptions following Hurricanes Harvey and Irma. On the plus side, the unemployment rate fell to 4.2% from 4.4%, hitting its lowest level since December 2000. Also on the positive side of the ledger, wages were on the rise adding 0.5% or 12 cents to $26.55 an hour. Over the past year, hourly pay has increased 2.9% matching the post-recession high. The government raised its estimate of new jobs created to 169,000 in August, an increase of 13,000 from July.
Manufacturing in the U.S. continues to rebound according to the latest figures from the Institute for Supply Management (ISM). ISM’s manufacturing index added two points last month, hitting its highest level in almost 13 years at 60.8. Economists had only expected a reading of 58.1. In the details, a remarkable seventeen out of the eighteen industries surveyed reported growth in the latest reading, reflecting the robust growth in an economy that’s been growing for more than eight years. Of concern, however, is that manufacturers continue to have a difficult time finding enough skilled workers. An executive at a manufacturer of transportation equipment remarked, “Labor shortages continue to haunt operational capacity.”
New orders for U.S.-made goods rose in August and orders for core capital goods were stronger than previously reported, according to the latest data from the Commerce Department. Factory goods orders increased 1.2%, exceeding economists’ expectations by 0.2%. Orders for non-defense capital goods ex-aircraft, seen as a measure of business spending plans, rose by 1.1%. Spending on these so-called core capital goods is helping to support manufacturing which currently makes up about 12% of the U.S. economy. Business investment in equipment grew at its fastest pace in nearly two years in the second quarter.
In the services sector, the Institute for Supply Management’s (ISM) index of service-oriented companies jumped to a 12-year high of 59.8 last month, a gain of 4.5 points. The ISM services reading is particularly important as the services sector is responsible for almost 80% of the nation’s jobs. In the details of the report, fourteen of the seventeen nonmanufacturing industries surveyed reported growth last month. In addition, the business activity index increased 3.8 points, the new orders index jumped 5.9 points to 63, production climbed 3.8 points to 61.3 and employment added 0.6 point to 56.8. The ISM services employment index increased for its 43rd consecutive month.
The major automakers posted respectable gains last month following heavier consumer discounts and robust demand to replace hurricane-damaged vehicles. General Motors said U.S. sales rose 12% last month, compared with the same time last year, while Ford’s sales rose 9%. Both GM and Ford reported sharply higher sales of pickup truck and SUV’s—their most profitable products. Fiat Chrysler reported a drop in its sales by 10%, hurt by reduced demand from rental-car companies. Toyota and Nissan reported sales increases of 15% and 10%, respectively, while Honda’s sales increased by 7%. While auto makers cited replacement demand for the hundreds of thousands of vehicles lost due to flooding from the twin hurricanes, heftier discounts also helped lift September’s results. Research firm J.D. Power reported incentives averaged $4,048 per vehicle last month—a new record high.
The Commerce Department reported that construction spending rose 0.5% to $1.21 trillion in August, and increased 2.5% on a year-over-year basis. The government said the recent hurricanes did not appear to have a negative effect as the responses from Texas and Florida for construction spending data were “not significantly lower than normal.” Spending on private residential projects increased by 0.4%, its fourth consecutive month of gains, while spending on nonresidential structures rose by 0.5% snapping a two month losing streak. Public construction projects rose 0.7% in August after falling 3.3% in July. Spending on public construction projects rebounded 0.7% after falling 3.3% in July. State and local government construction spending gained 1.1%, while federal government construction spending fell to its lowest level since spring of 2007—down 4.7%.
International Economic News: In Canada, the merchandise trade deficit widened in August as exports fell for a third straight month. Statistics Canada reported that the country posted a merchandise trade deficit of $3.4 billion in August, an increase of almost $500 million CAD compared with July. The difference was substantially bigger than the $2.6 billion CAD economists had expected. The latest data is further evidence that the Canadian economy lost momentum in the third quarter. Robert Kavcic, senior economist at Bank of Montreal said, “In case there was any doubt that peak Canadian growth is behind us, this report all but cements the case.” Exports, which had been a major contributor to Canada’s impressive 4.5% second quarter annualized growth pace, fell 1% in August. Since peaking in May, exports have plunged nearly 11% in value. Economists say their expectation is that the economy has retreated to a much more moderate growth pace for the second half of the year.
In the United Kingdom, the Organization for Economic Cooperation and Development (OECD) reported that the United Kingdom has the highest inflation rate among all of the top economies of the world. In its latest indication that the Brexit vote is weighing on the living standards of Brits, the OECD stated the heightened cost of importing food and fuel is forcing prices to increase at a faster rate than anywhere in the G7 group of leading global economies. The annual growth in prices in the U.K. rose 0.3% in August to 2.9%–matching the four-year high reached in May. The average increase in prices across the OECD was 2.2%. Since the Brexit vote sparked a devaluation in the Pound Sterling, imports have become more expensive.
On Europe’s mainland, the French statistics agency Insee now expects the French economy to expand by 0.5% quarter-on-quarter in both the third and fourth quarters of 2017. For the year, the statistics agency hiked its economic growth forecast for France to 1.8%, which would be the fastest expansion in six years. With the French economy having expanded at a relatively weak 1% in recent years, an acceleration to 1.8% growth would represent considerable improvement. Business surveys point to renewed optimism following the election of the pro-business Emmanuel Macron. Insee also sees business investment growing by 3.9% this year, an increase of 0.5% over last year.
Recent German data showed industrial orders rebounded in August more than had been expected, due to strong foreign demanded. According to the Economy Ministry, industrial companies registered a 3.6% increase in orders after contracts for goods made in Germany fell by 0.4% in July. The latest reading was the strongest reading since December of 2016. In the details, domestic demand rose by 2.7%, while foreign orders jumped by 4.3%. ING Bank chief economist Carsten Brzeski stated in a note, “Combined with strong business surveys showing production expectations as well as order books close to record highs, German industry looks all set to end the year at maximum speed.”
In Asia, the People’s Bank of China cut its effective reserve requirement ratio for banks by 0.5% to 1.5% under certain circumstances, in what appears to be another example of the Chinese government pumping liquidity into its economy to support growth. Analysts believe that the cut in the reserve requirement is meant to increase loans to small and medium-sized businesses, with less of an effect on state-owned concerns. Officially, the Chinese government is still in a deleveraging phase as debt has increased from 85% of GDP in 2008 to more than 150% today. SMEs, or Small and Medium-sized Enterprises, have been negatively affected by the traditional governmental misallocation of capital from the banking system, and they stand to benefit the most from the cut in the reserve requirement ratio. SMEs account for less than 40% of loans, but contribute 65% to GDP, 75% of employment, and 50% of tax revenue according to recent comments from a government spokesperson.
A Japanese government index showed that Japan’s economy likely posted its second-best stretch of uninterrupted post-war growth. The index of coincident economic indicators rose a preliminary 1.9 points to 117.6 in August, the Cabinet Office reported. That marks the 57th straight month of growth, matching the second-best stretch of expansion since World War II. The coincident index is used to measure the state of the economy and is among the indicators the government uses when determining whether the economy is expanding or in recession. Under the government’s definition, the economy has been in expansion since December 2012, when Abe came into office.
Finally: Warren Buffett famously said “Be fearful when others are greedy and greedy when others are fearful.” Given that, the latest reading from CNN’s Fear & Greed Index may be cause for concern. The latest reading of the index is 95 on a scale of 100, its highest level in at least three years. That level is labeled by CNN as “Extreme Greed”, which would seem to qualify for Buffett-like caution, if not outright fear.
(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 slightly to 19.75 from the prior week’s 19.50, while the average ranking of Offensive DIME sectors fell slightly to 10.75 from the prior week’s 10.25. The Offensive DIME sectors maintained their lead over the Defensive SHUT. Note: these are “ranks”, not “scores”, so smaller numbers are higher ranks and larger numbers are lower ranks.
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Sincerely,
Dave Anthony, CFP®
Dave Anthony, CFP® 