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 32.17, up from the prior week’s 31.98, 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 80.49, up from the prior week’s 78.88.
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, 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), 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 mixed this past week as investors continued to process the potential impact of tax reform and political developments out of Washington D.C. The Dow Jones Industrial Average managed a third consecutive week of gains, adding 97.5 points to close at 24,329. The technology-heavy Nasdaq Composite retreated a slight -0.11% to 6,840. By market cap, large caps showed relative strength with the large cap S&P 500 adding 0.35%, but the mid cap S&P 400 slipped -0.20%, and the Russell 2000 fell -1.00%.
International Markets: Canada’s TSX retraced some of last week’s loss, rising 0.36%. It was a strong week in Europe with major market up across the board. The United Kingdom’s FTSE added 1.28%, while on the mainland France’s CAC 40 rose 1.6%, Germany’s DAX surged 2.3%, and Italy’s Milan FTSE soared over 3%. In Asia, China’s Shanghai Composite fell a fourth straight week, down -0.8%. Japan’s Nikkei ended the week essentially flat, down just -0.03%, while Hong Kong’s Hang Seng index retreated -1.5%. As grouped by Morgan Stanley Capital International, developed markets ended the week unchanged and emerging markets added 0.2%.
Commodities: Precious metals continued to lose their luster. Gold was down for a third straight week, falling -$33.90 to $1,248.40 an ounce, a loss of -2.64%. Silver, which often trades in tandem with gold, fell an even larger ‑3.45% to $15.82 an ounce. Energy continued to weaken following its surge of two weeks ago. West Texas Intermediate crude oil retreated -1.7% to $57.36 a barrel. Copper, seen by some analysts as an indicator of worldwide economic health, fell for a second week, declining -3.7%.
U.S. Economic News: The Labor Department reported that initial unemployment claims for new unemployment benefits fell by 2,000 to a five-week low of 236,000 last week. Economists had expected claims to rise to 240,000. Unemployment remains near a 17-year low and the biggest problem in the labor market continues to be a shortage of skilled workers, not a lack of job openings. Job openings are near a record high and many companies are actively recruiting. The less volatile monthly moving average of claims fell slightly to 241,500. Analysts view readings below the 300,000-level as indicative of a “healthy” jobs market. The number of people already receiving unemployment benefits, known as continuing claims, declined by 52,000 to 1.91 million. That number is reported with a one-week delay.
According to payrolls processor ADP, private employers added a healthy 190,000 jobs last month. The latest reading exceeded economists’ expectations for 180,000 new jobs, but was a decline of 45,000 from October. According to ADP, small private-sector businesses added 50,000 jobs, medium-sized businesses added 99,000, and large businesses added 41,000. The vast majority of the jobs added were in the service sector, with 155,000 new jobs. Goods producers added 36,000 new jobs. Mark Zandi, chief economist at Moody’s Analytics stated, “It is hard to find any problems in the job market. We are very likely to have a sub-4% unemployment rate as we move into 2018.”
The government’s Non-Farms Payroll (NFP) report said 228,000 new jobs were created last month, another strong gain highlighting the strongest U.S. labor market since the year 2000. The increase exceeded economists’ forecasts for a reading of 200,000. Unemployment remained unchanged near its 17-year low of 4.1%. Professional and business services, and education and health services led the gains, with 46,000 and 54,000 jobs created, respectively. According to most analysts, the strong jobs report almost guarantees the Federal Reserve will hike interest rates in December. Many analysts noted that there was one ingredient missing from the otherwise very healthy jobs report: wage growth. Companies don’t appear to be offering more generous pay to the vast majority of workers. Kate Warne, investment strategist at Edward Jones noted, “For highly skilled jobs, raising wages doesn’t really create more qualified applicants. And firms are not willing to pay for skills that people don’t have.” She added that she expects wage growth will remain soft for “a while”.
New orders for U.S.-made goods fell less than expected in October, dropping -0.1%, largely due to less demand for passenger planes, cars, and trucks, according to the Commerce Department. Economists had forecast factory orders falling -0.4%. John Ryding, chief economist at RDQ Economics stated, “These data remain consistent with a solid upswing in manufacturing activity and an acceleration in corporate capital spending.” Orders for non-defense capital goods excluding aircraft, so-called core capital goods orders, rose 0.3% in October instead of the 0.5% drop reported last month. These orders are used as an indication of business spending plans. Shipments of core capital goods, which are used to calculate business equipment spending in the gross domestic product report, advanced 1.1% in October instead of the previously reported 0.4% rise. Jesse Edgerton, an economist at JPMorgan noted, “The shipments revision adds upside risk to our already double-digit forecast for fourth-quarter equipment spending growth, and the revised orders data show no sign of a slowdown in capital expenditures in the months ahead.”
In the services sector, the Institute for Supply Management’s (ISM) index of service-oriented companies fell 2.7 points to 57.4 last month pulling back from its 12-year high of 60.1 in October. Despite the decline, overall the report was still very strong. Out of the 17 industries tracked by ISM, all except one said their businesses were expanding. In the details of the report, the new orders index fell 4.1 points to 58.7%, production slipped 2.7 points to 57% and employment declined 2.2 points to 55.3%. The services sector is the dominant force of the American economy, making up almost 80% of the U.S. economy. Andrew Hunter of Capital Economics noted that the readings from the two ISM indexes are “still consistent with annualized GDP growth of around 3.5%.”
Sentiment among the nation’s consumers dropped to a 3-month low as concerns over tax reform weighed. The University of Michigan’s index of consumer sentiment fell 1.7% to 96.8 in December, missing economists’ expectations for a rise to 99. Richard Curtin, chief economist for the Surveys of Consumers said in a statement that “most of the recent decline was concentrated in the long-term prospects for the economy. The rise in inflation expectations in early December was a surprise, and confidence in this finding must await confirmation in the months ahead before any inferences are drawn,” Curtin said. The index measures 500 consumers’ attitudes on future economic prospects, in areas such as personal finances, inflation, unemployment, government policies and interest rates.
International Economic News: The Bank of Canada kept its key interest rate steady but pointed to several positives that could support a rate increase in the coming months. The central bank left the rate at 1% for two straight policy meetings after the strengthening economy prompted it to raise its benchmark interest rate twice over the summer. In announcing its latest decision, the bank pointed to several recent positives that could support higher rates in the coming months. They included encouraging job and wage growth, sturdy business investment and the resilience of consumer spending despite higher borrowing costs and Canadians’ heavy debt loads. In addition, the bank said there’s increasing evidence in the economic data that the benefits from government infrastructure investments have begun to work their way through the economy. On a negative note, the bank reported exports had slipped more than expected in recent months and that the international outlook faces considerable uncertainty.
Across the Atlantic, in the United Kingdom, the question on everyone’s mind is “how much will it cost for the United Kingdom to leave the European Union?” It turns out nobody knows. The government official responsible for shepherding Britain’s departure from the EU acknowledged that the government had made no formal assessments of the economic impact of leaving the bloc. Brexit Secretary David Davis told a parliamentary committee that “no quantitative assessment” was carried out before the cabinet decided to leave the EU and that the nation should be prepared for a “profound shift” in the way the economy operates, on a scale similar to the 2008 financial crisis. The House of Commons’ Brexit committee’s chair, Hilary Benn, described the situation (with typical British understatement) as “rather strange” given the momentous decisions at hand and since authorities wish to start renegotiating Britain’s trade relations with the rest of Europe within weeks.
France and China held their fifth High-Level Economic and Financial Dialogue last week in Beijing. French Minister of Finance and Economy Bruno Le Maire and Chinese Vice-Premier Ma Kai co-chaired the annual dialogue. The two countries reached 71 agreements during the series of meetings, agreeing to boost cooperation in automobile, aerospace, nuclear power, advanced manufacturing, and the Belt and Road initiative. Le Maire described the meetings as the “beginning of the new era in the economic relationship between France and China.”
Germany is home to the fourth-largest economy in the world and the largest in Europe. The country has been the stable center of the EU for decades. Analysts believe that if Germany destabilizes, the existence of the European Union could be in question. While that’s not an imminent threat, what has occurred is Germany’s political environment has shifted somewhat dramatically. In recent elections, both of Germany’s predominant parties, the CDU and the SPD, have lost roughly 20% of their seats in parliament, with the right-wing Alternative for Germany, or AfD, gaining 93 seats to become the third-largest party in parliament. The AfD is characterized as a German nationalist far-right political party that is critical of the European Union and, especially, immigration.
Despite a decent performance this year the Italian economy is likely to underperform in 2018, according to Capital Economics economist Jack Allen. During the third quarter, gross domestic product grew 0.4% sequentially instead of 0.5% growth estimated previously, revised data showed on December 1. The growth was driven predominantly by a 3.0% rise in investment. Allen noted, “This is particularly encouraging as investment has been the slowest component of expenditure to recover from the crisis – it is still almost 24% below its pre-crisis peak.” Allen expects a weaker economic performance next year because after years of loose fiscal policy, he expects the government to “tighten its purse strings” going forward.
In Asia, China’s powerful Politburo has listed its top economic priorities for the coming year—curbing financial risks, eradicating poverty, and fighting pollution. The statement from the 25-member Politburo noted its most pressing task was to stem financial risks. Financial institutions would also be required to strengthen support for the real economy and “positive effects” should be achieved from risk prevention measures. The Politburo also called on rank-and-file members to improve living standards and to make “solid progress” on fighting poverty and environment protection. The International Monetary Fund warned in a financial risk analysis that Beijing should put financial stability above its development goals and said monetary and fiscal policies aimed at supporting employment and growth had led to a surge in debt.
The Japanese the economy expanded at an annualized 2.5% in the third quarter, data showed. The growth rate was faster than expected, and higher than the initial estimate of 1.4%. Growth was driven by rising global exports amid healthy global demand, and also by increased domestic spending by Japanese firms on equipment and facilities. The spending helped to offset weaker spending by consumers. The world’s third-largest economy has now grown for seven straight quarters, putting Japan on its longest stretch of uninterrupted growth since at least 1994. Prime Minister Shinzo Abe’s economic policies, known as “Abenomics”, have been partly credited for the expansion. The policies comprised a mix of monetary easing, government spending, and structural reforms designed to re-ignite the economy.
Finally: The Lords of Silicon Valley are supposed to be the drivers of our economy, and they certainly are this era’s economic rock stars. But at least for now, according to this week’s Non-Farm Payrolls report, the lowly blue-collar folks out in “flyover country” are experiencing a renaissance in jobs that has been a long time coming. Whether one credits Trump or not, the jobs growth is currently quite real in manufacturing – and, just for irony, note the decline in the high-tech “Information” category.
(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 23.00 from the prior week’s 22.75, while the average ranking of Offensive DIME sectors rose to 10.50 from the prior week’s 13.00. 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®