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NOTE: Areas with blue text show the most recent market updates since the February Capital Highlights email.
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 manias. See Fig. 1 for the 100-year view of Secular Bulls and Bears.
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 29.36, little from prior week’s 29.34, and only a little lower than 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 74.28, up from the prior week’s 72.17.
In the intermediate and Shorter-term picture:
The Intermediate (weeks to months) Indicator (see Fig. 4) turned positiveon November 10th. The indicator ended the week at 33, 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 January, indicating positive prospects for equities in the first quarter of 2017.
Timeframe summary:
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. The Quarterly Trend Indicator (months to quarters) is positive for Q1, and the Intermediate (weeks to months) timeframe (Fig. 4) is negative. Therefore, with two of three indicators positive, the U.S. equity markets are rated as Positive.
In the markets:
The major U.S. indexes ended flat to modestly higher, mostly on the back of an impressive rally on Wednesday. The Dow Jones Industrial Average performed the best for the week, adding +183.95 points to close at 21,005. The technology-heavy NASDAQ Composite rose +0.44% to end the week at 5870. By market cap, large caps edged smaller caps. The LargeCap S&P 500 logged its fifth straight weekly gain, rising +0.67%, while the S&P 400 MidCap index added only +0.16%, and the SmallCap Russell 2000 trailed the others by ending the week down -0.03%.
In international markets, Canada’s TSX rebounded from last week’s weakness by rising +0.48%. Across the Atlantic, the United Kingdom’s FTSE surged +1.8% to an all-time high. On Europe’s mainland, major markets logged a very positive week. France’s CAC 40 jumped +3.09%, Germany’s DAX gained +1.89%, and Italy’s Milan FTSE surged +5.74%. In Asia, China’s Shanghai Composite index slumped -1.08%, while Japan’s Nikkei was up +0.96%. As defined by Morgan Stanley Capital International, emerging markets as a group ended down -0.8%, while developed markets as a group rose +0.9%.
In commodities, precious metals gave up their luster from the past few weeks. Gold fell for the first time in 5 weeks, falling -2.53% to $1,226.50 an ounce. Likewise, Silver gave up its gains of the last few weeks by falling ‑3.62% to $17.74 an ounce. The industrial metal copper remained essentially flat, rising just +0.02%. Oil continued trading in a narrow $52-$55 range, falling -1.22% to $53.33 a barrel for West Texas Intermediate crude oil.
In U.S. economic news, the number of Americans who applied for unemployment benefits last week fell by 19,000 to just 223,000—a new post-recession low. The low number of jobless claims reflects the strength of the U.S. labor market. New claims have been under the key 300,000 threshold that analysts use to define a healthy job market for 104 straight weeks, according to the Labor Department. The less-volatile smoothed four-week average of initial claims dropped by -6,250 to 234,250. That number is at its lowest level since April of 1973. Companies continue to report difficulty finding skilled workers to hire.
The National Association of Realtors (NAR) reported that its gauge of pending home sales fell in January as the market felt the weight of insufficient inventory and rising prices. The NAR’s index fell ‑2.8% to 106.4—its lowest level in a year. The index forecasts future sales by tracking real estate transactions in which a contract has been signed, but the deal has not yet closed. Housing markets were mixed by region. The Northeast and South saw gains of +2.3% and +0.4%, respectively, while in the Midwest and West, the index plunged ‑5% and ‑9.8%, respectively.
Home prices surged higher in December. The S&P/Case-Shiller 20-city index rose +5.6% in the three-month period ending in December, compared to a year ago. The broader national index was up +5.8% for the year in December, the biggest increase in two and half years. In the S&P/Case-Shiller report, the hottest markets were once again in the West: Seattle, Portland, and Denver saw home price increases of +10.8%, +10%, and +8.9%, respectively. The national price index is now +0.5% higher than its previous peak in July 2006, while the 20-city index is still 6.7% lower.
Manufacturing in the Chicago area surged higher last month. The Chicago Purchasing Managers Index (PMI) for February rose +7.1 points to 57.4 in February, its highest reading in more than 2 years. It was the indicator’s biggest single month gain since early 2016. The new orders PMI component jumped by +10.1 points, while the production gauge rose to a 13-month high. In addition, the prices-paid PMI component gained +7.2 points to 68.6—its highest level in two and half years. Commenting on the report, Shaily Mittal, senior economist at MNI Indicators, stated “With inflationary pressures on the rise and the job market having improved, the next rate hike could come soon, possibly in the coming quarter.”
The Institute for Supply Management (ISM) reported its national manufacturing index rose +1.5% to 57.5 in January, to its highest reading since August 2014. According to the report, 17 out of the 18 industries tracked showed growth. Textile mills and apparel, leather and allied products led industry growth, while furniture and related products were the only laggards. Looking at the individual components, the new-orders index rose +4.7 points to 65.1, while the production index added +1.5 point to 62.9. As with the PMI reports, ISM reports use a scale in which readings above 50 indicate expansion.
Business investment got off to a weak start at the beginning of the year, according to one closely-watched measure from the Commerce Department. The Commerce Department reported that orders for durable goods rose +1.8% in January, but the gain was due to a spike in orders for commercial and military aircraft. Non-defense capital goods orders excluding aircraft - or “core” capital goods orders - dropped -0.4% in January. Some analysts view the weakness as a sign that businesses are awaiting new policies by the Trump administration before acting; but most aren’t sounding the alarm just yet. Stephen Stanley, chief economist at Amherst Pierpont Securities stated, “My view on business investment remains that there is a good deal of pent-up energy that had been held back by an adverse and uncertain policy environment.”
The service side of the economy that employs the vast majority of Americans expanded last month at its fastest rate in over a year. The Institute for Supply Management’s (ISM) non-manufacturing index rose to 57.6 in February, up +1.1% from January. Sixteen of the eighteen sectors tracked by ISM expanded last month, the highest number since the middle of 2014, according to the survey. In the details of the report, the business activity index rose +3.3 points to 63.6, while the new orders index added +2.6 points to 61.2. Anthony Nieves, chair of ISM said, “Respondents' comments continue to be mixed, with some uncertainty; however, the majority indicate a positive outlook on business conditions and the overall economy.”
Consumers are the most confident in the U.S. economy in over 15 years, supported by the strongest job market since 2007 and a surging stock market. The Conference Board reported that its survey of consumer confidence rose to 114.8 in February, up +3.2 points from January. The robust job market has lifted the spirits of consumers—the share of respondents who said jobs were “hard to get” fell to an eight-year low of just 20.3%. Millions of Americans have found new jobs since 2010, bringing the unemployment rate down to below 5% and forcing companies to increase wages and benefits. Analysts note that the rise in consumer confidence is particularly notable given the bitter and divisive presidential election. President Trump has promised tax cuts, reductions in regulations, and increased spending for public works. The measure that asks respondents of their expectations for the next 6 months increased +3.1 points to 102.4. Lynn Franco, director of economic indicators at the board remarked, “Overall, consumers expect the economy to continue expanding in the months ahead.”
GDP remained at 1.9% in the fourth quarter of last year—weighed down by a larger trade deficit that offset a surge in consumer-spending. Data from the Commerce Department showed that consumer spending increased +3% in the fourth quarter, 0.5% more than initially reported. Yet the increase was offset by smaller increases in business investment and state and local government spending. As a result GDP was unchanged from its original estimate. In the details of the report, a large portion of the upward revision was due to higher spending on new cars and trucks, which bode well for the economy. Automobile sales typically improve as the economy strengthens. However, the bulk of the increase was due to spending on health care. The rising cost of health care coverage continues to eat into the budgets of U.S. households.
The higher cost of gasoline and other products pushed the level of inflation to its highest level since 2012. The Federal Reserve’s preferred inflation measure, known as the Personal Consumption Expenditures (PCE) price index jumped +0.4% in January. The index is up +1.9% over the last 12 months, matching its highest year-over-year level since October 2012. The rate of inflation is now close to the Fed’s 2% long-term target. A move higher could push the central bank to raise interest rates more aggressively. The rise in inflation over the last year has been mostly correlated with the increase in the cost of oil; however other staples such as healthcare and the cost of rents have also increased. The Core PCE index that strips out the cost of food and energy has been more stable. That index was up +0.3% in January, and has remained between 1.6% and 1.7% over the last 13 months.
In a speech Friday, Federal Reserve Chairwoman Janet Yellen stated that an interest-rate hike at the next policy meeting in less than two weeks is “likely”. In a speech to the Executives’ Club of Chicago, Yellen stated, “At our meeting later this month, the Federal Open Market Committee will evaluate whether employment and inflation are continuing to evolve in line with our expectations, in which case a further adjustment of the Federal funds rate would likely be appropriate.” Yellen’s remarks followed similar comments from other Fed officials. Most notably, New York Fed President William Dudley said on Tuesday that the case for an interest rate increase for March had become a “lot more compelling”. Todd Lowenstein, head of research at HighMark Capital Management remarked, “The market views this as normalization, not a tightening, and as a consequence it will not derail the economy.”
In international news, the Canadian economy gained momentum in the fourth quarter of last year, rising at a +2.6% annualized rate, according to Statistics Canada. In the report, the single biggest driver of GDP growth was the increase of +0.6% in household consumption. But business investment fell for its ninth consecutive quarter, falling -2.1%. The final number was a retreat from the 3.8% annualized rate set the third quarter, following the rebound in the energy industry after the Fort McMurray wildfires. Brian DePratto, senior economist with TD Economics released a note to clients stating “Canadians opened their wallets both at stores and construction offices, delivering a solid fourth-quarter economic performance.”
In the United Kingdom, British Prime Minister Theresa May said there was economic case for breaking up the United Kingdom following remarks by Scottish nationalists pushing for independence. Since last year’s Brexit vote, Scottish National Party leader Nicola Sturgeon has repeatedly said she could push for a new independence referendum if the country is forced into a clean break with the bloc. May told her Conservative Party’s Scottish conference, “The economic case for the union has never been stronger. There is no economic case for breaking up the United Kingdom, or of loosening the ties which bind us together."
In France, presidential candidate Marine Le Pen laid out a plan envisioning the “protective hand of the state” to guide a reordered economy that punishes companies that fail to serve the interests of the country and rewards those that put France first. In a speech, Le Pen laid out her policies based on “economic patriotism” that would be enacted if she wins the two-round presidential election. The plan includes a tax of 35% for French companies that produce their goods elsewhere and then reimport them. Companies that manufacture products in France would be compensated. She said, “No country has ever succeeded in building its industry without protecting it.”
In Germany, a new report has shown the poverty rate is breaking new records in Germany, even as GDP continues to grow. Several of Germany’s major charities have called for a “rigorous change of course” in the government’s tax and finance policies to fight growing poverty. The poverty rate reached a new record level of 15.7% in 2015, according to a report entitled “Human dignity is a human right” by an alliance of organizations called the Paritatische Gesamtverband. While the charities are calling for better redistribution of wealth, some economists say factors like immigration are likely playing a large role.
China is working on various infrastructure projects around the world in an ambitious desire to be the world’s next economic superpower, at the same time that President Trump is turning his back on globalization. This year, a 300-mile railway will begin transporting people through Kenya from the capital Nairobi to one of East Africa’s largest ports, Mombasa. The formerly 12-hour trip will now take only 4 hours, and it is hoped the train will lead to an economic and tourism revival in the region. China Road and Bridge, a state-owned enterprise, leads the construction of the $13.8 billion project. Trump’s pivot to economic nationalism and disdain of multilateral trade deals creates an opportunity for China, says Louis Kuijs, head of Asia Economics at Oxford Economics, who states, “As the U.S. becomes more insular in economic philosophy, I think it gives China one more reason to say, ‘We are still interested, and we want to continue globalization.’ ”
In Japan, factory output unexpectedly fell -0.8% in January, its first decline in 6 months and the latest in a series of economic concerns for the world’s number three economy. The figure missed economists’ expectations of a +0.4% expansion and came a week after Japan registered its first trade deficit in almost six months. Taro Saito, director of economic research at the NLI Research Institute said, “This is a reminder to be cautious for those who have been upbeat on Japan’s economy.” Although production of electronics expanded the first month of the year, it was offset by a decline in vehicle production.
Finally, here’s a cautionary tale that should remind us that “nothing is forever”. Everyone knows that one of the original smartphone pioneers was Blackberry. In fact, for some time, it was the dominant smartphone. Back in 2011, Blackberry’s handset sales peaked at over 52 million units. But as iPhone and Android sales gained ground, Blackberry’s share of the market slid precipitously. The reasons are myriad, but in short Blackberry devices were surpassed by the hardware and most importantly the apps and software available for the Apple iPhone and Google Android devices. Despite numerous attempts featuring new hardware and software, Blackberry has never been able to regain even a shadow of its former glory. In the final quarter of last year, Blackberry hit a terrible milestone by recording a 0.0% (rounded) market share of the smartphone market, according to research firm Gartner. The chart below, from Gartner and tech research firm Recode, illustrates the steep decline to effectively zero.
(sources: all index return data from Yahoo Finance; Reuters, Barron’s, Wall St Journal, Bloomberg.com, ft.com, guggenheimpartners.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 sharply to 16.75 from 21.75, while the average ranking of Offensive DIME sectors slipped to 17.50 from the prior week's 16.75. The Defensive SHUT have overtaken and now lead Ofensive DIME sectors. Note: these are “ranks”, not “scores”, so smaller numbers are higher ranks and larger numbers are lower ranks.
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