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 31.66, down slightly from the prior week’s 31.73, and still exceeds the level reached at the pre-crash high in October, 2007. This value is in the lower end of the “mania” range. 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 65.13, down slightly from the prior week’s 65.78.
In the intermediate and Shorter-term picture:
The Shorter-term (weeks to months) Indicator (see Fig. 4) turned positive on April 3rd. The indicator ended the week at 10, down from the prior week’s 13. Separately, the Intermediate-term Quarterly Trend Indicator – based on domestic and international stock trend status at the start of each quarter – was negative entering April, indicating poor prospects for equities in the second quarter of 2018.
In the Secular (years to decades) timeframe (Figs. 1 & 2), the long-term valuation of the market is simply too high to sustain rip-roaring multi-year returns – but the market has entered the low end of the “mania” range, and all bets are off in a mania. The only thing certain in a mania is that it will end badly…someday. 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 negative for Q2, and the shorter (weeks to months) timeframe (Fig. 4) is positive. Therefore, with two indicators positive and one negative, the U.S. equity markets are rated as Neutral.
In the markets:
U.S. Markets: The major U.S. stock indexes ended the week in mixed fashion, helped by a strong finish to the week that mostly compensated for a poor start. The NASDAQ Composite performed the best, helped in particular by a strong performance by heavily-weighted Apple. The Dow Jones Industrial Average finished the week down 48 points closing at 24,262, a loss of -0.2%. The NASDAQ Composite rose 89 points, or 1.3%, ending the week at 7,209. By market cap, smaller cap stocks ended the week in positive territory with the small cap Russell 2000 adding 0.6% and the mid cap S&P 400 index rising 0.3%, while the large cap S&P 500 declined -0.2%.
International Markets: Canada’s TSX rallied for a fourth consecutive week, ending the week up 0.4%. An even longer winning streak is found in the United Kingdom’s FTSE, which rose a sixth straight week, up 0.9%. Markets were also positive on Europe’s mainland, where France’s CAC 40 gained 0.6%, Germany’s DAX surged 1.9%, and Italy’s Milan FTSE gained 1.7%. In Asia, China’s Shanghai Composite rose for a second week adding 0.3%, while Japan’s Nikkei ended the week flat. Most international markets were negative, however, did not do nearly as well as the “headline” markets mentioned above. As grouped by Morgan Stanley Capital International, developed markets finished the week down -0.1%, while emerging markets slipped -1.8%.
Commodities: The rally in energy continued. West Texas Intermediate crude oil rose 2.4% to close at $69.72 per barrel. Precious metals finished the week mixes with Gold falling -0.7% to close at $1314.70 an ounce, while Silver managed a slight gain by rising 0.1% to close at $16.52 an ounce. Copper, seen as a barometer of global economic health due to its variety of uses, rose 0.7% for the week.
April Summary: For the month of April, the Dow Jones Industrial Average added 0.3%, while the Nasdaq Composite ended the month essentially flat, up just 0.04%. By market cap, the large cap S&P 500 added 0.3%, the mid cap S&P 400 gave up -0.3%, and the small cap Russell 2000 gained 0.8%. Developed International markets on the whole did much better than the U.S. market, while Emerging International markets lagged for themonth. Canada’s TSX gained 1.6%, while the United Kingdom’s FTSE surged 6.4%. On Europe’s mainland, France’s CAC 40 rallied 6.8%, Germany’s DAX added 4.3%, and Italy’s Milan FTSE jumped 7%. In Asia, China’s Shanghai Composite ended the month down -2.7%, while Japan’s Nikkei rallied 4.7%. Developed markets finished the month of April up 1.5%, while emerging markets were down -2.8%. Precious metals were mixed for the month with Silver rising 0.8% but Gold retreating -0.6%. The industrial metal copper ended the month up 0.9%. Energy had its third consecutive month of gains as West Texas Intermediate crude oil rallied a robust 5.6%.
U.S. Economic News: After falling to its lowest level since 1969 last week, initial jobless claims rebounded only slightly to 211,000, according to the Labor Department. The reading was still far below the average of 225,000 forecast by economists. The more stable four week average of claims decreased by 7,750 to 221,500—its lowest reading since March of 1973. Looking at the big picture, the U.S. labor market is in its best shape of the nine-year economic expansion. The low level of claims suggests that solid job growth will continue and the unemployment rate will continue to fall. Continuing claims, which counts the number of people already receiving unemployment benefits, fell by 77,000 to 1.76 million.
The unemployment rate fell to a 17-year low and the U.S. added 164,000 new jobs in April, according to the Bureau of Labor Statistics’ Non-Farm Payrolls report. The nation’s unemployment rate fell 0.2% to 3.9%, after holding at 4.1% for six months in a row. The increase in new jobs was led by professional businesses, which added 54,000 workers. Hiring also rose among health care providers and manufacturers, each of which added 24,000 jobs. Construction firms increased payrolls by 17,000. The tight labor market is also evident in the so-called “real” or “U-6” unemployment rate. The U6 rate also includes people who can only find part-time work and those that are no longer looking for a job. The U6 rate fell to 7.8% in April, the first time it’s dropped below 8% since 2006.
Construction activity slipped 1.7% in March, with public sector construction project spending little changed, but private sector spending falling 2.1%, according to the Commerce Department. Residential construction spending is 3.5% lower for the month, but still up 5.3% from the same time last year. Total construction spending year-to-date is 5.5% higher than the same period in 2017. Stephen Stanley, Chief Economist at Amherst Pierpont Securities, attributed the weakness to the weather noting, “Construction spending was quite soft in March, falling by 1.7%, likely reflecting at least in part the difficult weather during the month. I continue to look for a sizable bounceback in construction activity in the spring, as weather delays dissipate.”
Spending by the nation’s consumers increased 0.4% in March after remaining unchanged in February, the Commerce Department reported. On an annualized basis, consumer spending grew at a 1.1% annualized rate in the first quarter—its slowest in almost five years. Data showed Americans spent more on new cars and trucks and paid more to heat and power their homes. Consumer spending accounts for roughly two-thirds of the nation’s economic activity.
A gauge of manufacturing activity in the Chicago region ticked higher in April, but remained well below its year-to-date high. The Chicago Purchasing Managers’ Index for April came in at 57.6, missing economists’ expectations for a reading of 59.3 and not rebounding nearly as much as economists had hoped from March’s plunge. While the report still indicates healthy activity, as readings above 50 indicate improving conditions, the last two months’ readings are down significantly from last winter. The new-orders growth hit a concerning 15-month low.
Nationwide, manufacturers grew at a slower pace in April, hindered by higher prices for raw materials such as steel and continued skilled labor shortages, according to the Institute for Supply Management (ISM). The ISM manufacturing index fell to 57.3 last month, down 2 points from December. The reading missed economists’ forecasts who had expected a stronger reading of 58.7. In the report, most executives said their firms are growing and business is still very strong, but they complained about higher prices for steel following the recent U.S. tariffs. The cost of other materials also continued to rise, and many firms continue to report difficulty finding workers. In the details, ISM’s index for new orders was little changed at 61.2, but production fell 3.8 points to 57.2. The employment gauge slipped 3.1 points to its lowest level in almost a year. Overall the U.S. economy continues to expand at a healthy pace, now almost nine years since the last recession. Analysts note that such a long period of growth is bound to give rise to higher inflation, especially given the low unemployment rate.
The U.S. trade deficit fell to a 6-month low of $49 billion in March, but analysts note that the trade gap is unlikely to fall much further. Despite the 15% decline, the U.S. remains on track to run another large trade deficit in 2018 that exceeds the deficit of 2017. In the report, exports advanced 2% to $208.5 billion and set a new record. The U.S. shipped more petroleum, passenger planes, and agricultural products ahead of pending tariffs by China. U.S. imports dropped 1.8% to $257.5 billion as the U.S. imported far fewer consumer electronics, toys, appliances, wine and beer. The U.S. trade deficit in goods increased with all its major trading partners except China. More American-made goods were sent to China and fewer Chinese goods were received in the U.S. in March.
Inflation hit the Federal Reserve’s 2% target for the first time in a year according to its preferred inflation measure and fell just short in another measure. The Federal Reserve’s preferred inflation barometer, the Personal Consumption Expenditures (PCE) index reached 2% year-over-year in March, a 0.3% gain from February. In addition, the closely followed core inflation rate, which measures price increases without the volatile food and energy sectors, rose to a 12-month high of 1.9% year-over-year. That’s the biggest yearly gain in the core rate since April 2012. Overall, inflation has been increasing steadily for months due to the rising cost of oil, higher home prices, and the tightest labor market in decades. While still low by historical standards, the Fed may be inclined to raise interest rates more aggressively to ensure it doesn’t get out of hand.
The Federal Reserve left its key U.S. interest rate unchanged this week, but the central bank acknowledged prices were rising and that it now expects inflation to “run near” its 2% target “over the medium term”. The somewhat more hawkish language by the FOMC about price levels, suggests the Fed is paying closer attention to inflation, but is not unduly alarmed. Analysts note the changes in the central bank’s policy statement could boost expectations that the Fed will raise its benchmark interest rate four times this year, instead of the three previously planned. The vote to hold rates steady was 8-0.
International Economic News: Canada’s economy rebounded in February more than economists had estimated, a good indication that the nation is poised to emerge from its recent soft patch in growth. Statistics Canada reported Gross Domestic Product expanded 0.4% in February, following a 0.1% contraction the previous month. Economists anticipated a 0.3% gain. The improvement was due to idled oil and auto production coming back on line. In addition, the report showed broad-based increases in key sectors such as manufacturing. Transportation bottle-necks also appeared to be dissipating. Many economists are now calling for growth above 2% in coming months which would in turn prompt the Bank of Canada to continue with interest rate increases. Royce Mendes, economist at CIBC Capital Markets summed it up best, albeit with mixed metaphors: “The Canadian economy hit a pot-hole to begin the year, but February’s GDP reading suggests that it was only a temporary bump in the road.”
The United Kingdom’s economy remains stuck in the slow lane as its services sector grew at a slower-than-expected pace last month. Research firm IHS Markit reported its Purchasing Managers’ Index (PMI) for the industry saw only a modest rebound from the almost 2-year low posted in March. The reading of 52.8 was the weakest services PMI reading since September of 2016. Based on its three industry surveys, Markit estimates an expansion in the United Kingdom consistent with a “disappointingly subdued” quarterly rate of 0.25%. While 0.25% is an improvement over the 0.1% seen in the first quarter, it’s considerably slower than the growth seen in the second half of last year.
Intermittent strikes against the new economic reforms enacted by French President Emmanuel Macron may be the toughest test yet for the new president. Strikes continue to target the national state-owned railway company SNCF where protest leaders say the strikes are set to last at least three months. The French government is seeking to reform the railway sector before the summer. The SNCF has a staggering $57.7 billion debt which is compromising future investment. In February, Edouard Philippe, the Prime Minister, outlined plans to open up the rail monopoly to competition. The government decided to stop short of privatization but said the SNCF should nevertheless be placed on equal footing with private competitors.
As Europe’s biggest exporter to the United States and with more than a million jobs on the line, Germany is desperate to avoid a European Union trade war with America. As the June 1 deadline nears when U.S. President Donald Trump has threatened to impose steel and aluminum tariffs on the EU, Berlin is urging its European partners to show flexibility and to pursue a broad trade deal that benefits both sides. However, that puts Germany at odds with its peers such as France. The other major power for European integration is distancing itself from Germany’s sentiment and wants a tougher EU stance against the U.S. tariffs. Holger Bingmann, president of Germany’s BGA Foreign Trade Association stated, “There is a great danger of slipping into a trade war that way.” The European Commission has said the EU will set duties on 2.8 billion euros ($3.36 billion) of U.S. exports, including peanut butter and denim jeans, if its metals exports to the United States, worth 6.4 billion euros, are subjected to tariffs.
The Chinese economy, the world’s second-largest, remained strong in April, supported by an uptick in industrial output and a rebound in exports despite its rising trade tensions with the United States. China’s economy grew at a slightly faster-than-expected annualized pace of 6.8% in the first quarter, but economists still expect growth to slow significantly by the end of the year. In talks late this week, the U.S. and China reached a consensus on some areas of their trade dispute, but are still relatively far apart on other issues, Chinese state media reported. U.S. President Donald Trump has threatened $150 billion in new tariffs on Chinese imports, though none of the tariffs have been implemented yet.
After six years of solid growth, Japan’s economy likely slowed in the first quarter of the year data from the Finance Ministry showed. Rising prices for everyday goods weighed on consumers while declining exports of electronic parts and other items raised questions about global economic health. Analysts estimate export values grew just 0.5% in the first quarter, year-over-year, down from two consecutive quarter of growth in the 2% range. Though one quarterly decline doesn’t necessarily mean Japan’s broader recovery is over, the deceleration in global exports raises questions about the strength of global demand. The prevailing view from a consensus of twelve private research firms holds that Japan will regain an annualized growth rate in the 1% range in the second quarter of the year and beyond.
Finally: In the dustbowl days of the depression, signs taped to westbound Model T’s frequently said “California Or Bust”. But now, eastbound cars might as well have signs taped to them saying “Busted by California”!
With the median sale price for a home in California now more than double the national average, citizens continue to exit the state in sizeable numbers. From 2006 to 2016 over a million more people moved out of California than moved in, with the high cost of housing appearing to be the #1 cause. A report from Next 10 and Beacon Economics showed that the high cost of housing is hitting lower-income people the hardest, driving them to more affordable neighboring states.
Most people leaving the state earn $50,000 or less per year. And while California is a still a net importer of highly educated professionals in the information, professional, and technical sectors that can afford the higher cost of homes, the accommodation, construction, manufacturing, and retail trade sectors are experiencing a huge exodus. Who will be left to serve drinks and food, turn down the sheets, build and clean the houses of all those software engineers?
(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 fell to 20.25 from the prior week’s 23.75, while the average ranking of Offensive DIME sectors fell to 11.25 from the prior week’s 10.00. The Offensive DIME sectors lost some of 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®