The SITREP | For the week ending August 25, 2023
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SITREP: n. a report on the current situation; a military abbreviation, from ‘Situation Report.’
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Sources for items discussed are listed at the bottom of the SITREP, before Figures 1-3.
The very big picture (a historical perspective):
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 further increases in market prices only occur as a general response to earnings increases, instead of rising “just because”). The market was recently above that level and has fallen back.
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 “Roaring Twenties” of the 1920s, and the “Tech Bubble” of the late 1990s – 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 were 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 30.39, up from the prior week’s 30.14. Since 1881, the average annual return for all ten-year periods that began with a CAPE in this range has been slightly positive to slightly negative (see Fig. 2).
Note: We do not use CAPE as an official input into our methods. However, if history is any guide – and history is typically ‘some’ kind of guide – it’s always good to simply know where we are on the historic continuum, where that may lead, and what sort of expectations one may wish to hold in order to craft an investment strategy that works in any market ‘season’ … whether the current one, or one that may be ‘coming soon’!
The big picture:
As a reading of our Bull-Bear Indicator for U.S. Equities (comparative measurements over a rolling one-year timeframe), we entered a new Cyclical Bull on April 21, 2023.
The complete picture:
Counting-up of the number of all our indicators that are ‘Up’ for U.S. Equities (see Fig. 3), the current tally is that three of the four are Positive, representing a multitude of timeframes (two that can be solely days/weeks, or months+ at a time; another, a quarter at a time; and lastly, the {typically} years-long reading, that being the Cyclical Bull or Bear status).
In the markets:
U.S. Markets: The major stock benchmarks ended the week mixed as investors reacted to conflicting signals on the economy and the course of monetary policy. Growth stocks outperformed value, while financial stocks pulled back early in the week after S&P Global downgraded its credit ratings of five regional banks. The Dow Jones Industrial Average shed 154 points finishing the week at 34,347, a decline of -0.4%. The technology-heavy NASDAQ Composite rebounded 2.3% after three weeks of losses ending at 13,591. By market cap, the large cap S&P 500 rose 0.8%, the mid cap S&P 400 finished unchanged, and the small cap Russell 2000 retreated -0.3%.
International Markets: The majority of major international indexes finished the week in the green. Canada’s TSX ticked up 0.1%, while the United Kingdom’s FTSE 100 rose 1%. France’s CAC 40 and Germany’s DAX added 0.9% and 0.4% respectively. In Asia, China’s Shanghai Composite declined -2.2%. Japan’s Nikkei finished up 0.6%. As grouped by Morgan Stanley Capital International, developed markets gained 0.6%, while emerging markets rose 1.3%.
Commodities: Precious metals finished the week up with Silver rising 6.6% to $24.23 per ounce and Gold adding 1.2% to $1939.90. The industrial metal copper, viewed by some analysts as a barometer of world economic health due to its wide variety of industrial uses, gained 1.5%. Oil finished down for a second consecutive week. West Texas Intermediate crude oil retreated -1% to $79.83 per barrel.
U.S. Economic News: The number of Americans filing new claims for unemployment benefits fell last week, as labor market conditions remained tight. Initial claims for state unemployment benefits decreased by 10,000 to a seasonally adjusted 230,000 for the week ended Aug. 19, the Labor Department said. Economists had forecast claims to total 240,000. The labor market is continuing to defy expectations in the face of the Fed’s aggressive interest hikes since March 2022, as employers hoard workers after struggling to find labor during the COVID-19 pandemic. Labor market strength and receding inflation are fanning optimism that the economy could avoid a recession. Meanwhile, the number of people receiving benefits after an initial week of aid decreased by 9,000 to 1.702 million. These so-called “continuing claims” remain low by historical standards, indicating that some laid-off workers are experiencing short spells of unemployment.
Higher mortgage rates and a persistent shortage of homes for sale pushed U.S. home sales last month down to a six-month low. Sales of previously owned homes fell by 2.2% to an annual rate of 4.07 million in July, the National Association of Realtors said. The monthly figure missed economists’ forecasts for a reading of 4.15 million. Compared with the same time last year, sales were down by 16.6%. Of note, the median price of an existing home in July was $406,700—up 1.9% from a year ago. Lawrence Yun, Chief Economist at the National Association of Realtors stated, “Two factors are driving current sales activity—inventory availability and mortgage rates.” Housing inventory is at its lowest level since the early 1980’s while the 30-year mortgage rate hovers around 7.5%. Buyers are pulling back and analysts state it’s likely to continue to weigh on home-sales figures for the foreseeable future.
Sales of new homes in the U.S. rose in July as home buyers continued to turn to builders for their housing needs. U.S. new home sales rose 4.4% to an annual rate of 714,000 in July, the Commerce Department reported. The pace of sales in July was the highest since February 2022. The jump exceeded expectations on Wall Street where economists had forecast new home sales to total 703,000. The rise in new home sales was led by a sharp increase in the Midwest. New home sales have been generally trending higher in the past few months as home builders are one of the few players offering inventory to buyers. In the report, the median sales price of a new home sold rose to $436,700 from $415,400 the month prior.
U.S. business activity stalled this month, according to a pair of surveys from S&P Global. S&P Global said its flash U.S. Composite PMI index, which tracks both the manufacturing and service sectors, fell to a reading of 50.4 in August from 52 in July—its biggest drop since November 2022. While August’s reading was the seventh straight month of growth, it was only fractionally above the 50-level separating expansion and contraction. Service sector business activity growth was the slowest since February at 51.0 in August, while the Manufacturing PMI fell deeper into contraction territory at 47.0 down from 49.0 in July, the fourth straight month of contraction. Chris Williamson, chief business economist at S&P Global Market Intelligence wrote, “A near-stalling of business activity in August raises doubts over the strength of U.S. economic growth in the third quarter. The survey shows that the service sector-led acceleration of growth in the second quarter has faded, accompanied by a further fall in factory output.”
Orders for goods expected to last at least three years, so-called ‘durable goods’, fell more than expected indicating a substantial weakening in demand for manufactured goods. Orders for durable goods decreased 5.2% in July from a month earlier to a seasonally adjusted $285.9 billion, the Commerce Department reported. The drop was the steepest since April of 2020, and worse than economists’ forecasts of a -4.1% pullback. On a positive note, the majority of the decline was due to a drop in transportation equipment such as passenger airplanes. New orders for nondefense capital goods excluding aircraft, a closely watched proxy for business investment, actually rose 0.1% on the month to $73.63 billion.
Federal Reserve Chair Jerome Powell gave some indication of how he was interpreting mixed economic signals at his speech before the central bank’s annual symposium in Jackson Hole, Wyoming. Powell acknowledged that higher rates had slowed growth in industrial production and wages, while tightening bank lending standards were also cooling the economy. On the other hand, he noted that economic growth remained above its longer-term trend and that the housing sector appeared to be “picking back up” after slowing sharply over the past year and a half. “As is often the case,” he concluded, “we are navigating by the stars under cloudy skies.”
International Economic News: Canada launched a program to recruit immigrants from Silicon Valley to boost its economy. Canada offered a three-year work permit to those with a U.S. H-1B visa, a common entry permit for immigrants working in the tech sector. The program, aimed partly at workers laid off in Silicon Valley’s recent downturn, drew 10,000 applicants in its first 48 hours — “a strong indication of just how competitive Canada is on the global stage,” a spokesman for the country’s immigration ministry said. Prime Minister Justin Trudeau has increased immigration by over 40% in the last five years, adding 400,000 permanent residents in 2021.
A recent survey forecasts Britain’s economy is at risk of falling into a recession this quarter as a slump in factory output and higher interest rates weighed on its economy. The S&P Global/CIPS composite Purchasing Managers’ Index (PMI) for the United Kingdom dropped from 50.8 to 47.9. “The fight against inflation is carrying a heavy cost in terms of heightened recession risks,” said Chris Williamson, chief business economist at S&P Global Market Intelligence. Services prices grew at their slowest pace since the second quarter of 2021, while manufacturers, who make up 10% of Britain’s economy, reported the steepest drop in output prices since 2016. The manufacturing PMI fell deeper into contraction from 45.3 to 42.5 this month, while the services sector dropped into contraction from 51.5 to 48.7. “The PMIs are unquestionably bad,” said James Smith, an economist at ING.
French Economy and Finance Minister Bruno Le Maire vowed to continue lowering taxes. Le Maire stated France intends to accelerate the reduction of its debt, while at the same time reinforcing its policy to lower taxes for households and businesses. Le Maire said the French state must reduce public spending, confirming that gas and electricity price caps would cease. During a visit to the French Alps, Le Maire said that inflation has started to slow and “we will stick to our fiscal policy.” France remains under pressure to bring finances into balance after social unrest over unpopular pension reforms. Prime Minister Elisabeth Borne said the French government has no plans to make households pay higher taxes, but government sources said other tax hikes were under consideration.
German business activity fell at its fastest rate since May of 2020. The Hamburg Commercial Bank German Flash Composite Purchasing Managers’ Index (PMI) fell deeper into contraction from July’s 48.5 to 44.7, a 39-month low. The survey highlighted a “deepening downturn in manufacturing,” with output falling for the fourth consecutive month. Activity in services fell for the first time in eight months from 52.3 to 47.3—a 9-month low. Business sentiment remains pessimistic amid rising interest rates, customer uncertainty, and high inflation. The negative outlook continues to weigh down demand for goods and services. “Any hope that the service sector might rescue the German economy has evaporated,” said Cyrus de la Rubia, chief economist at Hamburg Commercial Bank. “Instead, the service sector is about to join the recession in manufacturing, which looks to have started in the second quarter.”
China’s central bank has cut one of its key interest rates for the second time in three months as its economy struggles to recover. The People’s Bank of China (PBOC) lowered its one-year prime rate to 3.45% from 3.55%. A property crisis, falling exports, and weak consumer spending have slowed the country’s ability to recover after the pandemic. Official figures showed China’s imports and exports fell sharply last month due to weak global demand. Jun Bei Liu from Tribeca Investment Partners said the move is unlikely to have a major impact but indicates that the Chinese government is committed to reviving the economy. “We will need a bigger stimulus package to boost confidence and in turn drive up consumption and growth. Without it, the economy is risking faltering into deflation which will be harder to revive,” she added. Beijing has stopped releasing youth unemployment figures, which were seen by some as a key indication of the country’s slowdown. “Youth unemployment tends to drive government policy ahead of most things because nobody wants a disaffected group of young workers,” said George Godber, a fund manager at Polar Capital in London.
Japan’s factory activity shrank for the third consecutive month in August. The au Jibun Bank flash Japan manufacturing purchasing managers’ index (PMI) climbed to a seasonally adjusted 49.7 this month from 49.6 in July. The index remained below the 50.0 index point threshold, which is the divide between contraction and expansion. In the manufacturing sector, output and new orders shrank for the third consecutive month in August. Employment remained unchanged. Firms cite high crude oil prices and uncertainty over the global economic outlook as contributing factors to the accelerating input prices. The au Jibun Bank flash services PMI grew to a seasonally adjusted 54.3 this month, the highest level in three months. The bank’s composite PMI, which combines the manufacturing and service sector activity, was up 0.4 point to 52.6 from 52.2 in July.
Finally: Florida and Idaho are the fastest-growing states according to the latest data from the U.S. Census Bureau. As the following graphic from Statista’s Katharina Buchholz shows, their populations increased by 1.9 percent and 1.8 percent, respectively, from July 2021 to June 2022. The two are followed by South Carolina, Texas and South Dakota. While Texas is seeing both a high number of births and high levels of national and international migration, domestic movement of people has been a major factor for Idaho, South Carolina and South Dakota to achieve population growth. In Florida, the state with the largest net birth deficit, immigration to fuel population growth has been even more crucial. While states in the South or West had been attractive to new residents even before the pandemic because of their lower cost of living, lower taxes, and lower priced housing, less severe Covid-19 restrictions have also been recently named as a factor.
(Sources: All index- and returns-data from Norgate Data and Commodity Systems Incorporated; news from 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.)
The Very Big Picture: 123 Years of Secular Bulls and Bears
Figure 1
The Very Big Picture: Historical CAPE Values
Current reading: 30.39
Figure 2
The Current ‘Complete Picture’: The Sum of Positive Indicators.
Figure 3
This information has been prepared by W.E. Sherman and Co, for Kevin Hegedus who is a Portfolio Manager for PWM Private Wealth Counsel with iA Private Wealth and does not necessarily reflect the opinion of iA Private Wealth. The information contained in this newsletter comes from sources we believe reliable, but we cannot guarantee its accuracy or reliability. The opinions expressed are based on an analysis and interpretation dating from the date of publication and are subject to change without notice. Furthermore, they do not constitute an offer or solicitation to buy or sell any of the securities mentioned. The information contained herein may not apply to all types of investors. The Portfolio Managers can open accounts only in the provinces in which they are registered. iA Private Wealth is a trademark and business name under which iA Private Wealth Inc. operates. iA Private Wealth Inc. is a member of the Canadian Investor Protection Fund and the Investment Industry Regulatory Organization of Canada.
