7-2-2018 Market Update

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 32.30, down from the prior week’s 32.74, and 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 67.98, down from the prior week’s 71.68.




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 22, down from the prior week’s 26.  Separately, the Intermediate-term Quarterly Trend Indicator – based on domestic and international stock trend status at the start of each quarter – was positive entering July, indicating positive prospects for equities in the third quarter of 2018.



Timeframe summary:

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 positive for Q3, 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:

U.S. Markets:  Stocks closed lower for the week as the tech-heavy NASDAQ Composite and smaller-cap indexes reversed their prior-week outperformance.  The Dow Jones Industrial Average lost 309 points on the week closing at 24,271, a decline of 1.3%.  The NASDAQ Composite retreated -2.4% closing at 7,510.  By market cap, the large cap S&P 500 finished down -1.3%, while the mid cap S&P 400 and small cap Russell 2000 were off -1.9% and ‑2.5%, respectively.


International Markets:  Canada’s TSX retraced all of last week’s gain falling -1%.  Across the Atlantic, the United Kingdom’s FTSE retreated -0.6%, while on Europe’s mainland it was a sea of red.  France’s CAC 40 ended down ‑1.2%, Germany’s DAX was off -2.2%, and Italy’s Milan FTSE finished down -1.2%.  It was a similar story in Asia.  China’s Shanghai Composite fell an additional -1.5%, its’ sixth consecutive down week.  Japan’s Nikkei 225 retreated -0.9%.  As grouped by Morgan Stanley Capital International, developed markets were off -1.2%, while emerging markets finished down -1.3%.


Commodities:  Precious metals, traditionally thought of as a safe-haven in times of market distress, failed to live up to their expectations with Gold falling -1.3% last week closing at $1254.50, while Silver gave up -1.6% ending the week at $16.20.  Energy, as measured by the price of West Texas Intermediate crude oil, surged over 8% last week finishing the week at $74.15 per barrel.  Copper, seen by some analysts as an indicator of world economic health due to its variety of industrial uses, retreated a third week in a row, down -2.0%.


June Summary:  In the U.S., modest gains and losses were the rule for June.  The Dow Jones Industrial Average fell -0.6%, while the NASDAQ Composite was up 0.9%.  The large cap S&P 500 added 0.5%, the mid cap S&P 400 rose 0.3% and the small cap Russell 2000 gained 0.6%.  For the month of June, Canada’s TSX finished up 1.3%.  Outside the U.S., results were almost all negative.  In Europe, the UK’s FTSE was off -0.5%, France’s CAC 40 fell -1.4%, Germany’s DAX lost -2.4%, and Italy’s Milan FTSE fell -0.7%.  In Asia, China’s Shanghai Composite plunged -8% while Japan’s Nikkei was the sole major-market winner, adding 0.5%.  Developed markets finished the month of June down -1.6% while emerging markets were off -4.5%.  Gold provided no safe haven, retreating -3.4% and silver was off -1.5%, but oil added a healthy 12.7%.  Copper finished the month down -4.2%.


Q2 Summary:  Despite June’s lackluster results, the second quarter was positive for most U.S. indices.  The Dow Jones Industrial Average rose 0.7% and the NASDAQ Composite gained 6.3%.  The large cap S&P 500 added 2.9%, the mid cap S&P 400 rose 3.9%, and the small cap Russell 2000 surged 7.4%.  Canada’s TSX rose 5.9%, the UK’s FTSE added 8.2%, France’s CAC 40 rose 3%, Germany’s DAX gained 1.7%, while Italy’s Milan FTSE retreated ‑3.5%.  China’s Shanghai Composite dropped a steep -10.1% while Japan’s Nikkei 225 rose 4%.  Emerging markets overall lost -9.7% while developed markets were off -2.0%.  For the quarter, Gold retreated ‑6.1%, while silver was off just -1.0%.  Oil was the big winner for the quarter, surging 19.5% while copper lost -2.9%.


U.S. Economic News:  The number of applications for new unemployment benefits rose for the first time in a month last week, according to the Labor Department.  Initial jobless claims climbed by 9,000 to 227,000 in the week ended June 23.  The reading exceeded economists’ forecasts of 220,000 new claims.  Despite the slight increase, initial claims remain near their lowest level in almost fifty years.  The more stable monthly average of new claims rose by a lesser 1,000 to 222,000.  Companies continue to report difficulty in finding qualified labor.  Continuing claims, which counts the number of people already receiving unemployment benefits fell by 21,000 to 1.71 million.  That number is reported with a one-week delay.


Sales of new homes rebounded last month as healthy demand lifted sales 8.8% higher than in the same year-to-date period last year.  The Commerce Department reported new home sales ran at a seasonally-adjusted annual rate of 689,000 in May.  Consensus forecasts were for a selling pace of just 668,000.  The median sales price of a new home in May was $313,000.  At the current sales rate, there is a 5.2 months’ supply of homes on the market, down slightly from April.  The biggest challenge for the housing market continues to be the lack of supply in the market.  Stephen Stanley, chief economist for Amherst Pierpont Securities noted that the average sales pace for 2017 was 613,000 per month, and that “it appears that a gentle uptrend remains in place.”


Prices of homes are also on the rise.  The S&P/Case-Shiller national index rose a seasonally-adjusted 0.3% in April and is up 6.4% for the year.  The more narrowly-focused 20-city index rose a seasonally-adjusted 0.2% and is up 6.6% compared to a year ago.  While April’s pace of growth is still robust, with home prices exceeding inflation and wage growth, both the national index and 20-city index were down one tick from March’s reading.  In April, three cities saw double-digit annual gains— the usual suspects: Seattle, San Francisco, and Las Vegas.  As of the latest reading, 10 out of the 20 cities tracked were higher than their peaks reached in 2006.  In its release, S&P Dow Jones Indices, the producer of the indexes, noted that Las Vegas is “the city with the longest road to a new high.”  Adjusted for inflation, Vegas is still 47% lower than its bubble-era peak, despite being one of the hottest markets for several recent months.  The only metro area to show a monthly decline in April was New York, where recent tax law changes and a glut of new apartment supply may be weighing on housing.


The National Association of Realtors (NAR) index of pending home sales declined 0.5% to a four-month low of 105.9 in May.  The index tracks real-estate transactions in which a contract has been signed but the transaction has not yet closed.  The reading missed the Econoday forecast of a 0.6% increase and is down 2.2% from the same time last year.  This decline marks the fifth straight month of negative year-over-year readings.  The NAR’s Chief Economist Lawrence Yun noted the story in the housing market continues to be about supply, not demand.  “Realtors in most of the country continue to describe their markets as highly competitive and fast moving, but without enough new and existing inventory for sale, activity has essentially stalled.”


Overall growth in the U.S. economy remains strong, just not as much as originally reported.  In its latest revision, the Commerce Department reported growth in the first quarter was trimmed to 2% from 2.2%, in large part due to lower spending on health care and a somewhat smaller buildup in inventories.  The softer GDP reading in the first quarter is essentially a moot point now that the U.S. economy roared back in the spring with some estimates predicting it will achieve its fastest quarterly growth in 15 years.  Of note, consumer spending, the trendsetter for the broader economy, was revised down a tick to a gain of 0.9%, while nonprofits spent less on healthcare and households spent less on financial advice and insurance.  Business spending, however, was revised upward as fixed investment rose 7.5% instead of the 7.2% previously reported.  Most other figures in the GDP calculations were little changed.


U.S. inflation has finally hit the Federal Reserve’s 2% target – the first time in six years.  The Personal Consumption Expenditures (PCE) index, the Fed’s preferred inflation gauge, rose 0.2%, along with the core rate that strips out the often-volatile food and energy sectors.  The rate of inflation over the past 12 months rose to 2.3%, its fastest pace since March 2012, while the core rate hit 2% – the Fed’s longstanding target.  In addition, the Commerce Department reported consumer spending rose 0.2% in May after a 0.5% gain in April.  Economists had predicted a 0.6% increase.  Economists had expected inflation to hit the Fed’s 2% target but not until later this summer.  Fed Chairman Jerome Powell welcomed the pickup in inflation at his last press conference and said that inflation may rise above the 2% target over the next few months given higher oil prices.  The Fed is picking up the pace of interest-rate hikes – it is now penciling in four increases in total this year, up from the three projected in March.


A measure of nationwide manufacturing activity turned negative in May for the first time since January.  The Chicago Federal Reserve’s index of national activity was reported at -0.15 last month, a significant decline from the upwardly revised 0.42 reading in April.  The Chicago Fed index is a weighted average of 85 economic indicators, designed so that zero represents trend growth and a three-month average below negative 0.70 suggests the country is entering a recession.  Last month, 39 of the individual components made positive contributions, while 46 were negative.  In the details of the report, the production-related indicators, meaning factory activity, weighed a negative 0.29 to the index, down sharply from the positive 0.33 it added in April.  The index’s less-volatile three-month moving average came in at 0.19 in May—also its lowest reading since January.

Orders for good expected to last longer than three years, so-called durable goods, fell in May as demand for autos weakened.  The Commerce Department reported orders for durable goods fell 0.6% in May, following a revised 0.1% decline in April.  The second straight decline in demand appears to be due to the biggest drop in new orders for cars and trucks since 2015.  Stripping out the often-volatile transportation categories of vehicles and aircraft, orders were off just 0.3%.  Orders for autos and parts shrank 4.2% in May, the biggest drop since the first month of 2015.  President Trump has threatened tariffs on Canadian and European cars amid ongoing disputes over free trade.  Overall business investment slowed a bit, but the longer-term trend was still fairly healthy.  So-called core orders, which strip out defense and aircraft, slipped 0.2% in May, but are up 6.8% over the past year.


The nation’s consumers are still very optimistic about the U.S. economy, but a little less so than they were a month ago.  The Conference Board reported its consumer confidence index slid to 126.4 this month from a revised 128.8 in May.  Economists had predicted a reading of 128.  The index is down slightly from its 18-year high of 130 hit earlier this year.  In the details, the present situation index, which measures how the economy is doing “right now” was essentially flat at 161.1, while the expectations index that measures respondents’ views six months into the future declined four points to 103.2.  Lynn Franco, director of economic indicators at the board noted, “While expectations remain high by historical standards, the modest curtailment in optimism suggests that consumers do not foresee the economy gaining much momentum in the months ahead.”


International Economic News:  Stephen Poloz, governor of the Bank of Canada, observed that the twin impacts of an escalating trade fight with the United States and new mortgage rules which tighten standards for borrowers will “figure prominently” in the central bank’s decision to raise interest rates at its next meeting.  The central bank, Poloz said, has been incorporating into its projections the fallout from U.S. steel and aluminum tariffs along with retaliatory measures taken by Canada and others.  In the lead up to his July 11th rate announcement, the bank is also studying incoming individual-level data showing the effect of Canada’s new lending rules on the housing market.  Before U.S. President Donald Trump imposed the tariffs, experts had widely predicted Poloz to raise his trend-setting rate at the upcoming July 11 policy meeting.  Since then, however, there have been growing doubts Poloz will hike at next month’s meeting.


Confidence in the U.K. took a turn for the worse this month as both businesses and consumers became more pessimistic on the economic outlook.  Lloyds Bank reported business optimism dropped to its lowest level of the year, citing Brexit and increasing global trade tensions as particular areas of worry.  In a separate survey, research firm GfK reported its index of British consumer confidence fell 2 points to -9, with Britons declaring themselves “markedly more gloomy and unwilling to make major purchases”.  Client Strategy Director at GfK Joe Staton stated, “Consumers are yet again feeling less upbeat.  Shoppers are holding on to their cash and consumers in general seem set on their path of self-imposed austerity.”

Munich-based research institute Ifo stated bluntly that Germany’s economic boom times are over and Europe’s largest economy is now on the way to a more “normal” growth path.  Ifo economist Klaus Wohlrabe reported the institute’s latest survey showed deterioration in Germany business confidence due to concerns over a global trade war and slowing of the global economy.  Ifo’s business climate index fell to 101.8 in the month of June.  He added that uncertainty among German companies was growing and export expectations had fallen even further.


Italy has delayed an EU leaders’ summit this week until a deal is reached on migration.  Italy, along with Greece, has borne the brunt of the migration of millions of people from North Africa and the Middle East to Europe.  While initially accepting hundreds of thousands of migrants, France has been detaining and returning migrants to Italy in border cities such as Menton and Ventimiglia.  Rome blocked decisions on the economy, security and digital issues in the meeting’s opening session in Brussels as it sought “concrete” help to deal with its influx of asylum-seekers.  “If this time we do not find any willingness from other EU countries, this Council could end without the approval of shared conclusions,” warned Giuseppe Conte, Italy’s prime minister.


As trade tensions continue to rise, China’s manufacturing activity has begun to slow down.  China’s National Bureau of Statistics reported its Purchasing Managers’ Index, a key gauge of factory conditions, declined almost half a point to 51.5 in June, pulling back from the eight-month high set in May and missing economists’ expectations.  Although the number was a setback it still held above the crucial 50-level that separates expansion from contraction.  In a statement, NBS analyst Zhao Qinghe noted, “the manufacturing industry’s fundamentals are on the whole trending positive” and that “manufacturing and demand are expanding at an overall steady pace.”  In the details, even though large firms continued to expand in June, small and medium-sized businesses were experiencing contraction, and both groups dropped below the 50 mark.


In an ominous warning, Japan’s government stated this week that higher U.S. tariffs on auto imports could backfire, jeopardizing hundreds of thousands of American jobs created by Japanese auto-related companies, raise prices for U.S. consumers, and “devastate” the U.S. and global economy.  In a position paper submitted to the U.S. Department of Commerce by Japan’s Trade Ministry, Japan noted any trade restrictions, if imposed, would increase costs for U.S. consumers and “could seriously affect” U.S. jobs.  In addition, it stated U.S. automakers would lose competitiveness and export markets for U.S. vehicles would shrink undermining the entire U.S. economy.  A recent study by the Peterson Institute for International Economics warned up to 624,000 people could lose their jobs in the U.S. if a 25% tariff were levied on automobiles and auto parts followed by other countries imposing retaliatory measures.


(sources: all index return data from Yahoo Finance; Reuters, Barron’s, Wall St Journal,,,,,,,, Eurostat, Statistics Canada, Yahoo! Finance,,,, BBC,,,, FactSet; Figs 1-5 source W E Sherman & Co, LLC)


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