Mario Draghi needs to quit talking and start walking towards additional ECB stimulus or all of Europe will be back in a recession soon.

Market Statistics

German industrial output fell -4.04% for August and the worst reading since January 2009 and the financial crisis. Analyst estimates were for a drop of -1.5%. Germany is considered the strongest economy in Europe but their GDP for Q2 declined -0.64%. The odds are very good the Q3 decline will be even worse with the country falling back into recession.

Last week German manufacturing PMI dropped into contraction territory a 49.9 and a 15 month low. New orders fell at the fastest pace since 2012. Some of this is related to the Russian sanctions but the entire EU is seeing economic activity shrink briskly. It is almost inconceivable that Europe can avoid a recession.

With the dollar at 4 year highs and the European economy in trouble it is going to be a serious drag on Q4 earnings and probably some Q3 earnings were depressed due to the double whammy. Europeans don't have the money to spend on our products and those that do want to buy are faced with higher costs due to our dollar strength. This is a recipe for U.S. earnings weakness in the months ahead.

The IMF cut global growth forecasts from 4.0% to 3.8% for 2015 and +3.3% for 2014. The IMF said U.S. growth was supporting the global forecast. The IMF expects U.S. growth will be +2.2% in 2014 compared to prior estimates at +1.7%. The fund expects the Fed to raise rates in the middle of 2015 and they believe the current accommodative monetary policy remains appropriate.

The IMF expects Europe to grow by +1.3% in 2015, down from prior estimates of +1.5% but higher than the +0.8% expected for 2014. However, "We see the major risk in the stalling of the euro zone" and "the risk of recession is there." European authorities should increase infrastructure spending to boost growth. If inflation does not improve in the EU the central bank should purchase sovereign bonds to stave off deflation, according to the IMF.

Estimates for Japan were cut from +1.1% growth to +0.8%. Brazil was cut from +1.3% to +0.3% with 2015 growth cut from +2.0% to +1.4%. China's expectations were cut to +7.4% this year and +7.1% for 2015.

The IMF also warned about the risk of rising geopolitical tensions and a financial market correction as stocks reach "frothy" levels. The IMF has apparently taken a cue from Janet Yellen when she warned about over valuations in small caps several weeks ago. The IMF said it is concerned some investors may be "under pricing risk" and not "fully internalizing the uncertainties surrounding the macroeconomic outlook and their implications for the pace of withdrawal of monetary stimulus in some major advanced economies. (USA)

The fund warned that Ukraine would be in recession in 2015, Russia would be stagnant or worse, and the Middle East would see severe economic impacts from the military strife in Iraq, Syria and Libya. They left out the economic impact from Ebola in West Africa.

Last week IMF Director Christine Lagarde warned that officials have to act to prevent a prolonged period of sluggish growth, a trend she called the "New Mediocre."

European markets moved lower on the weak economic news and that carried over into the U.S. markets. Friday's short squeeze was erased and markets closed on their lows.

The negative open was also influenced by comments from Kansas Fed President Ester George Monday night. She said "the time has come" for Fed officials to start talking seriously about boosting short term interest rates. "Starting this process sooner rather than later is important. If we wait for employment and inflation to reach our stated goals they we risk having to move faster and steeper in interest rates in a way that is destabilizing to the economy in the long term." George is a noted hawk and has lobbied for higher interest rates in recent speeches but every time it tends to roil the markets.

The economics were light today. The weekly chain store sales rose only +0.1% after a -0.2% decline last week. This number is usually ignored.

The Job Openings Labor Turnover Survey (JOLTS) for August showed a slight increase in the openings rate from 3.3% to 3.4%. The number of available jobs rose to 4.8 million and the highest level since the survey began in 2001. Despite the rise in openings the number of hires fell from 4.9 million in July to 4.6 million. The JOLTS report was ignored as a lagging indicator since September payroll reports have already been released.

Consumer credit rose only $13.5 billion in August, down from a +$21.6 gain in July. The August number was the slowest rise since November. Consumers appear to be hesitant to take on additional debt in an economy where wages are shrinking and food and healthcare prices are rising. This is another contrarian indicator for rising spending for the holiday season. If consumers are hesitant to add to credit card debt the holiday sales forecasts could be too high.

The calendar for Wednesday is headlined by the FOMC minutes from the last meeting. With multiple Fed heads speaking out on their views about raising rates or keeping them low the recent meeting was probably contentious. With QE ending in three weeks that will require a statement change and the minutes could have some revelations on both topics. Today's market decline could have been influenced not only by the warnings from Europe but also fear over the minutes.


Geopolitical concerns include not only Iraq, Syria, ISIS, Libya, Russia and the Ukraine but North and South Korea, Pakistan and India. India and Pakistan traded mortar and small arms fire across the border between Kashmir and Pakistan for the second day. Both are nuclear countries.

Five Indian civilians were killed and 34 injured in heavy fire from across the border in Pakistan. India returned heavy retaliatory fire and the battle has been raging for two days. Pakistan targeted 40 BSF border outposts and adjoining villages throughout the night. More than 15 Pakistani civilians were killed in return fire from India. The India Times reported that BSF forces fired 1,000-1,200 shells into Pakistan overnight. Cross border firing occurs routinely but not to this degree of severity.

Warships from North & South Korea traded warning shots after a North Korean ship violated the western sea boundary. There were no casualties and the North Korean ship returned to North Korean waters. The situation in North Korea is very unstable today. The current figurehead leader Kim Jong-Un has not been seen in public since Sept 3rd. There are rumors of a coup and the capital city Pyongyang is thought to be in lockdown. That could be to either prevent coup plotters from leaving the city or it could be an attempt by the successors to impose order after successfully seizing control.

Other rumors include Kim having surgery on his ankles as a result of being overweight and having diabetes. Kim missed the meeting of the Supreme People's Assembly last month and this is the first time since he took power in 2011. Whatever the situation the world will only find out long after it is over.

The North has declared 2015 as the year of unification and Seoul said on Tuesday the North has geared up for all out war by conducting tactical training sessions and boosting its attack capabilities. The North has doubled the number of training exercises compared to prior years. They boosted the number of portable rocket launchers to 5,100 with ranges of 60-200 km.

Back in the USA the National Retail Federation said holiday sales in Nov/Dec are expected to rise +4.1% and the biggest increase since 2011. Shop.org expects online sales to rise 8-11% to $105 billion, compared to an 8.6% rise in 2013. PwC said 50% of spending will occur in physical stores and 43% will be online. More than 58% of spending will be on gift cards, which is the hottest category next to clothing.

Not all outlooks are rosy. In a recent survey PwC said 84% of consumers are expecting to the same or less than in 2013. The average household spending is expected to decline from $735 to $684 according to the PwC survey. The lower spending is driven by families that make less than $50,000 annually and now represent 67% of American shoppers. That is up from 65% in 2013 and 63% in 2012. With food prices and medical costs constantly rising it is cutting into the available funds for holiday spending. Those earning under $50,000 expect to spend only $377, down from $435 in 2013. Shoppers said they will be increasingly price conscious and that will make this shopping season even more promotional than ever.

Crude oil declined again on the possibility of a recession in Europe. We have seen a long list of geopolitical concerns surrounding multiple oil producing countries and prices have not risen. With Saudi Arabia declaring a price war last Friday (Link to Price War article) we have risk of WTI declining to $85. This war is not only on other nations in OPEC but also against the USA. Since the cost to produce oil from shale and from oil sands is high they can halt development in the U.S. if they push prices low enough.

Brent declined to $92 and a level that has been support for the last four days. It is as though oil traders don't believe Saudi Arabia is serious and they are testing them. The good news is that U.S. gasoline prices will be under $3 soon and that will free up from extra cash for consumers to spend during the holidays.

The decline in energy prices is a plus for the consumer but it will push headline inflation even lower.



If the Fed is going to end QE in three weeks and raise rates in early 2015 then why are treasury yields collapsing? The yield on the ten-year declined to 2.35% and a five week low. We appear to be moving into a risk off posture with money flowing out of stocks and back into treasuries even though the six month view is for rising rates.


I think we are seeing the impact of the end of QE. Every QE program to date has caused a significant decline in the market when it ended and there is no reason for this one to be different. Yellen has already said QE will end in October and this is October. The market is simply anticipating the October 29th announcement. The end has been so widely telegraphed and the rally since the beginning of QE3 in January 2013 so pronounced that it is only reasonable to expect a similar decline.

The contrarian view is that prosperity is "breaking out" as Art Cashin has been saying. At this point it may be "sneaking out" but the economy in the U.S. is still in growth mode. That means any real dip will be bought and some of those yearend forecasts over 2,000 still have a chance to come true.


Shaded entries are revisions with the original target following their name.


Earnings warnings are flying fast. Agco (AGCO) shares fell -11% after the company warned of weaker than expected demand. The company cut its forecast for the full year to $4.10-$4.30 per share, down from $5.00. During Q3 the farm equipment company said demand declined to weaker than anticipated levels and they were compensating by making aggressive cuts in production schedules and expenses. Shares of Deere (DE) declined -3% on the AGCO warning.


The Container Store (TCS) fell to a historic low after reporting $193.2 million in revenue that missed estimates by about $6 million. Adjusted earnings rose +38.7% to 11 cents and in line with expectations. Same store sales declined -0.4% and well below estimates. The company tried to soften the blow by bragging about their TCS Closets initiative. The closet makeover line is launching across the country and the average sales price is $1,200 compared to the average ticket sale in the rest of the store at $60. Apparently nobody was excited with shares falling -25%.


SodaStream (SODA) warned that Q3 revenue would be about $125 million compared to analyst estimates for $154.1 million. The CEO said "we are very disappointed in our recent performance." He cited lower than expected demand as the reason. Analysts believe the soda machine is a limited audience product. With U.S. consumers drinking less soda every year those that wanted an in home dispenser have probably already bought one. Shares fell -22% on the news.


The demise of SodaStream and the settlement of a suit over the Vitaminwater brand helped push Coca-Cola (KO) to a 16 year high at $43.93. This is its second highest close ever with the highest close at $43.97 back on July 14th, 1998.


Glass maker GT Advanced Technologies (GTAT) announced bankruptcy unexpectedly on Monday and shares declined -90%. On Tuesday shares rebounded over 100% at one point but ended with a 51% gain. If you decline -90% on one day and rebound +100% on the next the first thought is that it recovered all its losses. Sorry, while the numbers are similar the results are not. GTAT declined from $10 to $1 on Monday. A +100% rebound from $1 only gets it back to $2. It would take a +900% rebound to get it back to the $10 level. The rebound came on a rumor that Apple was a large creditor having advanced GTAT cash to build the sapphire glass screens in quantity. Traders were hoping Apple would just acquire the company out of bankruptcy. If that happened the odds are good shareholders would be wiped out. Realization of that fact caused the share price to fade from the $2 high to close at $1.22.


Earnings guidance on Tuesday was very lopsided. Silicon Motion (SIMO) was the only company to give positive guidance. Shares rallied +5% on the news.

Four companies issued inline guidance. Integrated Silicon Solutions (ISSI), Landec (LNDC), Mistras (MG) and International Speedway (ISCA).

Five companies issued negative guidance. Yum Brands (YUM) warned that 2014 earnings would be in the range of $3.15-$3.27 compared to prior guidance of "at least $3.56." Analyst estimates were for $3.38. YUM shares fell -2.3% on the news.

Other companies warning were Christopher Banks (CBK), Haverty furniture (HVT) and AGCO and SODA, which I covered earlier.

Markets

It was not a fund day to be holding equities. The indexes gapped lower at the open, leveled out slightly midday and then plunged into the close. The Dow closed at a two month low at 16,719. Ditto on the Nasdaq at 4,385 and S&P at 1,935. The Russell closed at 1,076 and a 12 month low. All closed at their lows for the day.

The selling in the big cap indexes is accelerating with the Dow and Nasdaq losing -1.6% and the S&P -1.5%. That was very close to the -1.7% decline on the Russell 2000. I know you have read it here many times that the small caps lead in both directions and they are definitely leading us lower. The drop to a 52-week low is a technical breakdown that should lead to further selling. The close under the prior lows of 1,082 is a break of support and another technical sell signal. I hope we are not targeting a 20% correction but that level would be 965.


The S&P closed at 1,935 and well under all the stair step levels we have discussed over the last several weeks. The decline stopped right above the uptrend support from June 2013. The intraday low last Thursday was 1,926 and we are still about 10 points over that level. We are still well above the 1,904 level we saw in August. While the selloff is painful it is still just a hiccup until the long term uptrend support and that August low is violated. We have tested that long term support several times in the last two years and it has always held. However, QE was not ending in those prior tests. Make no mistake this is a critical juncture for the market.

Support is now 1,926 and 1,900.



The Dow is in breakdown mode. The prior support at 16,800 has been severely broken and the 200-day average at 16,585 is the next logical support followed by 16,368. There were nine Dow components that lost more than $2. Coke's historic high was the only positive stock in the index.

Support at 16,725 was pierced at the close by only 6 points so that level is still in play.



Fortunately the Nasdaq still has several levels of near term support but the chart is still bearish. The 4,344 and 4,371 levels have been tested several times and that range has halted several declines. We now have long term uptrend support at 4,385 that is similar to the long term chart on the S&P. If this level holds we could see a decent rebound because it is so clearly visible to any trader with a charting system. Conversely, should this uptrend support fail it could weaken sentiment significantly and target a decline to 4,000.




The Russell 3,000 (R3K), the largest 3,000 stocks in the market, is approaching an interesting convergence of support with the August lows and the 200-day average. The last time it traded below the 200-day average was November 2012. The decline last Thursday came within 3 points of the 200-day at 1,138 and we closed at 1,146 today. This would be a logical place for a rally after a retest. However, sentiment will have to change in a hurry.


The Transports ($TRAN) are still well above support at 8,000 despite two days of declines. The -209 drop today was significant on a sentiment perspective because oil prices are at the lowest level since April 2013. Transports should be bullish on the significant drop in crude prices. Q4 is normally bullish for transports because of the airline traffic and package shipments. For them to sell off that hard today suggests market sentiment is failing. Traders should watch this chart for confirmation of any further Dow declines. If the transports are weak as well then the Dow's future is bleak.


In the weekend commentary I showed a short term chart for each of the major indexes illustrating the failure of Friday's short squeeze right at downtrend resistance. Obviously that was a key inflection point. The weakness on Monday and the sharp decline today have pushed the indexes back into oversold conditions. We never know what causes these waterfall declines. It could have been a couple hedge funds exiting their long positions due to the weakness in Europe or a serious case of margin call selling or both. The point is that the markets are oversold again and a short squeeze could breakout at any moment. If one were to develop traders will be watching where it fails. If it remains below that downtrend resistance then it is just a blip and there is likely more selling to come.


The markets rarely move in a straight line in either direction. With the recent history pattern of 4% declines and then a rebound we have to think that traders are looking for another repeat. Despite all the apparent fury of the recent declines and the significant increase in volatility the Dow is only down -3.2% from its closing high of 17,279. That is hardly a material decline. Of course the Russell is off -10.9% and now in correction territory. Everyone is holding their breath that the Russell halts its decline there and frees the large caps to resume their upward trajectory.

Enter passively, exit aggressively!

Jim Brown

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