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 32.45, up from the prior week’s 32.17, 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 82.09, up from the prior week’s 80.49.
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 20, down 1 from the prior week’s 21. 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: Most of the major U.S. indexes recorded modest gains during the week, bringing the large-cap benchmarks and the technology-heavy Nasdaq Composite to new highs. The Dow Jones Industrial Average added 322 points to end the week at 24,651 for a gain of 1.33%. The Nasdaq Composite reversed last week’s loss, rising 1.41% to close at 6,936. By market cap, however, markets ended the week mixed. The large cap S&P 500 added 0.92%, the small cap Russell 2000 gained 0.57%, but the S&P 400 mid cap index retreated -0.22%.
International Markets: Canada’s TSX reversed last week’s rise, falling -0.34%. In Europe, the United Kingdom’s FTSE had a second week of strong gains rising 1.3%, but the other major European markets did not do as well. France’s CAC 40 fell -0.9%, Germany’s DAX declined -0.38%, and Italy’s Milan FTSE slumped -3%. In Asia, China’s Shanghai Composite fell a second week, declining -0.7%. Japan’s Nikkei retreated -1.1%, while Hong Kong’s Hang Seng reversed some of last week’s losses rising 0.7%. As grouped by Morgan Stanley Capital International, emerging markets rose 0.5%, while developed markets added 0.2%.
Commodities: Precious metals ended the week with a gain following three down weeks. Gold rose $9.10 to close at $1257.50 an ounce, while silver gained 1.5% to close at $16.06 an ounce. In energy, oil ended essentially flat. West Texas Intermediate crude oil slipped -$0.03 to end the week at $57.33 per barrel. Copper, seen by some analysts as a barometer of worldwide economic health, surged 5.24% this week.
U.S. Economic News: The Labor Department reported that initial claims for new unemployment benefits fell by 11,000 to just 225,000 in the week ending December 9th. In the details of the report, the biggest declines took place in New York, Texas, and California. The reading is just barely above the lowest post-recession low, and also near the lowest level since the early 1970’s. The less-volatile monthly average of new claims slipped 6,750 to 234,650. Overall, layoffs remain near a 45-year low and the unemployment rate is just 4.1%–the lowest in 17 years. Continuing jobless claims, which counts the number of people already receiving benefits, fell to 1.886 million from 1.913 million. That number is reported with a one-week delay.
The nation’s employers posted slightly fewer job openings in October than the previous month, but the number of people hired improved. The Labor Department reported that nearly 6 million jobs were available at the end of October, down from the 6.18 million open the month before, but total hires rose 4.4% to 5.55 million. Leading sources of the increased hiring were in restaurants and hotels, health care, manufacturers, and financial services. Overall, the U.S. has created almost 17.5 million jobs since 2010 bringing the unemployment rate down to a near 17-year low of 4.1%. Employers continue to report that their biggest problem is finding skilled workers among the shrinking labor pool. Some firms are dealing with the issue by spending more on technology such as automation to address the problem.
Sentiment among small-business owners surged last month to the second-highest reading on record the National Federation of Independent Business (NFIB) reported. The index of small business optimism rose 3.7 points to 107.5 last month, the second-highest reading in the 44-year history of the index and near its all-time high set in July 1983. Eight of the ten components of the index recorded gains, including a massive 16-point gain in expected better business conditions and a 13-point jump in the measure of sales expectations. NFIB Chief Economist Bill Dunkelberg said, “The NFIB indicators clearly anticipate further upticks in economic growth, perhaps pushing up toward four percent GDP growth for the fourth quarter. This is a dramatically different picture than owners presented during the weak 2009-16 recovery.”
Retail sales increased more than expected in November as holiday shopping got off to a brisk start. The Commerce Department reported retail sales rose 0.8% last month with households buying all types of goods. Internet retailers like Amazon posted a massive 2.5% increase in sales as consumers continued to favor online shopping for Black Friday and Cyber Monday deals. On an annualized basis, retail sales accelerated 5.8%. Core retail sales, which exclude automobiles, gasoline, building materials, and food services, jumped 0.8% following a 0.4% increase in October. David Berson, chief economist at Nationwide said, “November’s retail sales report suggests that consumers are responding positively to solid job gains, increasing income growth, and record levels of household net worth.”
The U.S. Consumer Price Index increased 0.4% last month according to the Bureau of Labor Statistics. Three-quarters of the gain were due to higher gas prices. Stripping out the volatile food and energy categories, the core rate of inflation rose a weaker 0.1%. Overall, the annual rate of inflation rose 0.2% to 2.2%, but the core rate fell slightly to 1.7%. While rising oil prices were a significant part of the increase in the cost of living, consumers also paid more for housing, rent, and new and used cars. Of note, clothing prices posted their biggest one-month decline in almost two decades.
At the wholesale level, the Producer Price Index (PPI) surged 0.4% last month, the third consecutive monthly gain leaving inflation near a nearly 6-year high. The Bureau of Labor Statistics reported the increase in producer prices was broad-based across multiple sectors. “Core” PPI, which strips out the volatile food and energy categories, also rose 0.4%. The increase in the PPI lifted the 12-month rate of wholesale inflation to 3.1%–its highest level since January 2012. The annual rate for core inflation climbed to 2.4%, its highest reading since mid-2014. Overall, the higher cost of energy was responsible for a sizeable part of the increase, but the wholesale prices for a larger variety of goods are on the rise.
The Federal Reserve Open Market Committee (FOMC) voted to lift the key U.S. interest rate a quarter percentage point, but the central bank took a wait-and-see stance in light of persistent low inflation and the pending change in leadership at the Fed. The FOMC raised its benchmark federal funds rate to 1.5%, its fourth increase in a year, and made no changes to its forecast for inflation and for three interest rate hikes in 2018. Interest rate hikes raise the cost of borrowing for consumers and businesses and are intended to help to keep the economy from overheating. Paul Ashworth, chief U.S. economist at Capital Economics noted, “The surprise is that, despite that stronger economic growth, the inflation and interest rate projections were left almost completely unchanged.”
International Economic News: Bank of Canada Governor Stephen Poloz stated Canada’s economy has reached a point of near-perfect balance, with most companies running at full capacity and inflation nearing the central bank’s 2% target. In a speech in Toronto, Mr. Poloz said, “We are at a point in the economic cycle that I think of as the “sweet spot”—we know that a majority of Canadian companies are running flat out.” The Bank of Canada has raised its benchmark interest rate twice so far this year to 1%. Mr. Poloz noted that rates at the level remain “stimulative”. Mr. Poloz said the bank would continue to be “cautious” and “data dependent” as it ponders its next rate decisions – the next of which is due on January 17th.
Britain and China pledged cooperation with each other as the Britain prepares to leave the European Union. Britain and China have pledged to promote London as a center for use of Beijing’s currency and cooperate in clean energy research and trade. British leaders are looking to China for trade and investment opportunities as they forge a new global role with reduced access to the 27 nations of the European common market. The two sides agreed to promote international use of China’s yuan and develop yuan-based business in London. That would benefit Britain by reaffirming London’s status as a global financial center. Britain’s Chancellor of the Exchequer Philip Hammond stated, “These are welcome steps that will help deliver our vision of a stronger, fairer, more balanced economy in the U.K. and will also support China’s vision for the future direction of its economy.”
Across the Channel, the French economy kept up a surging rate of expansion into December, capping a year that has seen the country go from one of the Eurozone’s laggards to one of its strongest performers. Research firm IHS Markit said its preliminary Purchasing Managers Index (PMI) for manufacturing rose 1.6 points to 59.3 for December hitting a more than 17-year high. The PMI reading for the service sector retreated a point but remained above the 50-point threshold indicating expansion. IHS Markit Chief Economist Chris Williamson noted, “France is very much leading the pack in the fourth quarter in terms of overall growth rates.” “The fact the French economy has shaken off its malaise, picking up growth momentum almost continually throughout the year to end on this super strong high note is a key factor in why the Eurozone is doing so well,” he said.
In Germany, the Munich-based Ifo Institute for Economic Research reported the German economy will expand by 2.6% next year in its latest forecast for Europe’s economic powerhouse. The bullish projection comes despite the apparent political stalemate with Chancellor Angela Merkel still trying to form a coalition government nearly three months after a federal election. If the prediction comes true, the growth rate would be the highest since the 3.7% registered in 2011. Ifo head Clemens Faust said, “The German economy is humming,” adding that the strong economic upturn would extend well into 2018.
It is expected that U.S. President Donald Trump will accuse China of engaging in “economic aggression” this coming week during the release of his national security strategy. The national security strategy is a formal document produced by every U.S. president since Ronald Reagan. The accusation will be the most aggressive economic response to China since the U.S. supported its entry into the World Trade Organization in 2001. Critics worry that if the U.S. pushes too hard, it could start a trade war that could have severe consequences for U.S. business and the global economy. Evan Mederios, former Asia adviser to Barack Obama said, “The concern about Chinese economic policy and practices is serious and real but the question is how you deal with it. Unilateral trade enforcement mechanisms are not going to do it. You need systemic tools that shape the economic environment around China in order to reshape their incentives.”
In Japan, the central bank survey known as a tankan showed that business confidence improved for a fifth straight quarter in the three months to December hitting an 11-year high. On a negative note, big manufacturers and non-manufacturers expect business conditions to deteriorate in the next three months, and they are thus reluctant to increase worker wages and business investment. Premier Shinzo Abe has struggled for almost two decades to get firms to spend more on wages to help end the deflation that has plagued Japan. Abe’s ruling coalition approved a plan to slash the corporate tax rate, but only for companies that increase spending. Hidenobu Tokuda, senior economist at Mizuho Research Institute said, “The tankan results support the BOJ’s bullish economic view backed by global economic recovery.”
Finally: In what may be a surprising twist at the end of a strong year in the market, Boston Consulting Group found that fully 46% of investors were pessimistic about equity markets for the next year. The reading is up from 32% a year ago, and just 19% in 2015. As global equity benchmarks have rallied, more investors also see the market as too expensive. Fully 68% of respondents said the equity market is “overvalued,” more than double the 29% of respondents who thought as much last year. And nearly 80% of investors describing themselves as market bears cited “overvaluation” as the reason for their market pessimism, the survey found.
(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 rose to 22.50 from the prior week’s 23.00, while the average ranking of Offensive DIME sectors rose to 9.25 from the prior week’s 10.50. 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®