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 32.56, up from the prior week’s 32.45, 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 83.63, up from the prior week’s 82.09.
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 22, up 1 from the prior week’s 20. 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 recorded modest gains for the week, as small cap benchmarks outperformed their large-cap counterparts. The Dow Jones Industrial Average added 102 points to end the week at 24,754, a gain of 0.4%. The technology-heavy NASDAQ Composite rose 0.34% but remained just below 7,000, closing at 6,959.96. By market cap, the mid cap S&P 400 and small cap Russell 2000 indexes gained 0.95% and 0.82%, respectively. The large cap S&P 500 index added 0.28%.
International Markets: Canada’s TSX reversed last week’s decline and rose 0.77%. In the United Kingdom, the FTSE surged 1.4% to new highs, its third consecutive week of gains. On Europe’s mainland, France’s CAC 40 rose 0.3%, Germany’s DAX fell for a second week losing -0.2%, and Italy’s Milan FTSE rose 0.5%. In Asia, China’s Shanghai Composite reversed five straight weeks of losses by rising 0.9%. Japan’s Nikkei added 1.55% and Hong Kong’s Hang Seng surged 2.5%. As grouped by Morgan Stanley Capital International, developed markets added 0.2%, while emerging markets rose 0.7%.
Commodities: Gold experienced a second week of gains, rising 1.7% to end the week at $1278.80 an ounce. Silver likewise added 2.4%, closing the week at $16.44 an ounce. Energy rebounded following three weeks of losses, rising 2% to close at $58.47 a barrel for West Texas Intermediate crude oil. Copper, seen by some analysts as an indicator of global economic health due to its variety of uses, had a second week of strong gains, rising 3.3%.
U.S. Economic News: The Labor Department reported the number of people applying for new unemployment benefits rose by 20,000 last week to 245,000, but still remained far below the 300,000-level analysts use to indicate a “healthy” labor market. The reading was above the 230,000 estimate of economists, and its highest level in five weeks. The more stable four week average of new jobless claims increased by 1,250 to 236,000. The increase is unlikely to cause any concern over the strength of the labor market. Layoffs remain very low with the unemployment rate still at 4.1%, its lowest level in nearly 17 years. Continuing claims, which counts the number of people already receiving benefits, rose by 43,000 to 1.93 million. That number is reported with a one-week delay.
Confidence among the nation’s home builders rose to its highest level in eighteen years, surpassing the peak set during the housing boom of 2006-2007. The National Association of Home Builders (NAHB) reported that its monthly sentiment index surged five points to 74, exceeding analyst forecasts by 4 points. Overall, the builders seem to be in a good position with economy supporting a strong rate of home sales and a new tax overhaul that should boost profits. In its release the NAHB stated, “Housing market conditions are improving partially because of new policies aimed at providing regulatory relief to the business community.” In addition, it noted that the NAHB “fully supports” the legislation agreed upon by the conference committee of House and Senate members.
The number of housing starts reached their second-highest pace of the recovery last month running at a seasonally-adjusted 1.297 annual rate, according to the Commerce Department. The reading was 3.3% higher than October’s and 12.9% higher than the same time last year. The number of permits, tracked by analysts as an indication of future building activity, ticked down -1.4% to 1.298 million rate, but remained 3.4% higher than at the same time last year. Economists had forecast only a 1.25 million annual rate for starts. After the report’s release, Trulia chief economist Ralph McLaughlin noted that starts are still running at only about 67% of their long-term average, despite years of pent-up demand following the financial crisis. Still, the shift from construction of multi-family homes, which are almost always intended as rentals, to single-family ones, should be welcomed, McLaughlin added.
Sales of existing homes surged to their highest level since before the housing bubble of 2006, hitting their highest level in almost 11 years. The National Association of Realtors (NAR) reported existing home sales rose 5.6% to a 5.81 million seasonally adjusted annual rate last month and were 3.8% higher than the same time last year. The reading was the highest since December 2006 and followed an upwardly revised 5.5 million-unit pace in October. The reading shows that housing is regaining momentum after almost stalling earlier this year. Existing home sales make up about 90% of U.S. home sales. At November’s sales pace, it would take a record low 3.4 months to exhaust the current inventory on the market. Strong demand amid a shrinking supply of homes pushed the median home price up 5.8% to $248,000, the 69th consecutive month of year-over-year price gains.
New orders for U.S.-made manufactured goods fell last month after four consecutive months of gains. The Commerce Department reported orders for non-defense capital goods ex-aircraft slipped -0.1% last month, missing economists’ forecasts for a 0.5% gain. On an annualized basis, core capital goods are 5.1% higher than the same time last year. Analysts believe that the dip is likely to be temporary given the passage of the Republicans tax cut package—the largest overhaul of the tax code in 30 years. Overall, orders for durable goods, items meant to last three years or more, rose 1.3% in November on the heels of strong demand for transportation equipment which surged 4.2%.
The mood of the nation’s consumers fell more than expected this month, slipping further from the decade high reached in October. The University of Michigan’s survey of consumer attitudes declined 2.6 points to 95.9 this month—economists had expected a dip to just 97.1. Overall, the indicator has remained in a narrow band this year, which the survey’s chief economist Richard Curtin said reflects American consumers’ increasing confidence about their income and employment prospects. The index measures 500 consumers’ attitudes on future economic prospects, in areas such as employment, personal finances, inflation, government policies, and interest rates. In its statement Richard Curtin, chief economist of the survey stated, “Consumer confidence continued to slowly sink in December, with most of the decline among lower income households.”
Spending among the nation’s consumers rose more than forecast last month, according to the Commerce Department. Purchases rose 0.6% following a 0.2% advance that was less than previously estimated. While partly reflecting rising prices and spending related to energy, the results indicate strength in consumption, which accounts for more than two-thirds of the U.S. economy. One concern is that the increase in spending may be coming at the expense of stored up funds. The savings rate fell to 2.9% in November, to the lowest level since late fall of 2007—just before the recession began.
The Philadelphia Fed’s Manufacturing Business Outlook Survey jumped 3.5 points to 26.2 in December, handily beating the consensus forecast of a fall to 21.8. According to the survey, factory conditions in the mid-Atlantic region are improving, with any reading over zero signaling improving conditions. In the details of the report, the new orders index surged 8.4 points to 29.8—a positive indicator about future activity. In addition, shipments also rose, while survey respondents “continued to report increases in employment”, according to the release. Analysts report that an improving overseas economy is stoking demand for American businesses, and sentiment has improved by the promise of tax cuts. Barclay’s economist Pooja Sriram noted, “Altogether, today’s reading remains well above the six-month average of 23.2 and continues to signal strong manufacturing production in the U.S.”
International Economic News: Ex-Canadian Prime Minister Pierre Trudeau once remarked that Canada’s relationship with the United States was like sleeping next to an elephant: “No matter how friendly and even-tempered is the beast, one is affected by every twitch and grunt.” With the biggest tax cut in decades being signed into law in the United States, the corporate tax rate drops from 35% to 21%. Previously, Canada could boast lower business taxes—the Canadian average combined federal-provincial tax rate had compared favorably to the American average combined federal-state rate of 39.1%. That advantage is now history. The new average American rate is just 26%. If that wasn’t enough, the current Troudeau government is heading in the opposite direction on taxes. Troudeau’s government has proposed a national carbon tax in 2018, scheduled a payroll tax beginning in 2019 to pay for higher Canada pension plan contributions, and introduced an automatic tax escalator on alcohol.
Across the Atlantic, in the United Kingdom households turned increasingly cautious in the third quarter as they increased their spending at the slowest annual pace since 2012, according to the Office for National Statistics. Britain has experienced slower growth than the other big European economies this year due the rise in inflation, caused largely by the fall in the value of the pound after the 2016 referendum decision to leave the European Union. Annual growth in the third quarter slowed to 1.7%, slightly higher than estimates, but still the weakest pace in over four years. From the second quarter, the economy expanded an unrevised 0.4%. In a Bloomberg survey, the U.K. economy is expected to expand at 1.5% this year and 1.4% in 2018. That would be well behind the rates expected for both the U.S. and the euro region.
On Europe’s mainland, ‘The Economist’ magazine has named France “country of the year 2017”, mainly due to the election of President Emmanuel Macron. The magazine, often described as center-left in regards to its political leanings, commended France for voting in Macron and his party La Republique en Marche. It noted that the President, despite coming from a party “full of political novices”, had “crushed the old guard” and “transformed the national political debate.” Macron was especially commended for having “passed a series of sensible reforms”, most notably restructuring France’s rigid labor laws. The magazine’s second place finisher was South Korea. The announcement came alongside an updated forecast from French national statistics bureau Insee that reported French gross domestic product would grow by 1.9% in 2017, a full percentage point higher than a previous estimate.
In Germany, business morale deteriorated unexpectedly this month after hitting a high in November, according to the Ifo Institute for Economic Research in Munich. The causative factor appears to be Chancellor Angela Merkel’s inability to form a stable government after her Conservatives lost voters to the Far Right in September’s election, and her attempts at a three-way alliance with two smaller parties also failed. The Ifo Institute said its business climate index, based on a monthly survey of about 7,000 firms, slipped 0.4 point to 117.2 from last month’s reading. In the details of the report, the decline was driven by managers’ less optimistic business expectations, however overall business morale remained at a relatively high level.
The Bank of Italy pointed blame at the European Union for plunging the Italian economy into crisis. Ignazio Visco, the Governor of the Bank of Italy, accused the European Union’s regulatory regime for contributing to Italy’s financial crisis. As ratings agencies downgraded Italy’s sovereign debt, it meant the cost of funding for Italian banks in the coming months would fall on the government. The country then received fiscal support from the Eurozone, and in particular Germany, leading to increased scrutiny over how its banks were supported after the 2008 financial crisis. Mr. Visco argues that the intervention from Brussels to use Eurozone public funds inhibited Italy’s ability to respond to the macroeconomic conditions. Italy is considered one of the most vulnerable economies in the Eurozone after twenty years of poor performance and a failure to adapt to increasing global competition.
In Asia, the most senior members of China’s Communist Party wrapped up a three-day, closed-door meeting on where they think the economy is headed. Some key points from the meeting are that China has left an era of “high-speed” growth and entered a new era of “high-quality” growth, meaning that economists don’t expect to see a dramatic rebound in economic expansion. Of utmost priority will be to manage and prevent major risks to the world’s second-biggest economy. In particular, China will work to strengthen its financial sector. Finally, Beijing will work to restore clean air over the country by cutting pollution dramatically by 2020.
The Bank of Japan left monetary stimulus unchanged in the final policy meeting of the year as weakness in the yen and the recovery in the global economy supported solid economic growth. Overnight interest rates remained at negative 0.1%, while 10-year bond yields were capped at “around zero”, and asset purchases will continue at an established pace of about $706 billion USD a year. Monetary policy has remained unchanged for a year as the Bank of Japan continues to strive to reach its 2% inflation target. As its press conference, Bank of Japan Governor Kuroda signaled that no tightening of monetary policy is imminent. As the BOJ aims for 2% inflation, monetary conditions would be “stable and sustained” adding that the policy will continue until the “necessary time”.
Finally: In a year of uncertainty that included a recalcitrant North Korea, Britain’s continued exit from the European Union, multiple terrorist attacks, and global populist uprisings, to say 2017 was a turbulent year is a bit of an understatement—except, that is, in stock markets. World stocks, as measured by the MSCI All-Country World Index have risen every month this year, so far. In fact, they haven’t had a negative return since October of 2016. As shown by the following graphic, if they were to finish December in the green, it would represent the first year ever without a single monthly decline. And the odds are good for the record continuing, with a positive December so far and just 4 trading days to go.
(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 22.75 from the prior week’s 22.50, while the average ranking of Offensive DIME sectors was unchanged from the prior week at 9.25. The Offensive DIME sectors retained their substantial 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®