Uncertainty over Wednesday's taper decision keep the market gains muted despite a steady creep higher.

Market Statistics

The endless headlines and sound bites over the potential taper decision on Wednesday monopolized all the news that was not focused on the Washington shooter. The consensus of opinions is for a $10 billion cut to the treasury portion of the QE with the mortgage backed securities portion remaining the same.

More than 80% of analysts and economists believe the taper will be announced because of the abundance of taper talk by Fed officials over the last three months. Guy Lebas, with Janney Montgomery Scott, said the "taper is the most telegraphed policy move in history."

At this point having the Fed not taper would be negative for the markets. It would suggest the Fed knows something bad that we don't know.

The Fed will issue its updated economic forecast at 2:PM and it is widely expected to be revised lower for 2013 but 2014 and farther out is likely to be revised higher. Since the Fed has never been right on their forecasts this is an exercise in market management more than accurate guidelines for the quarters ahead.

The Fed is not reducing the QE because the economics have improved to a "sustainable" pace. That has not happened and the economy appears to be slowly declining. The Fed is cutting the QE purchases because Bernanke wants to begin the process before his term ends on January 31st. By starting it now he can manage it for the next four months and hopefully produce a slow glide path to zero. Lastly the cost of QE is outweighing the benefits. Every dollar in purchases will have to eventually be unwound and that is where the devil is in the details. By continuing to purchase $85 billion a month they are compounding their future problems.

The Fed expected the economy to improve in Q3 when they started the taper talk three months ago. When it did not happen they had already positioned the market to accept a QE cut so they have to follow through. How they explain the QE decision with a declining economic projection will be interesting. That dynamic could impact the market more than the actual cut in QE.

Now that the black swan event of a Larry Summers nomination has been cancelled the market expects Bernanke and Yellen to keep the Fed on a steady pace towards removing QE and the extraordinarily low interest rates. The market breathed a huge sigh of relief when Summers "withdrew" from the nomination race. I believe that withdrawal was requested by the president in order to preserve political capital for the coming debt ceiling and budget battles. The president exhausted a lot of capital in the handling of the Syrian situation and he has some tough battles ahead. Since the Summers confirmation process was going to be ugly and definitely not guaranteed the president probably had Summers withdraw so it would not appear the president was backing down from the tidal wave of opposition. On Friday Summers ended his profitable relationship with Citigroup to clear the way for his confirmation process. That is not something he would have done if he knew he was withdrawing from the race on Sunday night.

The economics for Tuesday were mixed again. The NAHB Housing Market Index for September came in at 58 and flat with the lowered August revision. The August number was revised down from 59. The future single family sales component declined from 68 to 62 but the traffic component rose slightly from 46 to 47. The headline number remains at the highest level since November 2005. Rising mortgage rates have slowed the gains in the housing market but it is still operating at a robust level compared to the last four years. Shortages of land and workers are slowing the building rate but that will be positive for prices.


The Consumer Price Index (CPI) rose only +0.1% in August and the smallest increase in three months. Expectations were for a +0.2% increase and analysts thought they were low. The core rate, excluding food and energy, also rose only +0.1%. There is no inflation present in the system and a reason the Fed would want to maintain QE had they not already talked themselves into a box.

The trailing 12 month inflation fell to +1.5% and a three month low. The 12-month core rate gained a tenth to +1.8%. Helping to push the headline number lower was a -0.3% decline in gasoline prices and a sharp drop in natural gas prices. The main driver to the upside was another strong gain in fruits, vegetables, meat, poultry and dairy. Even with those components rising the trailing 12-month food component was up only +1.0%.

The Fed would like to see inflation closer to 2.0% with the upper threshold at 2.5% for changing monetary stimulus. With inflation at +0.1% per month we are closer to a depression than inflation. Inflation actually fell -0.4% and -0.2% in April and March.

The weekly chain store sales snapshot declined -1.6% after gaining +1.5% the prior week. This report is ignored as noise because it can be impacted by regional factors like the floods in Colorado.

The German ZEW sentiment survey rose from 42.0 to 49.6 and the highest level since April 2010 and suggesting the economy is rapidly improving. This bodes well for Angela Merkel winning the election on Sunday and providing continuity in the Eurozone.

The calendar for Wednesday will be all FOMC all day even though the decision at 2:PM and press conference is 2:30. The New Residential Construction at 8:30 will be ignored unless the numbers are well off the estimates.

FedEx (FDX) reports before the bell and estimates are $1.49 but the whisper number is $1.59. They could beat estimates and still be under pressure because the whisper number is so high.

The Philly Fed on Thursday is the last big report for the week. Estimates are for an improvement from 9.3 to 10.1.


In stock news Microsoft (MSFT) made headlines with the announcement of a $40 billion share repurchase plan and a +22% increase in the dividend. Microsoft announced a $40 billion buyback in 2008 and that one is almost completed so they made a big splash with a new program without expiration dates. On the surface that should boost the stock price and it appears shareholder friendly. However, there is a hidden reason for the plan.

Microsoft has purchased $110 billion shares over the last nine years. They are a serial repurchaser because that is one way to increase earnings per share without actually increasing earnings. If they made $2 billion a quarter every quarter for the next decade and bought back 10 million shares per quarter their earnings per share would go up every quarter because there would be fewer shares outstanding. IBM is the grandfather of this program. It is amazing they missed earnings last quarter because they have repurchased $100 billion shares in the last nine years and reduced its share count by one-third. Cisco has purchased $63 billion in shares and reduced the share count by -19%.

This trick is well known and probably why Microsoft shares only gained 13 cents for the day. Depending on how aggressive they are on the buyback it should lift shares eventually but Microsoft is at risk of becoming the next Research in Motion if they don't come up with some new products. The price of Windows is becoming so commoditized the PC makers hardly pay anything for it anymore and Linux is surging. IBM said it was spending more than $1 billion on Linux development in an effort to get away from the Microsoft licensing fees. I believe MSFT shares are dead money until they get a new CEO.


Redbox operator, Outerwall (OUTR), fell -11% to a seven month low after warning that discounts and shorter rental times would reduce Q3 and full year earnings. The company formerly known as Coinstar lowered Q3 revenue guidance to a range of $569-$589 million compared to prior guidance of $630 million. Earnings guidance fell from $1.36-$1.51 to .82 to .94 cents. The company said its promotional DVD strategy brought in customers but led to more single night rentals.

The Redbox DVD kiosks posted their best month ever in July with rentals rising +13% to 74 million. Customers kept movies for a shorter time and did not allow the company to charge for extended days on rent. Most movies are $1 per day, every day you keep them. Many renters forget/fail to return them for sometimes weeks at a time with the clock still running. Apparently those that frequently forget to return either mended their ways or swore off rentals completely.

Do the math here. They had a record rental month in July at 74 million rentals. Assuming that rate for the other two months means 222 million rentals for the quarter. They expect roughly $575 million in revenue. That means the average rental is not one day but just under three days to get $575 million out of 222 million rentals.


Safeway (SWY) shares soared +10% after the company adopted a poison pill program that limited shareholders from acquiring more than a 10% stake in the company. They did this after learning that activist fund Jana Partners had acquired a 14.45 million share stake worth 6.2% of the company.


Pandora (P) warned that growth was slowing and announced a 14 million share secondary offering. Ordinarily that would be a serious drag on the share price. Pandora saw shares rally +5% to a new record high. Go figure! The company is selling 10 million shares and existing shareholder Crosslink Capital is selling 4 million. Crosslink will still have 25 million shares after the sale. Pandora said they "may" use the proceeds for potential acquisitions of businesses, products or technologies." Songza and Raditaz were both rumored to be potential targets. Both are privately held. They could also expand into film and books since the technology is similar.


Lockheed Martin (LMT) said the Dutch government was going to buy 37 of the F-35 Joint Strike Fighters for a cost of $6.4 billion. They are replacing the F-16 which will be phased out in 2020. The first F-35 in the order will be delivered in 2019. The Netherlands is the seventh country to buy these fighters from Lockheed in addition to all three branches of the U.S. armed forces. Lockheed shares rallied to a new high on the news.

After the bell on Monday Altria Group (MO) raised its full year guidance from $2.51-$2.56 to $2.57-$2.62. Altria said the increase was due to several states not following through with terms of the 1998 tobacco settlement agreement on a timely basis. The company expects to receive a credit of approximately $145 million plus interest. Under the 1998 settlement the tobacco companies agreed to make annual payments to the states forever to resolve their liability for health-care costs attributed to smoking. The amount of the payments are based on cigarette shipments to their states. The states had to aggressively pursue those companies that were not a part of the settlement. Some states did and some did not and that is why Altria is getting a credit for their nonperformance. MO shares were up fractionally to $35.36. This is another example of dead money. Smoking is continuing to decline as older smokers die off or become unable to smoke due to disease. Youth are not picking up the habit at the rates seen in the past.

Werner Enterprises (WERN) warned on Q3 earnings with new guidance of 27-30 cents compared to estimates of 36 cents. The transportation company said it was hurt by higher equipment, maintenance and driver costs. They also suffered from the new federal rules forcing lower miles per truck and shorter hours per driver. Shares declined -4%.

Swift Transportation (SWFT) warned profits could fall to 27-30 cents compared to prior estimates at 30 cents. There were no reasons given but I would assume Swift is facing the same impact from the new federal rules. Shares declined -3.4%.

Fertilizer company Mosaic (MOS) warned that sales volumes and prices slipped in the current quarter and that customers have become more cautious over the last two months. Mosaic said dealers began to postpone purchases after a Belarusian potash venture broke up in July. The venture controlled a large portion of the potash market and the breakup was expected to lower prices. Dealers were putting off purchases until the lower prices appeared. Mosaic shares declined -50 cents.

Aeropostale (ARO) shares rallied +18% to $10.17 after private equity firm Sycamore Partners reported acquiring an 8% stake of 6.25 million shares. The PE firm said they took the stake after the big decline in August because ARO was attractively priced. Sycamore has a history of taking retailers private. Using the same metrics that Sycamore used in the Talbot deal would project an Aeropostale price around $10 per share.


Syrian headlines have moved off the front page and the price of oil is dropping rapidly. WTI has declined -$5 over the last week and Brent has declined -$8. The Brent decline is steeper since that is the index price that determines the price of the oil from the Middle East. Oil grades are quoted as a discount to Brent or a premium to Brent depending on the grade. Since the U.S. can no longer attack Syria as a result of the deal with Russia the risk of retaliation to places like Saudi Arabia has also faded.

Even Iran is making conciliatory comments. The Supreme Leader Ayatollah Ali Khamenei said he was "not opposed" to "correct diplomatic moves" with nations that are Iran's adversaries. That comment was seen as a signal the new President Hassan Rohani could engage with world powers when he attends the United Nations General Assembly later this month.

Khamenei also said, "I agree with flexibility because this move in certain circumstances is positive and necessary but it needs to rely on one condition. Understanding the opposing party’s nature and goal are essential." And, "A wrestler may exercise flexibility for a tactical reason but he won’t forget who his rival is and what his goal is." Khamenei has "issued the permission for the government of Hassan Rohani to enter into direct talks with the U.S." according to Hossein Mousavian, a former Iranian spokesman.

I expect crude prices to continue lower now that Libya's strike threats are subsiding and production is returning.

Two weeks ago global production was handicapped by -2.7 mbpd in combined outages around the world. Those outages are being corrected.



The big cap indexes moved higher yet again on Tuesday although their gains were muted by the uncertainty surrounding the FOMC meeting on Wednesday. The index that led the market was the Russell 2000. The Russell rallied for +1% and a gain of +10 points to a new historic closing high of 1066.39. I have said many times when we are attempting to determine the true nature of the market we should look at the Russell 2000 as the sentiment indicator for fund managers.

That sentiment indicator just broke out to a new high and it would be tough to construct a scenario where this does not continue. That assumes there are no big surprises from the FOMC. Art Cashin said this week the market is moving higher thanks to the "rationality put." Everyone expects everything to be worked out rationally. Syria, Summers, etc, have worked out. Investors are assuming the FOMC, debt ceiling and budget battles will also work out rationally.

When dealing with Washington politics I don't know how much we can count on them being rational but we have heard some calming words from the House in recent days. They are not yet in agreement in the Republican caucus but the ones pushing to defund Obamacare don't seem to have enough votes to succeed. That means rationality may prevail and they will choke down another debt ceiling increase and some version of a thrown together budget bill. The process may not be pretty and there could be some market volatility attached but it is hard to see a scenario where investors don't buy the dip.

Maybe that is what we should be worried about. Investors are too complacent that rational minds will prevail. Market upsets can come with little notice once investors seize on an excuse for taking profits.

The Russell is now in blue sky territory and the shorts have got to be pulling their hair out. ANY further gains after the FOMC decision and we could see a runaway market.


The S&P-500 gained +7 points to close at roughly 1,705 and only -5 points below a new high. The S&P is not as bullish as the Russell but it is not far behind. The gains since August have been methodical and dips are bought almost instantly. It appears investors are taking seriously the projected targets of 1,850 and higher for year end. I hope they are right.

Support is now 1680 and resistance 1710.


The Dow is actually lagging with only a +35 point gain but it has good reason after the +729 point sprint since August 30th. The Dow is very over extended but it did close over the 15,500 resistance today. The closing high on August 2nd was 15,658 or roughly +130 points above today's close. I don't know how much longer Boeing, 3M and American Express can keep dragging the Dow higher with strong resistance from here to the recent high.

Support is now 15,300 and resistance is solid from here through 15,658.


The Nasdaq also broke out to a new 13-year high with a decent gain of +27 points. With the Russell leading the charge and Apple posting a dead cat bounce of +$5 and not a drag for a change the Nasdaq cleared prior resistance. With the Nasdaq and Russell both breaking out the future looks bright. Keep your fingers crossed.


Wednesday is all about the Fed, or is it? I think as long as the Fed does not do something unexpected the rally will continue. It is their game to win or lose depending on how they play their cards Wednesday afternoon. Investors have already spoken and given their approval of a minimal QE taper of $10 billion. Is everything setting up too perfectly? Time will tell.

Enter passively, exit aggressively!

Jim Brown

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