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 31.98, up from the prior week’s 31.58, 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 78.88, up from the prior week’s 77.21.
In the intermediate and Shorter-term picture:
The Shorter-term (weeks to months) Indicator (see Fig. 4) turned negative on November 9th. The indicator ended the week at 21, up from the prior week’s 19. 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), unless a mania comes along 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, but the shorter (weeks to months) timeframe (Fig. 4) is negative. Therefore, with internal disagreement expressed by two of three indicators being positive but one being negative, the U.S. equity markets are rated as Neutral.
In the markets:
U.S. Markets: U.S. stocks were mostly higher in a week that was notable for the wide range of returns among the major indexes. The narrowly focused 30 stock Dow Jones Industrial Average had its best weekly gain for the year, while the technology-heavy Nasdaq Composite recorded a loss. The Dow Jones Industrial Average surged 673.60 points to close at 24,231 for a gain of 2.86%. Conversely, the Nasdaq Composite gave up some of last week’s gains by retreating -0.6% to close at 6847. By market cap, the S&P 400 mid cap index led the way with a 1.9% gain, while the small cap Russell 2000 and large cap S&P 500 gained 1.2% and 1.5%, respectively.
International Markets: Canada’s TSX reversed most of last week’s gain, falling -0.4%. Major European markets ended in the red, as well. The United Kingdom’s FTSE fell -1.5%, while on Europe’s mainland, France’s CAC 40 declined -1.4%, Germany’s DAX gave up -1.5% and Italy’s Milan FTSE ended down -1.4%. Asian markets were mixed. China’s Shanghai Composite fell -1.1% and Hong Kong’s Hang Seng dropped -2.7%, while Japan’s Nikkei rose 1.2%. As grouped by Morgan Stanley Capital International, developed markets finished the week down ‑0.7%, while emerging markets retreated -3.9%.
Commodities: Precious metals had a second down week with Gold falling -$5 to close at $1,282.30 an ounce, a loss of -0.4%. Silver suffered a much more severe drop, giving up -3.6% to end the week at $16.39 an ounce. Energy reversed some of last week’s gain. West Texas Intermediate crude fell -1% to close at $58.36 a barrel. Copper, seen by some analysts as a barometer of world economic health due to its variety of applications, retraced most of last week’s gain, ending the week down -2.4%.
November Summary: For the month of November, the Dow Jones Industrial Average rose 3.8%, while the Nasdaq Composite added 2.2%. The large cap S&P 500 and the small cap Russell 2000 each gained 2.8%, while the S&P 400 mid cap index added 3.5%. Outside the U.S., results were mixed. Canada’s TSX rose 0.26%, while the United Kingdom’s FTSE fell -2.2% and France’s CAC 40 ended down -2.4%. Germany’s DAX was down a lesser ‑1.6%. In Asia, China’s Shanghai Composite ended down -2.2%, but Japan’s Nikkei surged 3.2% and Hong Kong’s Hang Seng added 3.3%. As grouped by Morgan Stanley Capital International, emerging markets fell -0.4% while developed markets gained 0.7%. Gold went essentially nowhere in November, closing just 0.2% higher for the month, while West Texas Crude Oil ripped higher by 5.2%.
U.S. Economic News: According to the Labor Department, initial claims for unemployment benefits fell by 2,000 to 238,000 last week, a week that included the Thanksgiving holiday. The less volatile monthly average of new claims rose slightly to 242,250. Unemployment remains at a 17-year low. Jim O’Sullivan, chief U.S. economist at High Frequency Economics released a note stating that the very low level of jobless claims “continues to signal enough strength in employment growth to keep the unemployment rate trending down.” Continuing claims, which counts the number of people already collecting unemployment benefits increased by 42,000 to 1.96 million. That number is reported with a one-week delay.
Sales of new homes soared to their highest level in over ten years in October as sales were up 9% year to date, and 6.2% higher than in September. The Commerce Department reported new-home sales were running at a 685,000 seasonally-adjusted annual rate in the month of October. The reading was 18.7% higher than the same time last year. At the current sales rate, there is a 4.9 month supply of homes on the market—a decline of 0.3 month from September. The median price of a new home is $312,800—3% higher than a year ago. Stephen Stanley, chief economist for Amherst Pierpont Securities, released a note to clients stating, “The sector is in little danger of seeing inventories pile up any time soon…the months’ supply slid to 4.9 and has been below the 6 month level that has traditionally signaled a balanced market for more than three years running.”
Along with the number of new homes sold, home prices were also up according to the latest data from the S&P/Case-Shiller home price index. The Case-Shiller national index rose a seasonally-adjusted 0.7% in the third quarter, an increase of 6.2% compared to the same period a year ago. This slightly exceeded economists’ forecasts for a 6.1% increase. S&P Dow Jones indexes managing director David Blitzer said, “Most economic indicators suggest that home prices can see further gains.” The index is rising at its fastest annual rate since June of 2014. The more narrowly focused 20-city index rose a seasonally-adjusted 0.5% for the month, and was up 6.2% year-to-date. Of the 20 cities covered by the index, 13 reported price increases for the 12-months ending in September. Seattle, Las Vegas, and San Diego reported the highest year-over-year gains among the 20 cities. Case-Shiller’s national index regained its previous, bubble-era peak last year, but the 20-city index, which is skewed toward the metro areas that experienced the biggest booms, is still 1.5% shy of its 2006 high.
Pending home sales, which count the number of homes that are under contract but have not yet closed, surged 3.5% in October according to the National Association of Realtors (NAR). The reading exceeded analysts’ forecasts of only 1%. In the details of the NAR report, only the West recorded a decline—down -0.7%. In the Northeast, pending home sales rose 0.5%, while in the Midwest sales rose 2.8%. In the South, pending home sales soared 7.4%. On an annualized basis, the South is the only region in which pending home sales are higher than at the same time last year.
Confidence among the nation’s consumers hit a 17-year high last month; Americans haven’t been this optimistic about the economy since the year 2000. The Conference Board’s measure of consumer confidence rose to 129.5 in November, blowing past economists’ expectations of 124. Lynn Franco, Director of Economic Indicators at the Conference Board said, “Consumers are entering the holiday season in very high spirits and foresee the economy expanding at a healthy pace in the early months of 2018.” The index takes into account Americans’ views of current economic conditions and their expectations for the next six months. This indicator is particularly important because consumer spending accounts for about 70% of U.S. economic activity.
The Institute for Supply Management (ISM) reported its manufacturing index retreated slightly to a still-strong reading of 58.2 in November, down -0.5 point from October. In the details of the ISM report, the new orders index rose 0.6 point to 64, while the production index rose 2.9 points to 63.9—a six-year high. The employment gauge remained flat at 59.7. Overall the index reflected strong growth among manufacturers. Any reading over 50 indicates expansion, while readings near 60 are especially robust. One of the biggest problems manufacturers reported was getting supplies on time to produce enough goods to keep up with sales.
The U.S. economy’s rate of growth in the third quarter was raised 0.3% to 3.3% in the government’s latest revision to gross domestic product. The reading was the fastest rate of growth in three years. The improvement in GDP was primarily due to stronger business investment. Spending on equipment, particularly transportation-related, was raised by 1.8% to 10.4%. Overall the report was very positive. The U.S. has exceeded 3% growth for two quarters in a row and looks like it may have a third for the first time since 2004-2005.
The Federal Reserve’s Beige Book, a collection of anecdotal information on current economic conditions by each Federal Reserve Bank in its district, reported a “slight improvement in the outlook”, with overall growth in the U.S. remaining at a “modest to moderate pace”. In the report, inflation pressures strengthened over the past month with transportation and manufacturing costs rising. Wage gains remained modest to moderate despite the widespread reports of tightness in labor markets. The report was widely interpreted to give the Federal Reserve the green light to go ahead with an expected quarter-point rate hike at its next meeting later this month.
International Economic News: Canada’s economy is ending the year on a high note as the unemployment rate dropped below 6% for the first time since 2008 and employers added almost 400,000 workers over the past 12 months. Statistics Canada reported that the sharp rise in new positions brought the jobless rate down to 5.9% last month. The increase in employment is fueling an increase in household spending as well. A separate report showed that consumption is rising at its fastest pace since before the recession. Josh Nye, economist at Royal Bank of Canada stated, “Our forecast assumes the bank will raise rates again in April when they have more information on NAFTA renegotiation and how households are handling this year’s rate hikes. If anything, today’s blockbuster employment report raises the risk of an earlier move.”
United Kingdom surveys showed that British consumers, the main drivers of the economy, are their least confident since just after last year’s Brexit vote, and that business morale has also weakened. The GfK consumer confidence index dropped 2 points to -12 last month, to its lowest level since July 2016 and a point below economists’ forecasts. Joe Staton, executive at GfK stated, “Sadly there’s no festive cheer. Household jitters following the recent interest rate hike, squeezed incomes, higher inflation and economic uncertainty have dampened the consumer mood across the UK.” Britain’s economy has slowed this year as higher inflation, predominantly due to a fall in the British pound, pushed up costs for households and businesses.
French President Emmanuel Macron wants to create France’s own version of Silicon Valley. In a speech this week, the French president noted that France is among the world’s developed market economies where technology companies are significantly underrepresented. “I want France to be a start-up nation,” Macron told attendees at VivaTech, an entrepreneurial conference in Paris last June. Macron sees technology innovation as the way for his country to move up. The Macron government is expanding capital available to start-ups and proposing tax changes that will spur more private investment and support private initiatives. Analysts note that the French tax system, labor laws, and culture of avoiding risks have traditionally hindered technology investment.
The German central bank known as the Bundesbank warned that investors may be ignoring vulnerabilities, lulled into a sense of security by the country’s eight-year run of economic expansion. While Germany has been the main economic engine in the euro zone, the bank notes that there is a danger that the prolonged period of low interest rates may result in market participants underestimating risks. The central bank wrote, “Risks have built up, in particular, during the prolonged period of low interest rates — the valuations of many investments are very high, and the share of low-interest investments on the balance sheets of banks and insurers has risen steadily.” German banks are among the least efficient in Europe, with their return on assets among the lowest in the bloc and their cost to income ratio at 74.9% is the highest in the Eurozone. “This low level of profitability could increase the incentive to take on more risk in order to generate higher returns,” the report said.
In Asia, the United States has formally opposed China being granted “market economy” status by the World Trade Organization (WTO). China is also negotiating with the European Union for recognition as a market economy. The “market economy” designation makes it much more difficult for the targets of Chinese exports to impose tariffs or trade barriers. The U.S. and EU argue that the Chinese government’s pervasive role in the economy including huge subsidies means that domestic prices are deeply distorted and not market-determined. A victory for China before the WTO could open up many countries to a flood of cheap Chinese goods. U.S. Trade Representative Robert Lighthizer told Congress in June that the case was “the most serious litigation we have at the WTO right now” and a decision in China’s favor “would be cataclysmic for the WTO.”
The Japanese government reported that the Japanese economy remained in a “moderate recovery” for the sixth straight month, supported by private consumption, capital spending, and exports. In its monthly economic report, the Cabinet Office maintained its positive assessments on all key components of the economy including industrial output. The Cabinet Office said private consumption is “picking up moderately”, while business investment, industrial output, and exports were all “picking up”. But domestic demand, particularly private consumption (which accounts for nearly 60% of the country’s economy) is far from robust.
Finally: As the cryptocurrency Bitcoin hit a high of over $11,000 at one point this past week, more and more market watchers are predicting a crash of some severity. Unlike most of those “gut calls”, one study in particular was actually backed up with hard data.
The study, entitled “Bubbles for Fama” was authored by Robin Greenwood, finance and banking professor at Harvard Business School, and Andei Shleifer, economics professor. The researchers found that when an asset has a price run-up of 100% or more in a two-year period, the probability of a crash becomes 50%. When focusing on run-ups of at least 150%, that probability jumps to 80%. Higher than that and a crash is a near-certainty. Of note, the authors focused on the stock market in their study, not cryptocurrencies. But their research included nearly a century worth of historical stock data from around the world, and found similar conclusions regardless of the time period or country.
Bitcoin’s run-up over the last two years is nearly 2,500%.
(But who is “Fama”, you ask? He’s a well-known academic economist who is also a leading proponent of the “Efficient Market Hypothesis”, which states that the markets have already efficiently and effectively incorporated all known information into its pricing. But if that’s true, there can be no bubbles! So, the authors are offering up their study of genuine bubbles to Professor Fama for his consideration…)
(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 to 22.75 from the prior week’s 21.50, while the average ranking of Offensive DIME sectors rose to 13.00 from the prior week’s 16.00. 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®