The market train is climbing the mountain of worry. Is there still time to climb on board?

Market Statistics

The Dow, Nasdaq Composite, S&P-500, S&P-100 and Midcap 400 all closed at new highs on a Friday ahead of a weekend that could have some seriously negative headlines. The quadruple witching expiration Friday is normally a bullish day and that helped add to the gains. It would appear the market train is gaining momentum as we head for Dow 17,000 and S&P 2,000 but should we buy the breakouts?

I have said many times that new market highs attract new money faster than a picnic attracts flies. That does not mean it is always a buying opportunity. This time the market is slowly overcoming serious geopolitical events including the war in Iraq and the Russian buildup on the Ukraine border.

The markets ignored a cut in the economic forecast by the Fed and charged higher because Janet Yellen convinced investors that Fed stimulus would continue well into 2015. The Fed cut its 2014 GDP forecast from 2.9% to 2.3% but they used the "weather ate our economics" excuse so investors breathed a sigh of relief and charged ahead.

While it remains to be seen if the market will continue in rally mode for the rest of the summer it has proven one thing. Never short a dull market. With hedge funds currently net short S&P and Russell 2000 futures the most hated rally ever just keeps building on its gains in a very unspectacular fashion.

The slow melt up is confusing the bears. A market struggling to post gains day after day is normally one that is about to roll over. The bears are betting on that failure but so far those bets have been in vain. Now we are seeing the results of a rotation out of those short bets. Funds may not yet be convinced to go long but they are reducing their shorts.

Summer rallies are strange creatures. They are normally on low volume and without any material momentum. They just creep higher until one day they don't. When the direction changes in a low volume market it can be dramatic. This fear of the future is keeping a lot of traders on the sidelines.

Another factor adding to the confusion is the approaching Q2 earnings. S&P is predicting +7.1% earnings growth compared to only 3.5% in Q1. The forecast is based on the snapback concept from the horrible weather in Q1. Since hardly a day goes by without a couple high profile earnings warnings it makes you wonder where S&P is getting their bullish estimates.

The final GDP revision for Q1 will be on Wednesday. The initial estimate was for 0.11% growth. The second revision showed a contraction of -0.98%. The final revision is now expected to be a serious contraction of -1.9% according to Moody's estimates. Granted that was Q1 and Q2 did see an increase in activity but was it enough to send the markets to new highs? We still don't have any proof that earnings improved significantly in Q2 and that makes the coming earnings cycle a potential minefield for investors.

Bullish sentiment may be contagious as the market makes new highs but eventually there will have to be fundamentals to back up those record gains.

I am not saying earnings are going to be bad. I am only suggesting that without some positive earnings news we could see the current rally begin to fade. If the initial earnings begin to confirm the optimistic estimates we could see further short covering and potentially the conversion of those bears into bulls. Stranger things have happened.

We have not yet entered into the full blown mudslinging ahead of the midterm elections. When that begins history has proven that investors tend to pull back from the markets. The campaigns should shift into high gear in August so be prepared because the political climate is more adversarial than I can remember in years past. This is going to be a very heated election cycle.

Friday's economics were lackluster. The regional and state employment for May was little changed from April. The unemployment in the western region remained the highest at 6.9%. The state with the highest unemployment was Rhode Island at 8.2% with North Dakota the lowest at 2.6%. The unemployment rate rose in 16 states and declined in 20 with the remaining states unchanged. Nonfarm employment rose in 36 states and declined in 14 states. The report was ignored.

The calendar for next week has three regional Fed manufacturing reports from Chicago, Richmond and Kansas. The outlook is mixed and the numbers could decline as a result of the fading snapback.

We will see the latest new home sales and existing home sales and minor improvements are expected as a result of the spring selling season. Overall the activity is expected to be weaker than the Fed would like.

The GDP on Wednesday could be a pothole for the market since a lot of investors will not be expecting a major decline. It always amazes me that some of the largest traders don't really pay attention to economic forecasts. When a bad number appears it always seems to be a shock. I would rather expect the worst and then be pleasantly surprised. Economists seem to have a bullish bias and major estimate misses are common.


The stock news was sparse on an early summer Friday. We have one more week before we go to basically four trading days a week for the rest of the summer. Friday volume will die before noon as institutional traders head out early for the beach and leave the backup team to doze at their PCs while pretending to watch the markets.

Friday's quadruple witching produced the highest volume since March 21st, which was also a quadruple witching Friday. Volume then was 9.75 billion shares compared to only 7.7 million on Friday. That -2 billion share decline should be a clue to the diminishing interest in the market.

One of the few stocks making headlines last week was Coach (COH). Coach shares continued the decline from Thursday after the company said it was closing 70 locations or about 13% of its stores. This will cost Coach up to $300 million over the next several quarters. Coach said the retail environment had shifted and it had failed to keep pace. The company reported a -21% decline in same store sales for last quarter. Coach shares are down -$5 in two days.

Surprisingly Michael Kors, which saw same store sales increase over 20% last quarter is also down -$5 over the last several days. KORS is quickly gaining market share both in the U.S. and globally and I will be looking for a bottom in this decline to go long the stock. I believe they are being punished by the warnings in the sector because there was no news on KORS. The 200-day at about $86 would be my target for support.



Carmax (KMX) shares rallied +16% after the company reported earnings of 76 cents compared to estimates of 67 cents. Revenue was $3.75 billion and also beat estimates of $3.59 billion. Used vehicle sales rose +9.8% and same store sales rose +3.4%. Income from auto loans rose +8.7% to $94.6 million.

The key here is the spike in sales of used cars rather than new cars. This is a symptom of the shrinking consumer budgets that are also biting Coach, Walmart, Costco, etc. Consumers are looking for cheaper options.


Owens Corning (OC) warned for the full year for 2014 saying roofing volumes were -20% below year ago levels. That is a major decline, which points not only to the slowing sales of new homes but also to the shrinking budgets of consumers. The company said 2014 earnings would be less than the $500 million previously forecast but did not give a new number. They earned $416 million in 2013. If you reduce volume by 20% you would expect earnings to reduce by more than 20% since margins decline on lower volume. That may be why they did not give a new number because it would have been below the 2013 levels.


Turn out the lights, the party is over. Shares of Radio Shack (RSH) traded as low as 91 cents on Friday to put the stock in danger of being delisted by the NYSE. The chain is in the middle of yet another restructuring to try and save itself from going out of business. In March they announced the closing of 1,100 stores, leaving it with 4,000 locations. However, the lenders protested the massive closures and forced them to rethink their plans. In early June the company said its losses were larger than expected and revenue was shrinking because of competition in its mobile business. Shares declined -35% since the earnings miss on June 9th.

There have been miraculous recoveries in the past from companies that imploded because of changing times and or business models but very few come back from this level of decline. Rising debt, shrinking revenue and a shrinking customer base may be the death knell for Radio Shack. Far fewer consumers are running to Radio Shack to pick up some electronic parts, cables, connectors, etc. For non-hobby items like smartphones and CD players there is always Walmart and Amazon. I am a prime example. Decades ago I bought electronic parts for my computer hobby at RS at least a couple times a month. Now I have not even been in a RS store in a decade. Will the last customer please turn off the lights?


Software giant Oracle (ORCL) reported earnings of 92 cents that missed analyst estimates of 95 cents. Revenue of $10.94 billion was also below estimates of $11.48 billion. Making the move to cloud computing is proving harder than they expected. Oracle has posted sales growth of less than 5% for the past 11 quarters.

Oracle is fighting a flood of cloud providers like SalesForce.com and the profit margins are shrinking. New license sales were weak as customers are finding competitors that are offering cheaper solutions. Oracle projected revenue to climb 4-6% in the current quarter with earnings in the 62-66 cent range. Analysts were expecting a 5% rise in revenue and earnings of 64 cents. It definitely looks like Oracle scanned the analyst estimates and chose the median average on purpose to prevent a disaster. Time will tell if they will meet that forecast or miss again.

Oracle shares have been on the rise with a $10 gain since last summer but some analysts are now calling it dead money for the next couple quarters given the slow growth. Larry Ellison said the company just bought LiveLOOK, a real-time technology for co-browsing and screen-sharing. No price was given. He is also said to be in talks to buy Micro Systems (MCRS) for $5 billion. Oracle has been a serial buyer of other companies for years as a way to gain technology without inventing it and as an excuse for not growing earnings. Ellison is a compulsive spender and the every acquisition clouds the future earnings potential. The acquisition of SunMicrosystems was a failure for several years and the potential acquisition of MCRS suggests the SunMicro deal is still a failure.


Amazon (AMZN) shares rallied on the phone announcement but gave back a couple dollars on Friday. The phone has the technology to scan an item and immediately give you multiple buying options online. This is not entirely new but the Fire Phone has taken it to a new level. The phone's Firefly button/camera recognizes 70 million products and 100 million items. Not just bar codes but ANYTHING you can point the camera at. Hear a song playing in a restaurant, click, listen, identify, download. Point it at a TV show and Firefly will tell you what it is and even what episode it is. Point, identify, download. Point your phone at any product, push the button, buy. Walk into a store, look at the range of product offerings, point to the one you want and Amazon sells it to you cheaper and puts it on your doorstep within two days with free shipping. This is better than Google Goggles, Bing Vision and Shazam combined. You don't have to wait in a sales line, remove cash or a credit card from your pocket and have your brain register the pain of payment. Instead, point, click, buy in a very painless process and because there is no visible cash leaving your pocket and no credit card swiping, which makes the psychological barrier to spending money disappear.

Casino's use chips instead of money for a reason. They know your brain does not process the decline in a pile of chips in the same way it does a pile of $20 bills. Chips are not money therefore gamblers spend more of them at the tables. Amazon's Firefly button is not money. It is unfettered convenience without the pain of paying at the register. One analyst said the phone was unique. "Amazon launched a shopping machine and called it a smartphone." Shares were already up ahead of the announcement so a sell the news event was likely. However, regardless of what everyone says about Amazon's lack of profitability you have to admire them as a marketing machine.

I am the perfect example of a Prime customer. In the last three weeks I have purchased 11 items and 5 e-books from Amazon worth about $600 in total. All were cheaper than I could have bought them locally, I did not have to leave the house and they were delivered within two days for free. I won't be buying a Fire Phone because I like my existing Android phone but for those who do buy a phone they are putting an Amazon cash register in their pocket. As an added inducement to buy the $199 phone Amazon is giving a free 12 month Prime membership with every phone, a $99 value. In a few years we won't need the NSA because Amazon will know everything about everybody. We have truly arrived in the 21st century.


The Volatility Index ($VIX) hit a new seven-year low at 10.34 on Friday morning. In theory this should mean there is a disaster ahead. However, as Art Cashin has been proclaiming for the last couple weeks the VIX is broken. The VIX is based on call and put option premiums on the S&P-500 ($SPX). The volume in these options is now huge. When I used to trade SPX options 15 years ago there was one-tenth the volume we have today, maybe even less. The close to the money June SPX options had open interest of 20,000, 50,000 and even 100,000 or more on some strikes at expiration. With higher volume came cheaper premiums and narrower spreads. Those lower premiums translate into a lower VIX.

The S&P is also affected by the trade in the underlying shares of the S&P-500 components. Volume in those individual shares have declined as more and more institutions and individual use ETFs as their investment of choice rather than buying shares of individual stock. The ETFs are not as volatile, many times are cheaper and they have high volume and low bid ask spreads. While an institution buying 100,000 shares of an ETF can affect the prices of the underlying S&P shares the change is miniscule. The SPY ETF traded 101 million shares on Friday. Buying 100,000 shares of some S&P stocks could move the price significantly and impact the S&P.

The VIX is broken in terms of how it reacted in the past but I think we have moved into the new normal and we just need to understand how the VIX relates to this new paradigm. The VIX at 10.34 is still extremely low and it is cautionary for investors long the market. However, three times in the last year the VIX was over 21 and all three times were great buying opportunities. While the spikes over 21 lasted only a couple days the declines to record lows can continue for days, weeks or even months. In late 2007 the VIX traded between 9.00-12.50 for a record five months before suddenly rising to a record high of 89 in October 2008.

In the late 1990s a routine high was 40-45 and the lows were in the 17-20 range. The last time we hit 45 was in October 2011 when the debt ceiling debate was in progress. Since early 2012 the high has been 27, then 23. In 2013 it hit a high of 21+ three times. Art is right about the VIX appearing broken but it is broken for one main reason.

The main reason the VIX is broken is the Fed. The late 2012 spike was due to the end of Operation Twist 2. The current QE3 program was announced shortly after that and the Fed has been buying a boatload of treasuries every month for the last two years. They will still be buying $35 billion in July with an end to the taper in November. The constant inflow of that mountain of cash has broken not only the VIX but the markets themselves. There is no volatility because the Fed is preventing it with their fire hose of monthly cash. When the S&P can only go in one direction the VIX is going to be abnormally low. Yes, we have had some potholes in the road to 1,960 but they were minor and every dip was bought thanks to the constant flow of cash. I believe once that cash flow stops we will see the return of the VIX we used to know.



The S&P closed at 1,962.87 and a new historic high. That was the culmination of a +24 point move since the Janet Yellen press conference. It was aided by the quadruple witching but mostly by Yellen's "stimulus forever" stance in response to the questions. While she did not say stimulus forever that is the outlook. With the Fed cutting its economic forecast and projecting low inflation into 2016 a continued stimulus posture is implied. Of course they claim they are not on automatic pilot and they will react to the conditions but they admitted the conditions were weaker than they expected.

The Fed is going to keep putting money into the market through November at their current rate of tapering. When QE ends and the elections are over the market will get a chance to stand on its own two feet. Will it teeter slowly forward or face plant right into the asphalt? That depends on how well the economy is doing at the time but without that constant IV drip of Fed cash into the system there are going to be some stumbles.

Fortunately we don't have to worry about 2015 today. We only need to worry about next week and that could be a stress test for investors. The week after June expiration has been down 21 of the last 24 years. While past performance is no guarantee of future results that is a pretty strong record.

However, we just had a -30 point decline from 1,955 to 1,925 and the dip was bought despite geopolitical headlines from Iraq and Ukraine and the worry about some FOMC disappointment. Next week should be a cake walk compared to the prior week. We have found out in the past we can't run down to Staples and pickup an "easy" button for the markets. When the yellow brick road to profits seems the easiest something always pops up. The market needs a wall of worry to climb and we are going to have to depend on weak economics for our wall next week.


Overhead resistance is now 1,970-1,975 with round number resistance at 2,000. Support is 1,925-1,940 and well below Friday's close.


The Dow is edging slowly higher and closing in on that short term uptrend resistance at 17,000. This is also round number psychological resistance. This is now the official target and once targets are reached there is sometimes a sell the news event. "Ok, we made it, now what." This could be especially true heading into the summer doldrums. Unless something has changed in the market any dip will probably be bought. Last week's consolidation created some decent support in the 16,725 range.



The Nasdaq almost did the impossible last week of breaking through the 4,344-4,371 resistance top. Even though the Nasdaq closed at a new 14 year high at 4,367 it is not yet through the resistance band created by the two intraday touches of 4,371 back in March. We are really close but we need to complete the breakout over that level.

The Nasdaq rebound has been remarkable. The index has rebounded +333 points since the May 15th low at 4,035. That includes two separate weeks of consolidation where it traded flat to down for the week.

The last week it had to do it without Apple. Shares of Apple closed at a post split low of $90.91 on Friday as the post split depression period slowly takes its toll. Apple hit $95 the day after the split but it has faded ever since.


When the Nasdaq moves over 4,371 it will immediately face new resistance at 4,400 but that should be easier to overcome than the current resistance level.



The Nasdaq 100 ($NDX) is really struggling at the 3,800 level without the help from Apple. I thought we were going to see a breakout there last week but resistance was too strong.


The Russell 2000 turned in a good performance with a +2.2% gain for the week. It closed at the high of the day on Friday and the trend is our friend. However, with the Russell rebalance next week there is the potential for the index to decline. There are about 165 stocks coming out of the Russell 3000 and funds will be selling those stocks to make room for the 165 additions taking their place.

The amount of index movement may be minimal because the stocks leaving are normally the smallest stocks that no longer meet the requirements to be in the Russell 3000. Also reducing the impact is a coordinated effort to do a market on close order at Friday's close for all the stocks entering and leaving the index. However, we know how traders are. There will be a group of traders trying to game the rebalance by selling/shorting the deletions all week in hopes of profiting from the downward pressure the rebalance creates. Since the deletions are still in the index until Friday's close any downward pressure will push the index lower.

On the positive side the Russell 3000 ($RUA) is the 3,000 largest stocks in the USA and the 165 being deleted are the smallest of those 3,000 or they are being acquired by someone else. It is a very small subset of the index and pressure on the index should be minimal. The top 1,000 stocks in the Russell 3,000 are further defined as the Russell 1000 index ($RUI). The bottom 2,000 stocks make up the Russell 2000 ($RUT).

The Russell 2000 pushed through decent resistance at 1,180 and is now targeting 1,194 as the next stepping stone to a new high. The Russell is only 2% below its historic 1,208 close back in March. Support is strong at 1,160.


In theory the markets should continue to rise next week. As Yogi Berra once said "In theory there is no difference between theory and practice. In practice there is." We don't know what underlying events have worked together to push the market lower 21 of the last 24 June expirations. It could be something as simple as the Russell rebalance pushing the Russell 2000 lower and that negative sentiment drags the broader market lower. It could be a simply as individuals exiting the market for the summer after the June expirations. We don't know the answer but we need to hope for the best but expect the worst. A very large number of stocks are hitting new 52-week highs. If individuals wanted to take profits before the summer doldrums this would be the week to do it. With the summer vacation season starting the following week with a long July 4th weekend there may be some extra incentive for individuals to cash out.

Random Thoughts

ISIS fighters captured a Saddam Hussein chemical weapons depot on Thursday. The depot contains hundreds of tons of deadly poisons like mustard gas and sarin. The al-Muthanna facility is 60 miles north of Baghdad. A former British commander in the 2003 Iraq war said the facility had large stores of weaponized and bulk sarin and mustard gas. Most of these bunkers had been temporarily sealed under concrete to make them hard to access until the Iraqi government got around to destroying the weapons and materials. Under a 2012 agreement with Baghdad the MOD's Defence Science and Technology Laboratory was to provide training to Iraqi personnel in order to help them dispose of the chemical weapons and agents. Apparently they never got around to actually destroying the weapons. A US officer said they agents could not be readily loaded into the empty weapons without experienced personnel and a calm environment to study and prepare. "The only people who would likely be harmed by these chemical weapons would be the people who tried to use or move them." However, never underestimate the power of determined radicals.

Interesting read. 16 things you need to know about ISIS

Everything you need to know about Iraq in 4 minutes HERE

Putin is at it again. In President Obama's speech on Thursday he all but called for the removal of Iraq's Prime Minister Nouri al-Maliki to be replaced with someone able to create a new government that included Shia, Sunni and Kurdish representation. Within 24 hours Putin offered Maliki his "complete support." Putin is benefitting from the spike in oil prices and they are investing huge sums to renovate the vast West Qurna-2 oil field and increase production. Clearly Putin would not want it to fall into ISIS hands but more than anything he jumped at the chance to take another position opposite President Obama.

Putin is also building up Russia's military presence again in the Ukraine. Putin put 65,000 troops on alert and ordered them to take part in a drill a day after the Ukraine Prime Minister declared a one-week cease fire along the border. Putin said the drill would involve movement of 5,500 pieces of military equipment. Putin has been sending arms and equipment to pro-Russian fighters in the Ukraine. However, the Ukraine PM said the military had sealed the border crossings and future transfers of equipment would be impossible.

The U.S., Canada and EU states including France and Germany warned Putin there would be new and tougher sanctions imposed next week if he did not pull troops back from the Ukraine border and take concrete steps to de-escalate tensions in the region. On Friday Canada and the U.S. levied additional sanctions against 7 more Russians with "broader measures being readied against the finance, defense and technology industries."

Morgan Stanley warned that the rising oil prices were going to be a serious drag on the economy. The average price of gasoline has risen to $3.68 although several areas of the country are already over $4. One reporter paid $4.30 in California last week. Diesel is $3.90 on average. U.S. consumers burn 370 million gallons of gasoline a day. A 10 cent increase in gasoline prices will reduce consumer purchasing power by $37 million a day or $1.11 billion a month.

Gasoline prices are the highest for this time of year since 2008 and we know how that turned out. As gasoline prices soared consumers were no longer able to spend money on goods and services or make their mortgage payments and the downward spiral began.

Morgan Stanley said a $10 jump in oil prices would reduce GDP by -0.4% while a sustained spike in crude prices could stall the economic recovery and lower GDP by -1.7 points 12 months from now.

What is wrong with this picture? With the market at new highs investor sentiment must be soaring. Sorry, that is not the case. For the week ending on 6/18 the AAII Sentiment Survey showed that bullish sentiment collapsed from 44.69% to 35.17%. That is a -9.5% drop in just one week when the market was making new highs. That is the largest weekly drop since the first week of January. Bearish sentiment rose only +2.9% to 24.1%. Those in the neutral camp rose +6.6% to 40.7%. Yes, there are more people neutral on the market than bullish despite the new highs. That does not bode well for next week.

The pace of M&A activity suggests we could be at a market top. As stock prices soar those companies with a fat stock price tend to go shopping before their stock declines. This normally happens at market tops. According to Matthew Rhodes-Kropf, a professor at Harvard business School and an expert in the field, "Each of the last five great merger waves on record, going back more than 125 years, ended with a precipitous decline in equity prices." At the current pace of acquisitions we could see $3.51 trillion in deals in 2014. According to Dealogic that is the most since 2007. Matthew said this does not mean a market crash is imminent. "Everyone tends to call the bubble too soon," the M&A trend could last a while longer.

The S&P has not moved more than 1% in a single day in 42 days. That is the longest streak since 1995 when it went 96 days. Since 1950 there have only been 31 streaks of volatility this low. In 1963 there were 167 days from Feb-28th to Oct-24th without a 1% move. Boring!

With global interest rates at such absurdly low levels it should be no surprise to find out that global central banks are investing in the equity markets. Those banks are also charged with investing excess reserves, which they normally do by investing in treasuries issued by various countries including U.S. treasuries. With inflation higher than short term yields these banks have to do what every other investor does. They search for yield.

A research publication compiled by the Official Monetary and Financials Forum (OMFIF) titled "Global Public Investor 2014" (GPI) surveyed more than 400 public-sector institutions in 162 countries. There were 157 central banks, 156 public pension funds and 87 sovereign funds holding $29.1 trillion in investments. According to OMFIF the GPIs have lost up to $250 billion in interest income over the last several years. Over that period the GPIs have increased their investments in equities by more than $1 trillion. Obviously this has helped push global equities higher but it could also lead to a monster decline in the event of another crisis. When those GPIs exit the market to return to the "safety" of interest rate securities the decline in equities could be extreme. As long as rates remain absurdly low the equity markets should be safe. Once rates begin to rise toward normal levels we could have a rocky ride in equities. Read more here

I keep updating my graphic of year-end forecasts for the S&P as new predictions are discovered or prior predictions are updated. The average year-end target from the 24 firms listed below is now 1,974. It has been slowly rising as the market moves higher. The four companies in yellow recently upgraded their forecasts.

Revisions

Citigroup up from 1,975 to 2,000
Credit Suisse up from 1,960 to 2,020
RBC up from 1,950 to 2,075
S&P Capital IQ up from 1,985 to 2,100

Deutsche Bank, Bianco reiterated his call for a drop to 1,850.


Jonathan Golub, chief U.S. market strategist at RBC Capital Markets raised his forecast to 2,075 and warned that bull markets don't end until recessions appear. In a note to clients he pointed out that seven of the last eight bull markets ended only when a recession appeared. His chart below.

He said only one of his warning signals for a recession exists now and that is weak housing starts. He said, "The current economic rebound is the slowest of the post-war period. Growth is being held back by a modest housing recovery and weak business confidence. As a result, abundant spare capacity exists, which prolongs the length of the cycle." However, Jeff Kleintop at LPL Financial said one more thing needs to happen to keep the bull market going. The economic recovery must accelerate. Continuing to plod along at 2% GDP growth invites trouble. Any unexpected event could send us back to recession very quickly. The Fed lowered their GDP estimate for all of 2014 to 2.3% growth and that is barely over stall speed.


In theory the market should continue higher long term but each week has to stand on its own and there are quite a few economic reports this week that could upset investors.

Enter passively and exit aggressively!

Jim Brown

Send Jim an email

"Before this century is over, the Dow Jones Industrial Average will probably be over one million versus around 10,000 now. So for the long-term, the outlook is tremendously bullish if you buy stocks blindly to keep for a century."

Sir John Templeton, 2008