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 31.15, up from last week’s 31.11, 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 72.84, up from the prior week’s 70.90.
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: U.S. stocks largely continued their advance with many major indexes hitting record highs during the week. The Dow Jones Industrial Average rose for a fifth consecutive week closing at 22,871, a gain of 0.43%. The technology-heavy Nasdaq Composite added 15 points to close at 6,605, a gain of 0.24%. By market cap, large caps showed relative strength over smaller cap indexes with the S&P 500 large cap index rising 0.15%, while the S&P 400 index added just 0.02% and the small cap index was the lone loser for the week at -0.5%.
International Markets: Canada’s TSX rose for a fifth straight week, up 0.5%. In Europe, the United Kingdom’s FTSE enjoyed its fourth week of gains by rising 0.2%, while on the mainland France’s CAC 40 retreated -0.2%, Germany’s DAX added 0.3% and Milan’s FTSE rose just 0.09%. In Asia, major markets were green across the board. China’s Shanghai Composite rebounded from last week’s slight loss, rising 1.24%. Japan’s Nikkei surged 2.24%, while Hong Kong’s Hang Seng rose a slight 0.06%. As grouped by Morgan Stanley Capital International, emerging markets surged 2.3%, while developed markets added 1.7%.
Commodities: Precious metals rebounded strongly after four consecutive weeks of losses. Gold rose 2.3% last week to close back above $1,300 an ounce, at $1304.60. Silver, which trades similarly to gold albeit with more volatility, rose 3.7% to end the week at $17.41 an ounce. In energy, oil continued to trade in the $45-$55 a barrel range that has contained it for much of the last year and a half. Oil retraced most of last week’s weakness rising 4.48% to close at $51.45 a barrel. The industrial metal copper, seen by some analysts as an indicator of worldwide economic health, surged 3.45% last week—its third straight week of gains.
U.S. Economic News: According to the Labor Department, initial claims for unemployment fell by 15,000 to 243,000, a six-week low. Claims have remained in a downtrend since peaking near 300,000 on September 2, 2017 following Hurricanes Harvey and Irma. The four week moving average of claims, seen by analysts as a more accurate measure of labor market trends, dropped by 9,500 to 257,500. The number of people already receiving unemployment benefits, so-called continuing claims, dropped by 32,000 to 1.89 million. Continuing claims remain at their lowest levels in nearly 44 years.
U.S. employers continued to advertise a near-record number of job openings, although the number of job openings slipped 0.9% to 6.08 million in August. According to the Labor Department, job openings have risen as the number of unemployed has fallen to its lowest levels in more than ten years. The “quit rate”, which counts the number of people who voluntarily left jobs for presumably better opportunities, remained unchanged at 2.1%. In the details of the report, the number of job openings declined for most industries with employment in education hit with the heaviest losses. As has been the case for more than a year, employers continue to complain that they are unable to find enough skilled workers to fill available positions.
Sentiment among small-business owners weakened last month as expectations for future sales and economic growth plunged following the gridlock in Washington. The National Federation of Independent Business (NFIB) reported its sentiment gauge declined 2.3 points to 103 in September. Analysts had forecast a slight increase to 105.4. NFIB’s index soared following the election as business owners believed the election of Donald Trump would lead to more business-friendly policies from Washington. However, the inability of lawmakers to pass meaningful legislation to help businesses, such as a rollback of the Affordable Care Act, weighed on their outlook. NFIB’s chief economist William Dunkelberg said in the release, “Small business owners still expect policy changes from Washington on health care and taxes, and while they don’t know what those changes will look like, they expect them to be an improvement.”
Among consumers, sentiment soared to its highest level since 2004 according to the University of Michigan’s consumer sentiment index. The index rose to 101.1 this month, an increase of 5.8 points from September. Richard Curtin, chief economist for the survey, noted that current trends indicated consumer spending should continue to expand at least through the middle of next year. If that actually happens, it would mark the second longest expansion period since the mid-1800’s. The results reflect an “unmistakable sense among consumers that economic prospects are now about as good as could be expected.”
Consumer prices recorded their biggest gain in eight months as gasoline prices soared in the wake of storm-related refinery production disruptions along the Gulf Coast. The Labor Department reported its Consumer Price Index (CPI) jumped half a percent last month, lifting the year-over-year gain in the CPI to 2.2%. Gasoline prices surged 13.1% last month, and accounted for 75% of the increase in the CPI. Ex-gasoline, price pressures were relatively benign. In fact, excluding the volatile food and fuel categories consumer prices were up a mere 0.1%. In the 12 months ending in September, core CPI was up 1.7%.
Inflation at the wholesale level jumped by 0.4% last month led by a surge in gasoline prices. The Labor Department reported that its producer price index for final demand rose 2.6% for the 12 months through September. That’s the biggest gain since February of 2012, and a gain of 0.2% from August. Wholesale gasoline prices soared 10.9% last month after Hurricane Harvey knocked several major oil refineries out of commission. Core PPI, which excludes the volatile food, energy, and trade services categories, rose 0.2% in September and is up 2.1% over the last 12 months.
According to minutes of the Federal Reserve’s last policy meeting, the persistently low U.S. inflation had Federal Reserve officials debating whether or not an interest rate hike was needed in December. Multiple Fed officials said they now believed that it was going to take longer than they had previously anticipated for inflation to get back to the central bank’s 2% target. Multiple officials agreed that “some patience” was warranted before raising interest rates in order to assess trends in inflation. Kansas City Fed President Esther George, generally considered a Fed Hawk, was in favor of a hike and warned that a delay could spark asset bubbles. Minnesota Fed President Neel Kashkari, a Fed dove, argued for no further rate hikes until inflation was clearly above 2%. Mike Loewengart, vice president for investment strategy at E*Trade noted that “what is telling about these minutes is the growing rift among Fed officials and the notion that a December hike is anything but guaranteed.”
International Economic News: In Canada, the International Monetary Fund (IMF) raised its estimate for Canada’s economic growth rate for this year and 2018, lifting it to near the top of all advanced economies. The Washington-based IMF is now estimating Canada’s gross domestic product gain for 2017 will be 3%, an increase of 0.5% over its July estimate. The estimate puts Canada at the top of all other G-7 countries for the year, with the United States at an estimated 2.2%. The IMF’s estimate is consistent with the Paris-based Organization for Economic Cooperation and Development’s estimate which has also stated Canada’s growth would top the list of G7 countries.
The British Chamber of Commerce (BCC) stated that Britain’s economy showed little sign of breaking out of its lethargy and that it is “extraordinary” that the Bank of England is even considering raising interest rates. In the BCC’s Quarterly Economic Survey of businesses, it reported that sales at services firms, which make up the bulk of the UK economy, were steady in the third quarter. However, there was little sign of improvement in either pay pressures or investment, both of which the Bank of England somehow expects to rise notably next year. Overall, the BCC described its survey as “uninspiring”, with political uncertainty, currency volatility, and Brexit clearly affecting businesses. Suren Thiru, BCC head of economics stated, “We’d caution against an earlier than required tightening in monetary policy, which could hit both business and consumer confidence and weaken overall UK growth.”
On Europe’s mainland, French President Emmanuel Macron’s proposal to cut France’s wealth tax came closer to reality as a parliamentary committee approved the plan, despite opposition from the left. The measure which will limit the nation’s wealth tax was the most controversial proposal in the government’s 2018 budget. Macron and his supporters argue that the move will increase investment by reducing tax on “productive wealth”. The proposal limits the wealth tax, which is levied on incomes of 1.3 million euros or more, to real estate, exempting revenue from investments and savings. Under fire from the left, Macron’s Republic on the Move party amended the original proposal by adding extra taxes on “ostentatious signs of wealth” such as yachts, expensive sports cars, and gold.
German economics minister Brigitte Zypries made the prediction that Europe will be the big winner following the decision of Britain to leave the European Union as UK-headquartered companies may move their headquarters to the continent. In addition, she believes that French President Emmanuel Macron’s reforms in France will also benefit the whole of the EU. The German government now expects GDP growth of 2% this year, up from an earlier forecast of 1.5%, as Europe’s economic powerhouse continues to forge ahead. She also believes the economy will grow by 1.9% in 2018. At a press conference in Berlin, Ms. Zypries said Germany’s economic boom had “gained momentum and become more broad-based.”
Italian industrial production rose more than expected in August, further evidence that the recovery in the euro region’s third-biggest economy is gaining strength. According to Italy’s national statistics agency Istat, industrial output increased 1.2% from July, led by gains in intermediate goods such as basic metals, rubber, and plastics. On an annual workday adjusted basis, industrial production was up 5.7% year-over-year. In its monthly economic report, the statistics bureau said Istat’s leading indicator is “reinforcing the growth perspectives in the short term”, bolstered by the manufacturing sector and investments. August’s production increase was the fourth consecutive monthly increase.
In Asia, China’s exports were up 8.1% last month from the same time last year, while imports rose 18.7%. As an indication of overall global demand, Chi Lo, senior economist for Greater China at BNP Paribas Investment Partners stated “It seems the global demand is still there to support the demand for Chinese exports” and characterized the numbers as “pretty good”. China’s economic data has been showing robust growth ahead of leadership changes set to happen at the upcoming Party Congress. Chinese customs officials also highlighted the slide in trade with North Korea, perhaps to convince the world that China is “getting tough” with that rogue nation. Imports from North Korea collapsed 37.9% in September, marking its seventh month of decline, while Chinese exports to North Korea fell by 6.7%.
Japan’s main stock index, the Nikkei 225, rose to its highest level in almost 21 years this week, supported by a broad rally in global markets and growing optimism surrounding the Japanese economy. Japan’s gross domestic product has expanded for every quarter for the last year and a half, the longest expansion in 11 years. Unemployment is at multi-decade lows, and corporations are experiencing a surge in profits. Japan’s longtime economic nemesis—persistent deflation, appears to be on the mend with both consumer prices and incomes showing modest gains. It will still be some time, however, before Japan’s Nikkei can set all-time highs. Stocks remain well below the levels achieved at the height of Japan’s late 1980’s asset bubble.
Finally: An obscure but important record has been set in October: the velocity of money has set an all-time low. The velocity of money is defined as the number of times each dollar is spent to buy goods and services per unit of time. This is, on its face, shocking in a period of a rising US stock market and a growing economy. One would think that each dollar would be circulating faster and faster in such an environment. But analysts Viktor Shvets and Chetan Seth at global investment bank Macquarie Group note that “there is nothing normal in the current environment of unprecedented financialization and economic disruption.” They go on to explain that with the U.S. Federal Reserve and other major central banks around the world having pumped such massive amounts of money into the global financial system, there is simply too much money sloshing around in the system for the money to achieve anywhere near the “normal” range of monetary velocity and turnover. They also wonder if the artificial money buildup was the dominant reason for stock market gains and economic expansion, in place of the more traditional reason of honest to goodness increase in demand for goods and services.
(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 20.25 from the prior week’s 19.75, while the average ranking of Offensive DIME sectors fell to 12.25 from the prior week’s 10.75. 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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Dave Anthony, CFP®