The Russell 2000 hit a four-month low at the close dragging the other indexes lower.

Market Statistics

The cartoon below from Hedgeye says it all. The Russell 2000 is crashing and dragging the rest of the markets with it. The Russell is now down -8% since its 1,208 high close on July 3rd. The index declined -1.45% today alone or -16 points.

More than 50% of the small caps and Nasdaq stocks are already in a bear market with individual declines of -20% or more. Small cap declines are actually worsening. This will be resolved one of two ways. Either the big caps will eventually catch the same decline virus and race to catch up OR the Russell will hit the 10% correction level at 1,087 and dip buyers will show up in volume and reverse the trend.

The S&P-100 big cap index ($OEX) is down only -1.9% from its September 18th closing high at 2,011. The Nasdaq 100 big cap index ($NDX) is down only -1.3% from its high close at 4,103. We definitely have a wide divergence between large and small stocks and the small and midcap stocks (-5.1%) make up the majority of the market. Traders and market reporters may focus on the Dow and S&P but even at 500 stocks in the S&P that is only 11% of the broader market where the Russell 2000 is 45% of the market.


The advance-decline line on the small caps is plunging and shows no signs of improving. The MACD is in full retreat and fully bearish.


On the economic front there was some dramatic news. The Consumer Confidence headline number declined from 93.4 in August to 86.0 in September. This decline erased all the gains from Q3 and confidence is at the lowest level since May. The major cause for the decline was a sudden turnabout in the outlook for jobs. Fewer respondents said jobs were plentiful and more respondents said jobs were hard to get.

Both condition components declined sharply but the expectations component declined the worst. The present conditions component declined from 93.9 to 89.4. The expectations component declined from 93.1 to 83.7. That is a huge drop of nearly -10 points.

Those planning on buying a home declined from 5.3% to 4.9%. Auto buyers declined from 13.5% to 12.0%. Appliance buyers rose from 45.7% to 51.3%. The drop in the home buyers is probably related to the seasonal swings. Kids are back in school and nobody wants to move.

Those who thought jobs were plentiful declined from 17.6% to 15.1%. Those who thought jobs were hard to get rose only slightly from 30.0 to 30.1 but look at the total percentage compared to those who thought jobs were plentiful. Twice as many think they are hard to get.

Conflicts in Ukraine and the Middle East are probably weighing on confidence but there are no specific questions in the survey related to geopolitical concerns.

The job concerns could be a signal the payroll numbers this week may not be very strong. However, with more than one million people being hired for the holiday shopping season the next two months should show gains.


The Intuit Small Business Employment Index was basically unchanged in August. The index rose only +0.01% but compensation rose +0.59%. The index showed that employers were not hiring additional workers but to compensate the existing workers were working longer hours and that boosted the compensation metric.

Average monthly compensation rose to $2,791 or $33,500 per year. Average worker hours rose +0.6% to 25.3 hours per week.

Case Shiller home prices rose +6.7% in July and the lowest rate of gain since late 2012. This compares to the +8.1% gain in June. The mortgage financing problem along with declining wages in the U.S. are impacting consumers ability to buy homes. This reduces competition for existing inventory and prices decline.

The Texas Service Sector Outlook Survey rose from 22.8 in August to 27.5 in September. The revenue component was the biggest driver with a rise from 21.0 to 26.9. However, the employment component declined from 13.2 to 11.9. Are we seeing a trend here with the employment components in all the reports weakening?

On the positive side the retail sales sub-index rose from 14.9 to 35.5 and the highest level in seven years. The retail labor market index declined -4.9 points to 10.8. The Texas recovery is still progressing nicely compared to the rest of the country. Cheap labor, cheap real estate and a business friendly climate is attracting businesses from all over the country where taxes and wages are obscene. If only Texas could do something about the weather. I lived in Dallas for more than 40 years and the summers are brutal.

The Eurozone inflation number this morning was +0.3% and in line with market forecasts and well below the ECB target of 2.0%. As Europe moves closer to deflation the potential for the ECB to move to full-blown QE is increasing. Having the ECB buy government bonds would still be difficult with Germany dead set against it but fear of deflation is a powerful motivating factor. The ECB meets on Thursday to consider action and there is likely to be something new in the post meeting announcement and press conference.

The ADP Employment report is due out on Wednesday and expectations are for a decline from 204,000 to 198,000 jobs. There are whisper numbers in the 175,000 range. The Nonfarm Payrolls on Friday are expected to rise from 142,000 to 203,000. We could have a downside surprise here with the declines in the employment components from other reports. This is the 800 pound gorilla that investors may be trying to avoid by moving to the sidelines ahead of the report.


The dollar index continues to rise to new four-year highs. This is crushing commodity prices and will lower inflation in the USA. However, it is going to be a big worry to the companies that do business overseas. More than 50% of the S&P earnings come from overseas and all of our products just became more expensive. Exports will slow but imports should pickup because our dollar will buy more.


Crude prices imploded on the rising dollar, slowing European economy, falling consumer confidence, weak economics from China and rising OPEC production. Libya, Saudi Arabia, Angola, Nigeria and Iraq all increased production in September. WTI declined -$3.40 for the day. However, it is common for hedge funds to pull money out of commodities at the end of each quarter. This sharp decline in WTI could have been just some liquidation by a couple major funds. With the dollar and production rising it was a good day to exit on the headlines if you had bought the prior dip in mid-September. The $90 level is very strong support and although there are some analysts projecting a decline to $85 any dip to that level would be brief. OPEC has already said they will probably cut production quotas for 2015 because of the additional supply and decline in prices.

Brent crude declined another $2.45 to $94.80 and that is below the comfort level for OPEC members. Saudi Arabia and others need oil above $95 in order to continue their budgets and pay for their social programs to keep the Arab Spring at bay. Brent hit $113 in June and it has declined nearly $20 in almost a straight line. This means gasoline will be cheaper in the coming weeks and could easily move under $3 nationwide.



In stock news Ebay reversed the position it has held all year and agreed to spin out PayPal as a separate company in 2015. EBAY shares rallied $4 on the news for the biggest gain in two years.

The Ebay CEO has said in multiple interviews over the last year that PayPal and Ebay were better together than they would be separately. This was in response to an attack by Carl Icahn to try and split the company. Icahn never gave up and apparently he has convinced management to take the plunge.

The spinoff opens several doors for M&A. The new Apple Pay process is going to impact Google Wallet and Amazon's payment system. It is entirely possible that PayPal becomes an immediate acquisition target by either of those entities in an effort to offset the impact from Apple Pay. PayPal is entrenched in the online retail world and especially for Amazon it would be easy for them to integrate Paypal into the Amazon system.

Ebay could also become an acquisition target. With their $70 billion market cap today cut in half or even by two-thirds after the PayPal exit they could also become M&A bait. Alibaba could snap them up like a mid afternoon snack and immediately Alibaba has a huge foothold in America and numerous other countries.

PayPal will be free to establish relationships with other companies that were reluctant to embrace the Paypal system since they were part of Ebay. Splitting off removes the Ebay stigma from PayPal.

Several analysts were talking down Ebay after today's spike saying there was nothing else they could do to increase their value. Meanwhile others like Dan Loeb were racing to acquire a large stake because they think the PayPal spinoff will be huge and unlock significant value both in the spinoff and in the potential acquisition binge that could follow it.

I am with Loeb. I think spinning PayPal off will unlock a huge amount of value. Once it hits the public market the stock could move significantly higher. It is a sure bet that at least one post spin entity and probably both will be acquired within 12 months for a hefty premium.


FedEx (FDX) said it was going to buy back 15 million shares. The company must be feeling prosperous even after buying new trucks, planes and facilities to increase capacity. FDX and UPS also got a boost from China when Premier Li pledged to "open up" and move towards internationalizing the country's package delivery business. The government is embracing online shopping as a way to increase internal consumption and let the country rely less on exports.

The State Council chaired by Premier Li posted a statement late Wednesday saying the parcel delivery business will be "fully opened-up" to "create a fair and competitive business environment in which domestic and foreign-financed enterprises receive equal treatment."

Currently e-commerce sites use so-called "kuaidi" couriers to move products inside China. UPS and FDX are licensed to serve only a few limited areas. That will be expanded to nationwide. Li said the licensing requirements would be "simplified" to promote "the orderly and healthy development of the industry." Since January 1st more than 8.1 billion packages have been delivered in China according to government data. Most packages were delivered by Shentong, YTO, SF Express and ZTO. Li said that mergers with existing domestic shippers would be encouraged to improve industry efficiency. An underlying goal of the liberalization is "to create conditions that stimulate consumption by supporting businesses," FDX has been operating on a limited basis in China since 2003 and UPS since 2005.


Apple (AAPL) shares recovered from last Thursday's drop after China approved the iPhone 6 for sale in China. Sales will begin on October 17th. Reportedly Apple had to make plenty of promises and disclose numerous technical details in order to get the phone approved. China's approval cited "national security concerns" as the reason for the delay in approval. Analysts expect between 12-16 million will be sold in Q4 in China.

Despite positive gains today Apple shares are still experiencing post announcement weakness.


We are rapidly moving towards the Q3 earnings cycle and we are in the period where earnings warnings are plentiful. Today those were limited and mostly positive.

Schnitzer Steel (SCHN) said it expected earnings of 28-32 cents per share and analysts were looking for 20 cents. Shares of SCHN rallied +5.6% after a month long decline.

1-800-Flowers (FLWS) said it now expects earnings of 45-50 cents with $1.1 billion in revenue compared to prior estimates of 29 cents on $803 million in revenue. Shares were unchanged on the day.

Synacor (SYNC) reaffirmed estimates for Q3 revenue of $25-$26 million and full year of $100-$103 million. This was in line with consensus estimates. Shares were flat.

Intuit (INTU) said it was expecting a loss of 20-21 cents on revenue of $620 million. This was in line with consensus estimates. Shares were flat.

Moody's (MCO) now expects $3.95 to $4.05 per share for 2014 compared to consensus estimates of $3.98. Shares were up +39 cents.

Westport Innovations (WPRT) warned that 2014 revenue would now be $130-$140 million compared to prior forecasts of $175-$185 million. Consensus estimates were for $178.7 million. Shares declined -2.5% on the news to punctuate a two-month decline.

American Science and Engineering (ASEI) warned it now expects a loss for the quarter compared to analyst estimates for a 19 cent gain. Shares lost -2.5%.

Walgreen (WAG) reported earnings that were in line at 74 cents on sales that rose +6.2% to $19.1 billion. The company said margin pressures from increased Medicare and Medicaid prescriptions was being addressed they were still able to increase their market share by 30 basis points to 19%. Shares were down fractionally on the news.


Markets

This market analysis is going to be short tonight because nothing has changed. The Russell is in free fall and the other indexes could not capitalize on a morning rally that lifted the Dow +130 points off its lows to top at 17,145 at 11:30. That went from a -55 point decline to +73 point gain but the gains did not stick with the Dow closing down -28 points. That was a triple digit move up and a triple digit move down in the space of 2.5 hours. There is nothing bullish about that.

The S&P traded in a 16 point range between 1969 (-9) and 1985 (+7) and then closed near the bottom of the range at 1972 after a -16 point slide intraday. For the last four days the S&P has hovered around the 1970 price magnet but the lack of a sustainable rebound is troubling. Bulls will point to the 1969 level and claim support is holding but without a move over 1985 soon the bears will eventually become cocky and start piling on in expectations of a support break.

Only 39.8% of the S&P stocks are trading over their 50-day averages.



The Dow has tested support at 16,950 several times and each time it has held. Unfortunately it also tested resistance at 17,150 and that has been rock solid as well. The Dow closed near the bottom of its 128 point range at 17,042. For today the 17,000 interim support level did hold but the lack of a sustainable bounce suggests it will be tested again.


The Nasdaq Composite closed at 4,493 and near the low for the day. This is very close to the six-week low at 4,464 that was set at the open on Monday. The Nasdaq chart is bearish and it appears to be setting up for a lower low in the coming days.

However, the Nasdaq 100 ($NDX) continues to cheat the bears. The index has come within a few points of testing support at 4,000 several times but always rebounds immediately. I called the NDX the canary in the market coal mine in the weekend commentary with the 4,000 level critical support. As long as that level holds the rest of the Nasdaq is not likely to slip much lower. If 4,000 breaks that would signal a change in sentiment and selling could accelerate across all the indexes.

The advance-decline line on the Nasdaq is also in full retreat. This is extremely bearish.





The Russell 2000 is in free fall. Support at 1110 broke and the index appears to be targeting 1096 and 1082 with 1087 as the 10% correction level. As long as the Russell is leading the markets lower the outlook is the same. I do expect at least a trading bounce at 1096. The R2K has now broken below the common averages including the 300-day at 1126.


Futures were down -6 earlier tonight on news of the first Ebola case in the USA. A man that traveled through Africa a couple weeks ago came down with symptoms and was admitted to Presbyterian Hospital in Dallas. He tested positive and now they are rounding up everyone he came into contact with over the last couple of weeks. The disease can remain dormant in an incubation period for up to 21 days. This means dozens of people can be infected before the carrier realizes he has the disease. Fortunately it requires physical contact with the carrier and the exchange of bodily fluids. While that sounds easy to avoid a sneeze can infect a room full of people. Improper sanitary methods can allow common items to be touched with infected hands. I am not a doctor but I don't think the disease has much of a chance of spreading in the USA. We can be proactive whenever it is discovered and we have the best medical science in the world.

There have been reports of suspected terrorists trying to extract blood and liquids from corpses and accumulating bloody clothes and linens. Let your imagination run wild with those possibilities.

I remain bearish until proven wrong or the Russell hits 1087. Any bounce from that level will have to be watched carefully for traction. I remain confused as to why the big caps are clinging so stubbornly to the high ground. That would seem to suggest that a bounce by the Russell would immediately power the big caps back to the highs. Just remember that QE ends in 30 days and every QE end we have had to date has produced a market decline even when we knew it was coming.

After today's decline from the highs I am less confident a short squeeze is forthcoming.

Enter passively, exit aggressively!

Jim Brown

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