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The SITREP for the week ending 3/17/2017
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SITREP: n. a report on the current situation; a military abbreviation; from "situation report".
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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
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 29.30, little changed from the prior week’s 29.23, and now exceeds the level reached at the precrash 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 73.17 little changed from the prior week’s
73.04.
In the intermediate and Shorter-term picture:
The Shorter-term (weeks to months) Indicator (see Fig. 4) turned positive on November 10th. The indicator
ended the week at 28, down from the prior week’s 30. 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. 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 positive. Therefore, with all three indicators positive, the
U.S. equity markets are rated as Positive.
In the markets:
Most major U.S. and global stock markets ended the week on an upbeat note following this week’s rate hike and
mostly-dovish comments from the Federal Reserve. The Dow Jones Industrial Average tacked on 11 points to
close at 20,914. The tech-heavy Nasdaq Composite rose 0.67% to end the week at 5,901. By market cap, smaller
caps rebounded and outperformed large caps. The S&P 500 large cap index gained 0.24%, while the mid cap S&P
400 and small cap Russell 2000 added 1.18% and 1.92%, respectively.
In international markets, Canada’s TSX retreated a slight -0.1%. Across the Atlantic, the United Kingdom’s FTSE
gained 1.12%. On Europe’s mainland France’s CAC 40 gained 0.72%, along with Germany’s DAX which rose 1.1%.
Italy’s Milan FTSE was up over 2.1% as concerns over the stability of the nation’s banking system continued to
fade. In Asia, major markets were mixed. China’s Shanghai Composite gained 0.77%, while Japan’s Nikkei fell
-0.42%. Hong Kong’s Hang Seng surged 3.15%. As grouped by Morgan Stanley Capital International, emerging
markets as a group rose a very handsome 3.89%, while developed markets as a group gained a respectable but
lesser 1.93%. Both developed and emerging markets are now in the “Above Average – best for new positions”
group shown in the Asset Class Ranking table (Fig. 5).
In commodities, the precious metals group was positive for the first week in three. Gold rebounded 2.4%, to end
the week at $1,230.20 an ounce. Silver was up a similar 2.9%, closing at $17.41 an ounce. Oil rebounded slightly
from last week’s slump by rising 1.69% to $49.31 a barrel for West Texas Intermediate crude oil. The industrial
metal copper, seen by some as an indicator of world economic health, gained 3.72% last week.
In U.S. economic news, the number of Americans who applied for new unemployment benefits fell by 2,000 to
241,000 last week, essentially matching economists’ expectations for 240,000. Initial jobless claims have
remained below the key 300,000 threshold that analysts use to indicate a healthy job market for 106 consecutive
weeks, the second-longest streak since the mid-1960’s.
Construction of new houses in the U.S. climbed 3% to a seasonally-adjusted annualized rate of 1.29 million units
last month - its second-highest level since 2007. The increase beat expectations of 1.26 million units and is an
indication of the continuing demand for new housing amid a steadily growing economy. According to the
Commerce Department, single-family starts were up in the West, Northeast, and Midwest, but fell in the South.
In addition, single-family home building jumped 6.5% to a pace of 872,000 units last month, while multi-family
housing units such as apartments fell 3.7% to 416,000 units.
Among home builders, sentiment surged to a 12-year high following a series of proposals put forth by new
President Donald Trump. The National Association of Home Builders (NAHB) confidence index surged 6 points to
71 to its highest level since summer of 2005. A host of the index’s sub-categories also surged higher. The tracker
of current sales conditions, sales over the coming six months, and prospective buyer traffic all showed strong
gains. In its statement, the NAHB noted member approval for President Trump, including an executive order that
would roll-back a clean-water rule that the NAHB referred to as “burdensome”. However, the NAHB also noted
that rising rates will lead to increased mortgage costs and act as a headwind for future growth. NAHB Chief
Economist Robert Dietz said “While builders are clearly confident, we expect some moderation in the index
moving forward.”
Optimism among small-business owners slipped last month, but remained near long-term highs as owners
remained hopeful that the new president will bring more business-friendly policies. The National Federation of
Independent Business’ (NFIB) small business index fell 0.6 point to 105.3, better than the 0.9 point drop expected
by economists. The stronger economy’s tight labor market continued to hit small businesses particularly hard. In
its release, the NFIB wrote “This is one of the tightest labor markets in the 43-year history of the NFIB survey.”
Nearly one-third of respondents reported having unfilled job openings and 17% reported “finding qualified labor”
was their single most important problem—its highest level in eight years.
Most Americans remain optimistic that the U.S. economy will continue to grow, according to the latest University
of Michigan Consumer Sentiment index. However a sharp divide remained based on the party affiliation of the
respondent. The index of consumer sentiment rose 1.3 points to 97.6 for March. Economists had forecast a
reading of 98. Among Republicans, the March survey showed economic expectations climbing to 122.4, a level
that typically signals a “new era of robust economic growth”. However, among Democrats the survey slumped to
55.3, a number that has usually signaled “that a deep recession or depression is imminent.” As expected,
sentiment among swing voters was roughly in the middle at 88.3. Looking at the present, the index of current
conditions rose 3 points to 114.5, its highest level since 2000. Most respondents said their own finances were in
“very good shape”.
U.S. retailers reported weak sales last month, despite the unseasonably warm weather, according to the
Commerce Department. Sales at retailers nationwide were up a slight 0.1% last month, still an increase but a
sharp slowdown from the prior two months’ gains. The results for last month were dragged down by a 0.2% drop
in auto sales. Auto purchases account for about 20% of total retail spending. Gasoline stations also recorded a
0.6% decline in sales, but perversely that’s viewed as a positive because it’s beneficial to American households.
Ex-auto and gas, retail sales were up a 0.2% pace. Leading the gains were home-and garden centers, internet
retailers, and health and beauty stores. Among the laggards were department stores, along with electronic,
appliance, clothing, and sporting goods stores.
American consumers paid slightly more for goods and services last month according to the Bureau of Labor
Statistics. The Consumer Price Index rose 0.1% in February, meeting analysts’ expectations. Consumer prices
have risen 2.7% over the past year. Excluding the volatile food and energy categories, the so-called “core” prices
increased 0.2%, up 2.2% over the past year. Both measures have now exceeded the Federal Reserve’s stated goal
of a 2% rate of inflation, with several key categories now exceeding that target range. Housing costs are now up
3.5% over the past year, while the cost of medical treatment has climbed 3.4%.
Prices of wholesale goods continued to rise last month, up 0.3% as the cost of services such as financial advice,
legal help, and travel increased. The latest Producer Price Index reading pushed wholesale prices up 2.2% over
the last year, its highest rate since the spring of 2012. Stripping out the volatile food, energy, and retail margin
categories yields the more stable core PPI index. That index, which is of more interest to analysts, also increased
0.3%. Wholesale costs have been steadily rising since last summer, predominantly due to the rebound in energy
prices, while the cost of other commodities and raw materials have continued to climb as well. The move higher
in wholesale prices has been confirmed by other measures of inflation such as the consumer price index and the
personal consumption expenditures index.
This week, the Federal Reserve lifted its key short-term interest rate for the second time in three months, but
remained steadfast in its forecast calling for just two more rate hikes this year. Steady U.S. growth, an improving
labor market, and greater confidence among consumers and businesses gave the central bank the justification for
its quarter point Fed funds rate increase. In announcing the rate hike, Fed Chairwoman Janet Yellen said in a
press conference, “The simple message is: the economy is doing well.” The Fed also noted that the recent uptick
in prices has resulted in inflation moving close to its 2% target, which was another critical component in its
decision. Notes show the vote was 9-1 in favor of a hike, with only the Minneapolis Fed president preferring to
leave rates unchanged.
In Canada, Alberta Finance Minister Joe Ceci outlined a budget for the oil-rich Alberta region stating a pipeline to
the Canadian coast would be the “best way” to sell its energy resources. Alberta is at the center of Canada’s rich
oil and natural gas energy sector. In releasing its budget plans through 2020, the provincial government said the
dual headwinds of low oil prices and devastating wildfires last year meant that the economy is just now starting to
recover. The government estimates that the provincial economy will grow by 2.6% this year. Mr. Ceci said that
while drilling is on the rise and oil prices recover, the provincial economy is not yet “out of the woods”. While
new President Donald Trump supports the Keystone XL oil pipeline, Ceci focused his budget speech on breaking its
landlock for the sake of diversity. "Getting a Canadian pipeline built to a Canadian coast is the best way for our
world-class energy producers to sell our resources at world-class prices," he said.
In Germany, Economy Minister Brigitte Zypries said the EU could sue the US at the World Trade Organization if the
U.S. imposes its planned border tax. The comments came as German Chancellor Angela Merkel planned to meet
with President Donald Trump this week. Republicans in Congress are pushing for a “border adjustment” that
would impose a 35% tax on cars that Germany exports to the United States. Economy Minister Zypries said that
Germany had two possible responses: either adjusting the global tax system to make it conform with such a
border tax, or filing suit against the US at the World Trade Organization. She also said the US would be “shooting
itself in the foot” if it did proceed with high import duties “because they need our machines and plants”.
In Asia, China’s Premier Li Keqiang reassured investors that the world’s second-largest economy is strong and not
at risk of a “hard landing”, while stressing the government’s support for globalization and free trade at a time of
rising protectionism. Li also repeated earlier remarks that China does not want a trade war with the United
States, and urged talks with the American government to find common ground. Li said at the annual meeting of
China’s parliament "We do not want to see any trade war breaking out between the two countries. That would
not make our trade fairer.” While the accuracy of the official government data has been questioned repeatedly,
most analysts agree that economic activity did pick up last year supported by heavy government infrastructure
spending and record bank lending.
The Japanese central bank kept its monetary policy steady in the wake of the U.S. Federal Reserve’s second
interest rate hike in three months, underscoring the diverging policies of the world’s major global central banks.
Economists had not expected any change in the Bank of Japan’s policy settings as rising global protectionist
sentiment and a continuing U.S. rate hike cycle were expected to weigh on the first signs of recovery in the
Japanese economy. The Bank of Japan maintained its -0.1% short-term interest target and pledged to keep its
10-year government bond yields at near zero percent via its aggressive asset purchasing program. It also
maintained its pledge to maintain the rate of its annual increase in Japanese government bond holdings which is
currently 80 trillion yen ($706 billion). In its statement, the BOJ said “Japan’s economy continues to recover
moderately as a trend.”
Finally, this week the Federal Reserve hiked its key short-term interest rate a quarter of a percent – a move that
was widely expected. In her statement, Chairwoman Janet Yellen referred directly to one of the lesser-known
labor market indicators known as “Total Quits” (or referred to by some as the “take this job and shove it
indicator”). According to the latest data, quits surged by 135,000 in January—its biggest monthly increase since
December of 2015. That pushed the total number of Americans quitting their jobs in January to 3.22 million, a
level not seen since 2001. Chairwoman Yellen used the statistic, remarking on its positive meaning to the Fed
“We’re seeing more people who are feeling free to quit their jobs, getting outside offers, looking for other
opportunities.”
(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 noncyclical], "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 12.50 from the prior week’s
14.25, while the average ranking of Offensive DIME sectors fell to 17.25 from the prior week’s 16.00. The
Defensive SHUT sectors widened their lead over the Offensive DIME sectors for the third consecutive week. Note:
these are “ranks”, not “scores”, so smaller numbers are higher ranks and larger numbers are lower ranks
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