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The January 2021 Situation Report (SitRep)  Thumbnail

The January 2021 Situation Report (SitRep)

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 at that level.

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 34.19, up from the prior week’s 33.71.   Since 1881, the average annual return for all ten-year periods that began with a CAPE in the 30-40 range has been 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 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 remain in Cyclical Bull territory.

 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 four of 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. MarketsThe major indexes hit all-time highs but ended the week mixed, with small and mid caps recording losses.  The Dow Jones Industrial Average added 407 points to finish the week at 30,606—a gain of 1.3%.  The technology-heavy NASDAQ Composite rose for a third consecutive week, up 0.7%.  By market cap, the large cap S&P 500 added 1.4%, while the mid cap S&P 400 and small cap Russell 2000 retreated -0.4% and -1.5%, respectively

International MarketsInternational markets were also mixed.  Canada’s TSX and the United Kingdom’s FTSE 100 retreated -1.1% and -0.6%, respectively, but the rest of the major international markets finished to the upside.   France’s CAC 40 rose 0.5%, while Germany’s DAX added 1.0%.  Markets were particularly strong in Asia where China’s Shanghai Composite surged 3.3% and Japan’s Nikkei rallied 2.9%.  As grouped by Morgan Stanley Capital International, developed markets tacked on 0.8% while emerging markets gained 3.1%.

CommoditiesPrecious metals retraced last week’s decline rising 0.6% to $1895.10 per ounce while Silver rose 1.95% ending the week at $26.41.  Crude oil continued to consolidate around the $50/barrel-level.  West Texas Intermediate crude finished the week up 0.6% at $48.52 per barrel.  The industrial metal copper, viewed by analysts as a barometer of world economic health due to its wide variety of uses, ended the week down a second consecutive week giving up -1.2%.

December Summary:  For the month of December, the Dow rose 3.3%, the NASDAQ added 5.6% and the S&P 500 rose 3.7%.  Mid caps and small caps outpaced large caps, and rose 6.4% and 8.5% respectively. December was also a good month for international markets, with all major markets finishing in the green.  Canada and the United Kingdom rose 1.4% and 3.1%, while France added 0.6% and Germany gained 3.2%.  China rose 2.4% and Japan gained 3.8%.  Developed markets rallied a respectable 5.0% and emerging markets surged an even larger 7.1%.  Gold and Silver rose 6.4% and 16.9%, respectively, while Oil added 7.0% and Copper gained 2.4%.

4th Quarter Summary: In the fourth quarter, the Dow added 10.2%, the NASDAQ rose 15.4%, and large caps gained 11.7%.  Mid caps and small caps gained at a torrid pace, adding 23.9% and 31.0%.  Canada added 8.1%, the UK gained 10.1%, and France and Germany rose 15.6% and 7.5%, respectively.  China rose 7.9% and Japan gained 18.4%.  Developed markets rose 14.7% while emerging markets added 17.9%. Gold was essentially unchanged on the quarter, but Silver gained a solid 12.4%.  Oil and Copper were also strong in the quarter, surging 20.6% and 16.0%, respectively.

2020 Summary:  The Dow gained 7.2% for the year, and the S&P 500 recorded a 16.3% gain.  The big story in the U.S. was the NASDAQ Composite, which surged a whopping 43.6%.   The S&P 500 recorded a 16.3% gain, while mid caps added 11.8% and small caps rallied 18.4%.  Smalls and mids overcame a year-to-date deficit by rallying strongly in the closing weeks of the year.  Canada rose 2.2%, while European markets were mixed for the year.   The United Kingdom fell ‑14.3%, France declined -7.1% and Germany added 3.5%.  In Asian markets, double-digit gains were common, with China rallying 13.9% and Japan rising 16.0%.  As grouped by Morgan Stanley Capital International, developed markets rose 7.6% while emerging markets more than doubled developed markets by jumping 17.0%.   For commodities, 2020 was a pretty solid year overall with most sporting double-digit gains.  Gold and Silver rallied 24.4% and 47.4%, respectively.   Copper recorded a 25.8% gain.  But Oil went the other way, finishing the year down -20.5% as the coronavirus pandemic brought world travel to a standstill for much of the year.

U.S. Economic NewsThe number of Americans filing for first-time unemployment benefits fell last week.  The Labor Department reported initial jobless claims declined by 19,000 to 787,000.   Economists had expected claims to rise to 828,000.  The number of people receiving benefits across all unemployment programs dropped to 19.6 million, a reduction of 800,000.  However, the four-week moving average of claims, smoothed to iron-out the weekly volatility, rose by 17,750 to 836,750.  Analysts noted that the slow roll-out of the vaccine and the resurgence in cases continues to weigh on the economy.  John Ryding, economic advisor at Brean Capital stated, “There is no real improvement in the data.”  

Home prices surged across the nation as more people fled the cities for the suburbs, a recent survey showed.  The S&P CoreLogic Case-Shiller 20 large city home price index rose at a 7.9% annual pace in October—its fastest rate in six years.  That’s up 1.3% from the prior month.  A broader measure by Case-Shiller that covers the entire country, meanwhile, showed an even larger 8.4% increase in home prices over the past year.  That’s also up sharply from 7.0% in the prior month.  Prices have risen at the fastest clip since 2014 owing to record-low mortgage rates and a sharp rise in the number of people heading for the suburbs.  A small supply of homes for sale has also been a contributing factor.  The biggest yearly increases in home prices took place in Phoenix (12.7%), Seattle (11.7%) and San Diego (11.6%).  The smallest increases occurred in New York (6.0%), Chicago (6.3%) and Las Vegas (6.4%).

An indicator of future home sales fell for a third consecutive month in November, data from the National Association of Realtors (NAR) showed.  The NAR’s index of pending home sales, in which a contract has been signed but has not yet closed, dropped 2.6% in November.  Still, compared to last year, pending sales are up more than 16%.  Declines were seen across all major regions with the largest decrease occurring in the West.  The Northeast was next, followed by the Midwest and South.  The pending home sales index is the latest report to illustrate the difficulties home buyers are encountering in the housing market these days.  Lawrence Yun, the NAR chief economist, said in the report, “The market is incredibly swift this winter with the listed homes going under contract on average at less than a month due to a backlog of buyers wanting to take advantage of record-low mortgage rates.”

A measure of business conditions in the Chicago region rose in December, bucking a trend in other parts of the country where growth slowed amid the resurgence in coronavirus cases.   The Institute for Supply Management (ISM) reported its Purchasing Managers’ Index for Chicago edged up 1.3 points to 59.5—its first increase in three months.  Readings above 50 indicate an expanding economy.  The subindexes that measure employment and production both improved, but growth in new orders slipped.  Most companies stated they were holding off on spending plans for the new year until the effectiveness of the coronavirus vaccine is known.

International Economic News: After a tumultuous 2020, one expert says Canada’s economy can expect improvements in 2021.  Ian Lee, associate professor at Carleton University’s Sprott School of Business remarked, “I actually think the economy is going to do very well in 2021.  Not spectacularly, but much better than in 2020."  Lee attributed his view in part to Canadians’ savings rate in 2020 which he said has “gone through the roof.”  Statistics Canada reports that after the first quarter of 2020, Canadians saved an average of 7.6 per cent of disposable income.  But by the second quarter Canadians were saving 28.2%--a dramatic increase from the 3.1% they were saving at the same time the year before.

Across the Atlantic, Britain left the European Union’s trading bloc at 11pm London time on New Year’s Eve - arguably the biggest single economic change the country has experienced since World War II.  British Prime Minister Boris Johnson called it “an amazing moment for this country.”  The historic moment passed quietly, with U.K. lockdown measures against the coronavirus curtailing mass gatherings to celebrate - or protest.  Brexit, which had dominated public debate in Britain for years, was even pushed off some newspaper front pages by news of the huge vaccination effort against COVID-19, which is once again surging across the country.

On Europe’s mainland, the European Union and China agreed this week to an investment deal that will give European companies greater access to Chinese markets and help address what Europe sees as unbalanced economic ties.   As part of the deal, European firms will gain permission to operate in China in sectors including electric cars, private hospitals, real estate, advertising, the maritime industry, telecom cloud services, airline reservation systems and ground handling.  In return, China will ban the forced transfer of technology from foreign companies, and has pledged to be more transparent on subsidies and bar state-owned enterprises from discriminating against foreign investors.  The deal brings Europe a degree of parity with the United States, which has struck a "Phase I" trade deal with China containing many similar provisions.

German Chancellor Angela Merkel’s New Year’s speeches have typically touched on broad themes like immigration and climate change; however Ms. Merkel’s speech this year - her 16th as Chancellor - was noticeably different.  For what was almost certainly her last New Year’s Eve speech as Germany’s leader, she focused on a single topic—the coronavirus.  “The coronavirus pandemic was and is a once-in-a-century political, social and economic challenge,” Ms. Merkel said in the annual prerecorded televised speech.  The pandemic has killed more than 33,000 people in Germany and sickened hundreds of thousands more.  In her speech, Ms. Merkel made clear that the pandemic upended issues that she had hoped would have been her legacy such as climate change, digital transformation, and a robust social state.

In Asia, China was the first – and perhaps only - major economy to register positive economic growth in 2020 with its gross domestic product expected to exceed 100 trillion yuan ($14 trillion USD) for the year.   The International Monetary Fund had forecast in October that China, the world’s second-largest economy, would grow 1.9% in 2020, a sharp slowdown from its 6.1% gain in 2019, and then expand 8.2% in 2021.  That compares with an IMF forecast for a global economic contraction of 4.4% for 2020, the worst plunge since the Great Depression of the 1930s.  President Xi said in his New Year address that China had made major progress in developing its economy and eradicating rural poverty over the past year, despite the coronavirus pandemic.

Japanese business leaders pledged to revive their country’s economy through digital and sustainable innovation.  In its New Year’s message, Chairman of the Japan Business Federation Hiroaki Nakanishi noted the importance of both the public and private sectors to jointly make all-out efforts to stem further virus infections and revive the economy.  In order to make 2021 "the year of revival from the pandemic," Nakanishi said the key is digital transformation and deregulation in many sectors such as the administrative, medical and education systems in Japan.   Furthermore, he pledged his organization will proactively move toward greener policies led by Prime Minister Yoshihide Suga, who has said Japan will aim to achieve carbon neutrality (net zero emissions of carbon dioxide) by 2050.   "We need to refresh the current energy and electric power systems, and constantly create innovation," Nakanishi said.

Finally:  Have the lights in your neighborhood been dimming from time to time recently?  Maybe you’ve got a bitcoin “miner” next door!  A bitcoin miner is one who produces a new bitcoin by applying immense computing power – requiring immense amounts of electricity - to the algorithms and formulas necessary to properly produce the digital entity that is bitcoin.   The miner is then rewarded with…bitcoins.  The University of Cambridge’s Centre for Alternative Finance keeps track of just how much energy the Bitcoin network of miners consumes.  While the exact amount cannot be known due to the wide variety of equipment employed in bitcoin mining, the Centre says that an educated guess can be produced by tracking the total number of hashes (a building block of bitcoin) produced by the miners and estimating the efficiency of the equipment employed in the production. By this estimation, bitcoin mining activity’s power consumption is staggering - about 92.8 terawatt hours annualized.  This is more than the entire nation of Pakistan’s power consumption in 2016, and is heading toward the annual power consumption of the Netherlands!  Interestingly, two-thirds of bitcoin mining takes place in China, where most electricity is produced by coal-burning power plants – so although the currency might be virtual, its negative effect on the production of greenhouse gases is most certainly very real.  (chart from the Cambridge Centre for Alternative Finance)












 (Sources:  All index- and returns-data from Yahoo Finance; 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, CNBC, FactSet.) 





The Very Big Picture: 120 Years of Secular Bulls and Bears
















Figure 1







The Very Big Picture: Historical CAPE Values

Current reading: 34.19










Figure 2












The Current ‘Complete Picture’: The Sum of Positive Indicators.

 (Graphics for use on either light or dark email or website backgrounds.)