FBIAS™ market update for the week ending 6/16/2017
The very big picture:
In the “decades” timeframe, the question of whether we are in a continuing Secular Bear Market that began in 2000 or in a new Secular Bull Market has been the subject of hot debate among economists and market watchers since 2013, when the Dow and S&P 500 exceeded their 2000 and 2007 highs. The Bear proponents point out that the long-term PE ratio (called “CAPE”, for Cyclically-Adjusted Price to Earnings ratio), which has done a historically great job of marking tops and bottoms of Secular Bulls and Secular Bears, did not get down to the single-digit range that has marked the end of Bear Markets for a hundred years, but the Bull proponents say that significantly higher new highs are de-facto evidence of a Secular Bull, regardless of the CAPE. Further confusing the question, the CAPE now has risen to levels that have marked the end of Bull Markets except for times of full-blown market
Even if we are in a new Secular Bull Market, market history says future returns are likely to be modest at best. The CAPE is at 29.81, up slightly from the prior week’s 29.79, and now 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 just 3%/yr (see Fig. 2).
This further means that above-average returns will be much more likely to come from the active management of portfolios than from passive buy-and-hold. Although a mania could come along and cause the CAPE to shoot upward from current levels (such as happened in the late 1920’s and the late 1990’s), in the absence of such a mania, buy-and-hold investors will likely have a long wait until the arrival of returns more typical of a rip-snorting Secular Bull Market.
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 69.08, up from the prior week’s 68.72.
In the intermediate and Shorter-term picture:
The Shorter-term (weeks to months) Indicator (see Fig. 4) turned negative on March 24th. The indicator ended the week at 22, down from the prior week’s 23. Separately, the Intermediate-term Quarterly Trend Indicator – based on domestic and international stock trend status at the start of each quarter – was positive entering April, indicating positive prospects for equities in the second quarter of 2017.
In the Secular (years to decades) timeframe (Figs. 1 & 2), whether we are in a new Secular Bull or still in the Secular Bear, 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 Q1, and the shorter (weeks to months) timeframe (Fig. 4) is negative. 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. market indexes ended the week mixed. The tech-heavy Nasdaq Composite index had its second down week as the sell-off in mega-cap tech shares continued to weigh on the market. Of note, the Nasdaq’s so-called FAANG companies of Facebook, Amazon, Apple, Netflix, and Google represent well over $2 trillion in market capitalization alone. For the week, the Dow Jones Industrial Average gained half a percent to close at 21,384. The Nasdaq fell -0.9%, or 56 points, ending the week at 6,151. By market cap, large caps outperformed their smaller cap brethren. The S&P 500 large cap index was essentially flat, rising 0.06%, while the S&P 400 mid cap index fell -0.23%, and the small cap Russell 2000 retreated -1.05%.
International Markets: Canada’s TSX fell -1.8%, giving up this year’s gains. The United Kingdom’s FTSE also ended the week down by pulling back -0.8%. Major markets ended in the red across the board on Europe’s mainland. France’s CAC 40 retreated -0.69%, Germany’s DAX fell -0.49%, and Italy’s Milan FTSE gave up -0.86%. Markets were red in Asia as well. China’s Shanghai Composite fell -1.1%, along with Japan’s Nikkei which declined -0.35% and Hong Kong’s Hang Seng which retreated -1.55%. As grouped by Morgan Stanley Capital Indexes, developed international markets ticked up 0.1% for the week, while emerging markets declined -0.9%.
Commodities: Precious metals experienced their second down week. Gold fell -$14.90 to $1256.50 an ounce, a decline of -1.17%. Silver, gold’s more volatile cousin, also finished the week down, falling -3.26% to $16.66 an ounce. Oil had its fourth straight week of losses, retreating -1.88% to close at $44.97 per barrel of West Texas Intermediate crude oil. Copper, seen by some analysts as an indicator of worldwide economic health, retraced last week’s gain by retreating -3.23%.
U.S. Economic News: The number of Americans applying for first time unemployment benefits fell 8,000 to 237,000 last week, according to the Labor Department. New applications for benefits have remained under the key 300,000 threshold, used by analysts to indicate a “healthy” jobs market, for 119 straight weeks—its longest run since the early 1970’s. In addition, the number of people already receiving unemployment checks totaled less than 2 million for its ninth straight week. The last time these so-called continuing claims remained under 2 million for this long was in 1973. Combined, the total number of people applying for unemployment benefits and those already receiving them is now at a 45-year low.
Confidence among the nation’s home builders ticked down slightly in June, but remained near historically high levels according to the National Association of Home Builders (NAHB)/Wells Fargo housing market index. The NAHB’s housing market index fell 2 points to 67, after a downward revision May’s earlier-reported reading of 70. Any readings over 50 indicate that more builders view conditions as improving. In the details, the components measuring current sales conditions fell 2 points to 73, along with the index measuring sales expectations in the next six months, which also fell 2 points to 76. The measure of buyer traffic likewise retreated 2 points to 49.
The National Federation of Independent Business (NFIB) said its small-business optimism index remained steady at 104.5 in May from the prior month. The flat reading was seen as a positive by analysts as the sentiment index had fallen for three straight declines the prior month. Business owners are waiting for action in Washington regarding tax relief and rising healthcare costs. NFIB President Juanita Duggan said small business owners remain optimistic that tax and healthcare reforms can pass Congress. Confidence among small-business owners still remains at historically high readings following December’s surge by the largest amount in the 40-year history of the survey. In the details, five of the ten index components gained, four declined, and one remained unchanged. Of concern, only a net 28% of owners plan on making capital outlays—well below historic levels.
Inflation at the wholesale level remained flat last month following the sharp 0.5% increase in April, according to the Bureau of Labor Statistics. Lower costs for gasoline and other fuels kept in check upward price pressures in other areas of the economy. Inflation is becoming more widespread this year after being negligible for most of 2016. The 12-month rate of wholesale inflation stood at 2.4% in May, up from zero a year earlier and just a notch below a five-year high. Stripping out the volatile energy, food, and retail trade margins, core wholesale costs fell 0.1%. The core rate of inflation was up 2.1% over the past 12 months—this is the measure that gets the most attention from Wall Street and the Fed.
For American consumers, the cost of goods and services fell last month for the second time in three months as inflation for consumers continued to recede. The Consumer Price Index, known as the cost of living fell a seasonally-adjusted 0.1% last month with the drop in the price of gasoline (again) playing a major role. For consumers, the rate of inflation over the past 12 months slowed to a 1.9% back under the Federal Reserve’s 2% target. Despite the retreat the Federal Reserve still voted to hike interest rates at its meeting this week, due in large part to the surge in price pressures that accelerated at the end of last year. In the details of the report, gas prices sank 6.4%, while the cost of food rose for the fifth straight month. Stripping out the volatile food and energy categories, the so-called core CPI rose 0.1% in May. Over the last 12 months, the core CPI fell to 1.7% in May from 1.9% in April.
Retailers in the United States reported their biggest decline in sales in 16 months with auto dealers and gasoline retailers bearing the brunt of the weakness. The reversal last month retraced most of April’s 0.4% jump in sales. Overall, retail sales continue to increase at a pace consistent with the steady growth in the U.S. economy. Sales are up 3.9% in the first five months of 2017 compared to the same period in 2016. Gus Faucher, chief economist at PNC Financial Services stated, “More jobs, rising wages, low inflation, rising home sales, and low interest rates will continue to push consumer spending forward in 2017.” Stripping out auto and gasoline sales, retail sales were unchanged according to the Commerce Department. The bright spot of the report continued to be internet sales, with an increase of 0.8%. Shoppers continued their migration from brick-and-mortar stores to internet retailers as traditional department store sales fell sharply, losing 1% in May—their worst performance in almost a year.
The Federal Reserve lifted a key interest rate and laid out its plan to shrink its massive $4.5 trillion balance sheet this week. In a move that was widely expected, the Fed raised its benchmark federal-funds rate by a quarter percentage point to 1-1.25%–its third increase in a year and a half. The move will increase the cost of borrowing for consumers and business to help stave off the threat of excessive inflation and an overheated economy. Senior Fed officials also reiterated their intention to raise interest rates just one more time this year in the face of the unexpected recent softening in inflation data. The recent weak data gives the central bank the latitude to proceed more slowly with rate hikes if it so desires. Paul Ashworth, chief U.S. economist at Capital Economics stated, “The recent run of weaker core inflation readings has clearly rattled some Fed officials.” Still, Fed Chair Janet Yellen and other prominent members point to the tight labor market as a sign that price pressures are more likely to intensify. “Conditions are in place for inflation to move up,” Yellen said in a press conference after the Fed action.
In the “City of Brotherly Love”, the Philadelphia Fed’s manufacturing index retreated 11.2 points this month to 27.6. The reading was seen as a positive because economists had expected the index to fall to 24. The decline was expected following May’s second strongest reading in almost 30 years. In the details, a slowdown in the pace of shipment growth was responsible for most of the decline. The shipments index tumbled to 28.5 from 39.1 in May. On a positive note, new orders ticked up to 25.9 from 25.4 in the previous month.
In New York, manufacturing rebounded to its highest level since 2014 in a further sign of strength for the nation’s factories. The New York Fed’s Empire State index rose over 20 points to 19.8 in June from -1 in May. The new orders index rose to 18.1 after a -4.4 reading last month. The Empire State index only tracks factory activity in New York, but economists use the data as an early indication of factory output nationwide. The Empire State Index has risen seven of the last eight months. The reading is compiled from a survey of about 200 manufacturers in New York State.
International Economic News: After two years, Canada’s economy appears to be taking a positive turn. According to the latest Royal Bank of Canada Economic Outlook, consumer spending, housing starts, and a strong turnaround in business investment are largely responsible for the continued momentum that continues to build on last year’s gains. Bank of Canada governor Stephen Poloz said the economy is rebounding on a variety of fronts suggesting that the interest rate cuts put in place in 2015 “have largely done their work.” Senior Deputy Governor Carolyn Wilkins said that Canada’s economy is picking up after a period of low oil prices in 2014. The Bank of Canada is assessing whether further economic stimulus is still required, she said. Poloz refused to make any predictions about whether that means Canadians should expect a rate hike in the near future. Naysayers, however, point to the overheated real estate market as a bomb waiting to detonate the Canadian economy.
In the United Kingdom, the Bank of England came closer to raising interest rates this week than at any time over the past six years according to its rate-setting Monetary Policy Committee (MPC). In an unexpectedly close vote, MPC members voted 5-3 to keep rates at their historic low of 0.25% on the grounds that the U.K. economy’s recent weakness would keep inflation under control. In its statement, all of the MPC members agreed that the “inflation overshoot relative to the (bank’s 2%) target could be more pronounced than previously thought.” The committee was split on whether there were enough signs of life in the economy to offset the recent weakness in consumer spending from slowing wage growth and rising inflation.
On Europe’s mainland, the Bank of France maintained its second quarter GDP growth forecast of 0.5%. In addition, it anticipated an increase in the services and construction sectors for June. The central bank’s business climate survey for the manufacturing industry came in at 105, matching April’s reading of its highest level in six years. Its business climate indicator for services reading was 101, also matching April’s number.
In Germany, apparently what’s good for Germans is what’s good for the EU. According to a paper released by Swiss-based consultancy Prognos, the German economy is responsible for 4.8 million jobs in all of Europe. The paper asserts that high demand in Germany does not slow development in neighboring countries, but actually is an important driving force behind their growth. The Bavarian Industry Association (BIA) requested the report because of the continued criticism of Germany’s current account surplus from U.S. President Donald Trump and other world leaders. In 2015, Germany imported goods worth around $620 billion (555 billion euros) from other EU countries. A downturn in the German economy would have the effect of lowering economic output across the European Union by 36 billion euros by 2023. “Our study debunks the myth that German economic competitiveness harms our neighbors,” says Bertram Brossardt, head of the BIA.
In Asia, the International Monetary Fund (IMF) reported China’s economy generally remained on solid footing but tighter monetary policy, a cooling housing market, and slowing investment will weigh on the nation’s economy in the coming months. Still, Beijing is expected to meet its annual 6.5% annual economic growth target. The IMF raised its growth forecast for the country to 6.7% as it recommended China accelerate reforms and rein in credit. Economists at Nomura forecast China’s economy will grow an annual 6.8% in the second quarter, only marginally less than the 6.9 percent in the first quarter and providing enough momentum to achieve the government’s full-year target even if there is some second-half softening.
In Japan, the Bank of Japan voted to keep its lax monetary policy intact noting that its policies were supporting improvement in the world’s third largest economy. A statement issued by the central bank said it expects demand to accelerate as the central bank held its key interest rate at an ultralow -0.1%. Of interest, U.S. pension giant TIAA plans to invest about $1 billion in Japanese real-estate. The pension is betting that “Abenomics”, has put the Japanese economy in a position that it will see solid growth in the coming years. The nearly 100-year-old firm, known for offering retirement products to teachers, plans to invest in retail and logistic sites around Tokyo and Osaka. “For the global markets that we’re looking at, the story in Japan, particularly in Tokyo, looks really interesting,” Harry Tan, head of research for Asia Pacific at TH Real Estate, TIAA’s real estate arm.
Finally: As the stock market continues to grind higher and investors become more complacent we turn our attention to one data point that has remained a “stubbornly fail-safe marker” of economic contraction since 1960. Every time Commercial & Industrial (C&I) loan balances have declined or stagnated—a recession was already in progress or was imminent. This can be seen in the following graphic, from Zero Hedge using Federal Reserve data.
On a year-over-year basis, after growing at a 7% year over year pace at the beginning of 2017, the latest bank loan update from the Fed showed that the annual rate of increase in C&I loans is down to just 1.6%–its lowest since 2011. Should the rate of loan growth deceleration persist, in roughly four to six weeks the U.S. would post its first year-over-year loan contraction since the financial crisis. This graphic illustrates how steep the decline has been.
(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 8.00 from the prior week’s 8.50, while the average ranking of Offensive DIME sectors fell to 16.75 from the prior week’s 14.75. The Defensive SHUT sectors further widened their lead over the Offensive DIME sectors. Note: these are “ranks”, not “scores”, so smaller numbers are higher ranks and larger numbers are lower ranks.
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