Tuesday was Monday this week and the short squeeze appeared as expected.

Market Statistics

The S&P gapped to 1,911 at the open and that is exactly where it closed after investors failed to chase stocks higher. The short squeeze came after overseas markets reacted to the positive outcome from the Ukraine elections. The good guy won the election, Putin is backing off and Europe said it was going to postpone new sanctions against Russia. The markets celebrated as shorts fearing the worst in Ukraine were forced to cover but that is as far as it went. There was no follow through and the S&P, Dow and Russell 2000 closed where they opened or slightly lower.

The Nasdaq was the exception with a strong spike higher at the close. I suspect traders in the Nasdaq momentum stocks were the most short after their big gains last week. However, the gains today pushed the Nasdaq 100 right to major resistance.


Today was a busy day for economics and while the results were mixed there was a slight positive bias. The Durable Goods orders for April rose +0.8% compared to +3.6% in March and +2.6% in February. The slightly positive number was better than the consensus estimate for a decline of -0.5% and the Moody's estimate for a decline of -1.4%. This is another one of those numbers where bad news was priced in and even a weak gain was a positive surprise.

Excluding transportation orders (planes, trains, autos) the rise was only +0.1%. Excluding defense the new orders actually fell -0.8%. Machinery orders declined -1.4%. Defense orders rose +39.3% after a gain of +18.8% in March.

The Richmond Fed Manufacturing Survey for May came in at 7 and the same as April. The headline activity flattened but the components were mixed. New orders declined from 10 to 3 but backorders rose from -9 to +1. The employment component rose sharply from 4 to 10 and the average workweek rose slightly from 2 to 3. Wage increases spiked from 6 to 22. Those components suggest manufacturers have a brighter outlook for the future if they are willing to hire and pay more.

The Services survey roared higher from 1 to 13 thanks to surging retail sales. Excluding retail the headline number would drop to 7. However, the employment index declined from 6 to 4 as a result of the retail component falling from 20 to 10. Excluding retail it would have risen from 1 to 3. The expected demand for the next six months spiked from 3 to 20 for retail and 11 to 13 excluding retail.

The surge in retail can't be emphasized enough. This suggests the consumer is improving and that is the driver for the entire economy. It remains to be seen if this will be reflected all across the country or if this is just a winter weather snapback in the Richmond area.


The Texas Manufacturing Outlook Survey declined from 11.7 to 8.0 for May. The net percentage of positive responses did decline in May from April levels. The internal components were not as positive. The new orders component declined from 21.3 to 3.8 and inventories fell from 5.6 to -1.0. Backorders dropped from 3.1 into contraction territory at -8.1. The average workweek fell from 13.9 to 2.8. Prices paid nearly tripled from 10.2 to 26.3. The manufacturing outlook for Texas remains positive but there was a definite weakening in the components.

Consumer Confidence for May rose slightly from the downwardly revised 81.7 to 83.0 but below the Moody's forecast at 84.4. April was revised lower from 82.3 to 81.7. The present conditions component rose from 78.5 to 80.4 and the expectations component eased up from 83.9 to 84.8. Those respondents planning on buying a home declined from 5.6% to 4.9%. Auto buyers increased from 10.6% to 11.3% and appliance buyers declined from 45.9% to 45.1%.

Those that thought jobs were plentiful rose from 13.0% to 14.1% and those expecting a higher income jumped from 16.8% to 18.3%. However, those expecting a drop in income rose from 12.9% to 14.5% for an interesting conflict in trends.


There is nothing on the economic calendar for Wednesday that will move the market. The next important report is the Q1-GDP revision on Thursday. There is a wide range of estimates from -0.8% to +1.5% so it would be hard to produce a surprise. However, a negative reading could promote some selling by those expecting positive growth. Some people simply refuse to believe the negative factors and they could be shocked by a decline.

I think everyone should have adjusted to the "weather ate the economy" excuse for sharply lower GDP readings and earnings. However, the expectations for Q2 are rapidly getting out of hand. Earnings growth is now expected to rise more than 7% in Q2 and GDP growth is being quoted as high as 5%. Those are some big estimates to live up to and reality is likely to be somewhat different.


Stock news was pretty muted with everyone still mentally on vacation. The headline for the day was the $6.4 billion offer for Hillshire Brands (HSH) by Pilgrim's Pride (PPC) that could upset the Hillshire $4.23 billion offer for Pinnacle Foods (PF). Pilgrim is the world's second largest poultry producer behind Tyson Foods (TSN).

Hillshire makes Jimmy Dean sausage, Ball Park hot dogs, Hillshire Farms lunch meats and Sara Lee brand frozen baked goods. The Pilgrim CEO said the combination of Hillshire and Pilgrim would create "the most powerful branded combo of meat products in the industry." Analysts expect Hillshire to resist the offer. Hillshire shares spiked +22%, Pilgrim shares were up slightly and Pinnacle shares fell -5% on worries Hillshire would pull the bid for Pinnacle. Pilgrim said they would pay the $163 million termination fee owed Pinnacle if Hillshire terminates its offer.



Expedia (EXPE) shares rallied +3% after FBR said they experienced a sharp uptick in room volume in April. FBR said the weakness in Q1 bookings was due more to weather and the Easter calendar than weakness in the sector. Last week Cantor Fitzgerald raised their price target from $80 to $82 citing strong click volume for April that indicated hotel spending was increasing. Also, David Tepper started a new position in Expedia in Q1. Expedia shares gained +3% on the news.

In the same sector Booking.com, owned by Priceline (PCLN), was the recipient of a legal complaint filed by French Economic Minister Arnaud Montebourg claiming the contracts between hotels and Booking.com were unfair. He said the contracts prevent the hotels from renting a room at a price lower than the Booking.com price even if the customer did not come from Booking.com. There was a similar complaint against Expedia that resulted in fines in 2013.

Obviously Booking.com does not want customers surfing prices and availability online and then calling the hotel directly trying to get a lower price without paying the commission to Booking.com. Apparently investors thought the complaint demonstrated Booking.com's control of the marketplace and they immediately piled into Priceline shares for a +5% gain. Priceline rebounded off the 200-day average last week and closed just above resistance on Friday. This was probably as much short covering as anything else.


Autozone (AZO) shareholders got a nasty surprise when shares declined -4% after a decent earnings report. AZO said revenue rose +6.2% to $2.3 billion. Earnings rose +16.4% to $8.46 on a 52% gross margin compared to estimates for $8.44 per share. Same store sales rose +4%. They repurchased $420 million in shares. They have increased earnings per share by 10% or more for 31 consecutive quarters. Sounds like a great earnings report but investors keyed in on the +12% rise in inventory and they sold the stock. That has to be frustrating for the CEO to produce such a good quarter and get punished for one line item. I suspect some of the decline was related to investors getting out of the stock after it failed to break through resistance from February. They were hoping earnings would do it but when the selling started everybody piled on.


Biotech stocks were up strongly after multiple companies released announcements about drugs in process ahead of the ASCO meeting that starts on Friday. The sector was seriously oversold earlier this year but several of the most beaten down companies are now in rally mode. Stocks in this sector are either feast or famine depending on their latest press release. This is a very volatile sector but one where the rewards can be great if you pick the right company ahead of important drug news.

Biotechs were a major supporter of the Nasdaq rally today.


After the bell cloud computing company Workday (WDAY) reported a loss of 13 cents compared to estimates for a loss of 15 cents. Revenue rose +74% to $160 million compared to estimates of $152 million. They also issued guidance for the current quarter for revenue between $173-$178 million and analysts were expecting $172 million. Shares rallied $5 in afterhours trading.


Qihoo 360 (QIHU) posted earnings after the close of 54 cents compared to estimates of 34 cents. Revenue increased +141% to $265 million. The number of PC users rose +5% but smartphone users almost doubled. QIHU is a network security company in China. Daily clicks on the QIHU website rose +58%. The company issued guidance for revenue of $300 million or more in the current quarter compared to analyst estimates for $270 million. Shares rallied $5 in afterhours.


In geopolitical news the good guy won in Ukraine and Putin agreed to support the winner. Ukraine forces launched a violent attack against the remaining separatists and made it clear they were going to retake the country at any cost. It is not a good time to be a rebel this week. Europe said they were going to postpone any new sanctions against Russia. Assuming Russia does not bring back its troops and invade Ukraine this news story is over as far as the market is concerned.

Iran appears to have backed out of the nuclear discussions and they are not just over but the country has returned to its hard line roots. Iran's supreme leader, Ayatollah Ali Khamenei, all but said on Sunday that negotiations over the country's illicit nuclear program are over and that the Islamic Republic's ideals include destroying America. "Those Iranians who want to promote negotiation and surrender to the oppressors and blame the Islamic Republic as a warmonger in reality commit treason," Khamenei told a meeting of members of parliament. Khamenei emphasized that without a combative mindset, the regime cannot reach its higher Islamic role against the "oppressor's front" led by America.

"The reason for continuation of this battle is not the warmongering of the Islamic Republic. Logic and reason command that for Iran, in order to pass through a region full of pirates, needs to arm itself and must have the capability to defend itself." In response to a question by a parliamentarian on how long this battle will continue, Khamenei said, "Battle and jihad are endless because evil and its front continue to exist. This battle will only end when the society can get rid of the oppressors' front with America at the head of it. This requires a difficult and lengthy struggle and need for great strides." And, "The accelerated scientific advancement of the last 12 years cannot stop under any circumstances," he said, referring to the strides the regime has made toward becoming a nuclear power.

Iran presented new "red lines" to the negotiators at the P5+1 talks in Vienna. Those red lines that could not be crossed, including the expansion of the country's research and development for its nuclear program, the need of the country to continue enrichment, and the fact that the country's ballistic missile program — despite U.N. sanctions — is not up for negotiation.

Apparently the new openness towards negotiation and the permanent removal of sanctions has faded. Nearly every military analyst has warned for the last year that the six month agreement that ends in July was just a plan by Iran to secure the release of the $6 billion that was being held plus an opportunity to buy needed spare parts for their military and commercial equipment. After that six-month window opened they traded furiously with everyone possible and now they are ready to go back to work on their nuclear program and to heck with the sanctions.

Iran also failed to complete the seven "transparency steps" agreed on to occur by May 15th. Those included resolving IAEA questions on Iran's work on nuclear detonators and disclosure of Iran's secret nuclear sites and capabilities. Did anyone really expect that to happen?

This does not bode well for the Obama administration's goal to be able to claim a win in Iran ahead of the midterm elections. Al Qaeda is not dead and Iran is still on the path to nuclear weapons.

U.S. security firm FireEye (FEYE) reported last week that the Iranian Ajax Security Team was targeting U.S. defense companies in a cyber-espionage campaign that showed increasing sophistication by hackers in Iran. FireEye discovered the campaign and 77 victim companies in the course of analyzing malicious code disguised as anti-censorship tools. The Ajax team dates back to 2009 when it appeared on popular Iranian hacking forums.

Don't think that Iran is not going to be a problem in the future. They are growing stronger in their technical capabilities and they will acquire a bomb unless the deterrent methods used against them increase in severity and number.

China began to pressure companies to replace IBM servers with a local brand due to fears over spying. Since the spying scandal broke thanks to Snowden, IBM has been having trouble selling servers overseas. There are repeated rumors that the NSA has intercepted shipments of servers, routers and network hardware and installed tracking chips and software that give the NSA backdoor access into the boxes wherever they are installed. Cisco routers have been modified by the NSA in the past in the Tailored Access Operations (TAO) unit where they are intercepted in transit and "upgraded" with Trojan horse firmware. A NSA manager said the TAO operations were "some of the most productive operations because they preposition access points into hard target networks around the world." That is now backfiring against U.S. technology firms because of declining sales overseas and especially in Asia.

Markets

Short covering pushed the S&P to a new high well over the 1,900 close on Friday but there was no follow through. The real question today is what will happen on Wednesday. We have had a lot of bears come out of the woodwork suggesting we are going to see a correction in the near future. So far that has not happened. When those bearish projections are so prevalent it scares the weak holders out of the market. They can actually produce a stealth correction because the fear of a drop forces selling and that allows new investors to take positions.

I am not going to claim the S&P is headed higher because we really don't know. In theory there are plenty of shorts that have not covered. They are convinced the anticipated correction will occur and are willing to wait for it. However, as I warned last week the "correction anticipation" trade has been in play for several weeks. When so many people are expecting the market to go in one direction it rarely occurs.

Bank of America said that over the last two weeks speculators exited S&P longs at the fastest rate in two years. They are now net short the S&P. Another survey of 1,200 fund managers showed they had reduced longs and raised cash in anticipation of a large decline in July and August. To summarize there are a lot of investors expecting a decline and it is not happening.

That means if the market slowly grinds higher those same fund managers will be forced to chase prices because they can't afford to lag the other funds in performance. Managers live and die on their performance relative to other funds. That is how they attract new money is by bragging about their outstanding performance.

Since nearly everyone is expecting a correction that means almost everyone is positioned for a decline with shorts in their portfolio. If the S&P rises a few more points that should weaken the resolve of the short community. If the market does not decline on Wednesday we could see that resolve begin to fade.

However, there are no major events on the calendar to push the market in either direction. That means we could languish here for several days without a big move as traders try to read the technical tea leaves for market direction. Without any material news I think the trend is to grind higher.

For the S&P the new resistance target is the converging resistance at 1,925. Support is now 1,900 and 1,885.


The Dow has been the laggard over the last week. The gap open to 16,688 was the high for the day with the close at 16,675. There was very little movement after the opening spike indicating no follow through by new money. It was pure short covering.

The Dow's historic closing high was 16,715 and until the Dow joins the S&P at new highs the bullish market sentiment will not be complete. We already have the transports at new highs so once the Dow breaks out again the trio can lead higher. Interim support should be 16,650 followed by 16,600.



The Nasdaq 100 has stretched its breakout gains to close right at the resistance band from 3,720 to 3,740. These are the big cap tech stocks that have been leading the Nasdaq rally higher. If they can punch through to 3,750 we could have a real breakout on our hands with all the indexes surging to new levels. Just remember that Apple shares are a big contributor and they have a 7:1 split next week. That could cause some serious volatility if the post split depression occurs on schedule.


The Nasdaq Composite clearly exploded higher on short covering. The gap open to 4,225 was well over resistance at 4,183. In theory there should be more shorts left to cover followed by some price chasing by fund managers. However, the composite has a long way to go before making a new high at 4,357.

Support should be 4,183 and 4,150.



The Russell 2000 mirrored the Nasdaq with a strong +1.4% gain and breakout over downtrend resistance. The next hurdle for the Russell is resistance at 1,150 and 1,165. The Russell and the Nasdaq are both becoming a little over extended and should be due for a rest even if they are going to continue higher.


The markets could be positioned to grind slowly higher until the Dow breaks out to a new high. If that happens we could see the gains accelerate. We are not out of the woods for a potential summer correction but with the S&P over 1,900 the lure of a bullish breakout is in play. I am sure there are a lot of bullish investors laser focused on that breakout and poised to pull the trigger if it moves higher. There are probably just as many bears looking for any hint of failure to reopen their shorts.

Volume was light at 5.5 billion shares so despite the new highs there was no conviction.

Enter passively, exit aggressively!

Jim Brown

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