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 31.42, up from last week’s 31.15, 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 74.80, up from the prior week’s 72.84.
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 recorded solid gains and continued their advance into record territory as the flow of major third-quarter earnings reports continued to be stronger than expected. For the week, the Dow Jones Industrial Average surged over 450 points to close at 23,328, for a gain of 2.00%. The technology-heavy NASDAQ composite rose 0.35%, to end the week at 6,629. By market cap the large cap S&P 500 rose 0.86%, its fourth consecutive week of gains, while the S&P 400 mid cap index added 0.85% and the small cap Russell 2000 added 0.44%.
International Markets: Canada’s TSX had a sixth straight week of gains, rising 0.32%. Across the Atlantic the United Kingdom’s FTSE was off -0.16%. On Europe’s mainland, France’s CAC 40 rebounded from last week’s loss by rising 0.39%, and Germany’s DAX ended essentially flat. Italy’s Milan FTSE fell -0.3%. In Asia, China’s Shanghai Composite retraced some of last week’s gain, falling -0.35%, while Japan’s Nikkei surged a third straight week, gaining 1.4%. As grouped by Morgan Stanley Capital International, developed markets fell -0.3%, while emerging markets retreated -0.9%.
Commodities: Precious metals came under pressure after a brief respite last week. Gold fell -1.85%, or $24.10, to close at $1280.50 an ounce. Silver, which trades mostly in tandem with Gold albeit with more volatility, fell -1.9% to close at $17.08 an ounce. Crude oil rose for a second straight week, adding 0.76% to close at $51.84 per barrel of West Texas Intermediate crude oil. Copper, thought by some analysts to be an indicator of worldwide economic health due to its variety of uses, rose 1.02%.
U.S. Economic News: Initial claims for new unemployment benefits fell to a 44-year low last week, their lowest level since March of 1973. The Labor Department reported Initial claims fell by 22,000 to 222,000, well below economists’ forecast of 244,000. Overall, the U.S. labor market is the strongest it’s been in more than 15 years, as the current economic expansion enters its ninth year. Businesses still continue to complain about a shortage of skilled workers to fill a record number of job openings. Continuing claims, which counts the number of people already receiving benefits, declined by 16,000 to 1.89 million. That is also a 44-year low.
Home builders broke ground on fewer homes last month according to the Commerce Department, as housing starts for September fell to a 1.13 million seasonally-adjusted annual rate. Housing starts were down 4.7% from last month, but were 6.1% higher compared to the same time last year. Of note, in a positive sign for the U.S. economy as a whole, the number of single-family homes under construction continued to rebound. Single-family home starts were 9.1% higher year-to-date compared to the same period last year. Analysts view the shift from apartments to single-family homes as a sign of a stronger economy, as houses are predominantly built for purchase rather than rent, and they contribute more to overall economic growth.
Sentiment among the nation’s home builders jumped to five-month highs this month, according to the National Association of Home Builders (NAHB). The NAHB’s monthly confidence gauge rose four points to a reading of 68 (readings over 50 indicate improvement). Every component of the index increased, with current sales conditions and sales forecast over the coming six months both rising five points. Confidence among home builders surged following the presidential election as the industry believed there would be less regulation and more business-friendly policies. But the enthusiasm has somewhat faded as real reform has yet to materialize.
Low supplies and higher prices weighed on sales of existing homes, as sales rose 0.7% last month but remained below last year’s levels. The National Association of Realtors (NAR) reported that sales were at a 5.39 million annual rate, exceeding forecasts by 90,000. The increase was the first rise in the last four months. Total housing inventory was 6.4% less than the same time last year, currently at 1.9 million homes. The median price of an existing home increased 4.2% to $245,100. In the details, sales in the south fell 0.9%, while in the West and Midwest, sales rose 3.3% and 1.6%, respectively. Sales remained flat in the Northeast.
Manufacturing activity in the New York region jumped to a three-year high this month, according to the New York Federal Reserve’s Empire State manufacturing index. The index rose 5.8 points to close at 30.2 in October, beating economists’ expectations for a reading of 20. In the details of the report, the general optimism, shipments, and number of employees indexes all rose while the new orders index fell 6.9 points to 18. Analysts viewed the report as further evidence of optimism in the business sector due to a presumably more business-friendly administration along with an upturn in the global economy. The reading is compiled from a survey of about 200 manufacturers in New York State.
The Federal Reserve reported that industrial output across the country picked up in September, rising 0.3%. Industrial output rose as the effects of Hurricanes Harvey and Irma began to fade, and construction and utilities production rebounded. The Fed’s measure of the industrial sector is made up of manufacturing, mining, electric and gas utilities. In the details of the report, factory output improved 0.1%, while the mining and utilities sectors rebounded from declines in August. Mining posted a 0.4% monthly gain, while production at utilities rose 1.5%. Paul Ashworth, chief U.S. economist at Capital Economics, said “Overall, with global trade and economic growth booming and the dollar still down substantially from its peak early this year, the outlook for US manufacturing looks bright.”
The Federal Reserve’s “Beige Book”, more formally known as the Summary of Commentary on Current Economic Conditions, is a collection of “anecdotal information on current economic conditions” from each Federal Reserve Bank in its district. The Federal Reserve said the pace of growth in the U.S. was “split between modest and moderate”. In its latest Beige Book the Federal Reserve still isn’t seeing an inflation threat, despite shortages in the labor market that could lead to wage inflation. Despite the shortage of skilled labor, the increase in wages and cost of materials remained “modest”.
International Economic News: An unexpected decline in retail sales in Canada along with little evidence of inflation pressures will likely give the Bank of Canada reasons to delay a third consecutive rate increase at its meeting next week. Statistics Canada reported retail sales declined 0.3% in August, though analysts had expected a 0.5% gain. They also showed that inflation was little changed last month, other than a slight increase in gasoline prices. The two indicators are the last significant readings before the Bank of Canada’s October 25th rate decision. Swaps trading suggested that the odds of a rate increase next week fell to just 19% after the reports.
Across the Atlantic, data in the UK showed that inflation rose by 3% in the year to September, reaching a five year high. Furthermore, the Governor of the Bank of England, Mark Carney, gave testimony to the Treasury Select Committee that the likelihood is that inflation will rise further in the coming months. This makes an interest rate hike from the Bank of England by year-end almost inevitable, analysts say. It would be the UK’s first increase in borrowing costs in almost ten years. Consumer prices rose by 3% last month, overshooting the Bank of England’s official target of 2%. This follows August’s inflation rate of 2.9%. A hike in base interest rates help tackle inflation, but has the unfortunate side-effect of negative impacts on GDP growth.
On Europe’s mainland, the Conference Board’s Leading Economic Indexes for France increased 0.5% in August to 113.6, while its Coincident Economic Index rose 0.2% to 104.7. The two composite economic indexes are the key elements in the Conference Board’s analytical system designed to signal peaks and troughs in the business cycle. The news came alongside President Emmanuel Macron’s first television interview since his election as he tries to regain public support. Macron pressed his vision for an “economic transformation” of a stagnant France in the interview insisting that he wants to make France more “effective”.
In Germany, confidence in Europe’s largest economy increased in October according to ZEW institute. The survey of analysts’ expectations from the Center for European Economic Research, known by its German initials ZEW, rose 0.6 point to 17.6 this month. Economists had expected a rise to 20.4. The data is particularly encouraging because the German economy is facing the twin threats of a stronger euro making German exports pricier overseas and the gradual end of the European Central Banks’s (ECB) quantitative easing program. Jennifer McKeown, chief European economist at Capital Economics said in a note, “It is encouraging that a majority of investors still expect conditions to improve despite the stronger likelihood that the ECB will taper its asset purchases next year and the fact that the euro exchange rate has remained at a fairly high level.”
For Q3, China’s economy grew 6.8% year-over-year – slightly less than the previous quarter but still above the government’s full-year target. This all but assures that China will exceed its full-year target of “around 6.5%”. In the details of the report, a flood of new mortgage lending drove the surge in the housing market, and local government borrowing led to strong spending on infrastructure. President Xi Jinping had put heavy pressure on almost every government ministry to make sure that the economy put in a solid performance. The Chinese Communist Party’s twice-a-decade congress began this week, during which the country’s leaders want to portray an image of strength and predictability.
Japanese parliamentary elections this weekend will either reaffirm or call into question Prime Minister Shinzo Abe’s program of economic reform. Abe called the snap election last month in an effort to bolster his Liberal Democratic Party’s influence over parliament. The LDP is widely expected to win in Sunday’s vote, keeping the economy and Abe’s monetary policy on an even keel. Japan’s exports climbed in the third quarter, although data released this week showed export growth slowed last month. Overall, exports are still up a healthy 14.1% year-over-year, although that missed the median estimates for a 14.9% increase.
Finally: According to Swiss global financial services company UBS, their proprietary UBS Global Real Estate Bubble Index in select world cities has “increased significantly over the last five years”. Their research found that real house prices in the metro areas in their “bubble-risk zone” have climbed by almost 50% on average over the last 6 years. In some other major cities, prices have risen only about 15% over the same period. UBS states that falling mortgage rates over the last decade have led to the increase. The following graphic shows the cities with the greatest “bubble risk” at the top. At the other end of the spectrum, Chicago is the only very-large US city currently below fair value.
(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 was unchanged from the prior week at 20.25, while the average ranking of Offensive DIME sectors fell to 12.75 from the prior week’s 12.25. The Offensive DIME sectors still maintain 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®