Crude prices imploded again this week to crash below two-week support at $80 and dip to $75.84. This crushed the energy sector and weighed on the markets.

Market Statistics



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The price of crude began falling on Monday after Saudi Arabia lowered prices for crude exported to the USA. Since Saudi Arabia produced 9.65 mbpd in October and they only exported 609,000 bpd to the U.S. there is a signal in this move. This is Saudi telling the world they are willing to sell oil at a lower price in order to maintain their market share.

It is also a warning to U.S. producers that Saudi can force them out of the business if they really wanted to slow U.S. production increases. Since the U.S. still imports 7.2 mbpd on average we are far from energy sufficient. You have to wonder about Saudi Arabia's thought process here. If we continue at the present rate of drilling our production is expected to rise from the current 8.97 mbpd to close to 10 mbpd by 2017 but that is the peak according to the EIA.

Production is rising today because we are drilling about 9,500 new wells per quarter. Unfortunately those shale wells decline in production by about 65% in the first year alone. The pace of well growth has to stay over that 9,500 per quarter level in order to stay ahead of the decline rate for production to increase. Once the prime areas in the various shale fields are drilled the pace of new wells is going to slow significantly. The wells outside the prime areas cost the same $8-$12 million per well but they produce a lot less. That means less wells will be drilled and there will be smaller rates of initial production. There are more than 1.1 million active producing wells in the U.S. and EVERY one of them declines in production capacity every year. If we don't keep drilling 9,500 wells a quarter the declines in the existing wells will overpower new production.

The EIA predicts shale production will peak in late 2016, early 2017 and then began a terminal decline. Saudi Arabia knows this so why are they causing market ripples today? One analyst said they could easily offset the decline in prices by pumping more oil. If they boost production from 9.6 mbpd to 10.0 mbpd their budget numbers are met and everyone continues life with slightly cheaper oil prices.

There are multiple reasons why Saudi Arabia could be taking this aggressive action. One is Iran. There is a rumor circulating that the six western nations are close to a deal on Iran's nuclear future that will be favorable to Iran. Saudi does not want Iran to have nuclear capabilities and they have expressed displeasure about the process. By crushing the oil sector they are sending a message to the U.S. and at the same time pressuring Iran with lower oil prices. The Iranian negotiations have a November 24th deadline. If Iran does get a new deal they could immediately ramp up production and that will also hurt oil prices. They are currently exporting 1.25 mbpd under the current sanctions but they could ramp up to 3.0 mbpd if the sanctions were lifted.

Secondly Russia is the second largest exporter of crude and some theorize President Obama has asked Saudi Arabia to force oil prices lower to punish Russia for the Ukraine invasion. Unfortunately U.S. relations with Saudi Arabia are at multi-decade lows and it is unlikely Saudi Arabia would take this kind of revenue hit just to please the USA.

This leaves a lot of analysts scratching their heads on why Saudi Arabia has undertaken this price crusade. The consensus opinion is that Saudi Arabia wants to slow production in the USA. If they can slow the U.S. drilling rate they slow the increase in production and may actually force a decline in production within 6-9 months.


Oil in the U.S. costs a lot to produce. Some of the shale areas have production costs up to $80 per barrel but that is not the real number. The oil from these shale areas is heavily discounted because of the lack of pipelines and cost of rail transport to get it to market. For instance Bakken crude hit $69 today and Permian crude dipped to $73 and those prices will decline further in the days ahead. Both areas would like to sell their oil for WTI prices but they can't. That means a lot of those wells are already losing money on every barrel. If prices remain low the pace of new wells will decline significantly.


While the energy sector is getting crushed the drop in gasoline prices will benefit retailers this holiday season. The national average declined to $2.97 per gallon and is expected to continue falling to something in the $2.85 range. With U.S. consumers buying 2.6 billion gallons of gasoline a week a 10 cent drop in gas prices saves consumers and businesses $260 million a week in fuel expenses. The national average was $3.64 per gallon back on June 23rd. That -67 cent decline is saving consumers a whopping $1.74 billion a week compared to June prices. The drop in stock prices is painful but the benefit to the economy is huge because every penny of that savings is going right into the pockets of retailers. Very little of that is going into a savings account.

In economic news the Intuit Small Business Employment Index rose +0.07% and the strongest gain in four months. Companies with less than 20 workers added about 15,000 net positions in October. Average worker compensation rose +0.08% to $2,774 or about $33,300 a year. The report was ignored since the ADP Employment report is due out on Wednesday morning.

The ISM - NY headline number rose slightly from 654.8 to 657.2 and the slowest pace in six months. The quantity of purchase component fell from 60.5 to 53.1. The current conditions component fell from 63.7 to 54.8. This was not a good report even though it showed that business activity in New York City was still improving.

The International Trade deficit declined from -$40.1 billion to -$43.0 billion in September. Exports fell -1.5% to $195.6 billion, a decline of $3 billion from August. Imports were flat at $238.6 billion.

Factory Orders fell -0.6% in September after -10.1% decline in August. Analysts had expected a +0.5% increase. Durable goods orders fell -1.1% while capital goods orders fell -4.1%. Core capital goods fell -1.6%. If it were not for a spike of +7.4% in defense orders it would have been a very ugly report.

The big report for Wednesday is the ADP Employment with expectations for +220,000 new jobs. After listening to all the big retailers and shippers talking about how many temp workers they are hiring I would not be surprised with an upside surprise in both the ADP report and the Nonfarm Payrolls on Friday. It seems like nearly every news item has the retailers hiring more this year than last. The nonfarm numbers contain seasonal adjustments based on the long term averages but a surge in seasonal hiring over those adjustments could give us a big gain. However, these reports are for October and the majority of hiring is not done until November so any real surprise could still be a month away. The Nonfarm payroll forecast is for a gain of +233,000 jobs, down from +248,000 in September.

The ISM Nonmanufacturing report is expected to decline slightly but after the upside surprise in the manufacturing report on Monday we could see strength in services as well.

A challenge on Thursday is the ECB rate decision. There are some rumblings about Mario Draghi's management style and whether he is trying to do too much with the new QE process. If the ECB/Draghi says something the market does not like on Thursday we could see some market volatility.


The big stock news for the day was Alibaba earnings. BABA reported revenues that rose +53.7% and far better than Amazon's 20% growth rate. However, margins declined from 54.4% to 50.5% and still a number any retailer would kill to have. Revenue rose to $2.74 billion to beat estimates slightly. Gross merchandise volume rose +48.7% to $90.5 billion. Active users rose +53% to 307 million. Mobile revenue was 10 times higher than the year ago period and accounted for 22% of revenues. Adjusted earnings of 45 cents were in line with estimates.

The gross merchandize volume number is one you won't see on Amazon. Alibaba does not own the merchandise it sells. Amazon inventories merchandise and then sells it so the revenue number includes the sales price. Alibaba puts buyers and sellers together and takes a commission so they don't have the costs associated with the inventory model. The company said it was in acquisition mode to expand its customer base and to expect margins to shrink while they added to the business model. This brought back fears of an Amazon like model of perpetual shrinking margins and the stock opened down after the earnings. After investors had time to think about the strong growth the buyers appeared and shares rose to gain +$4.27 for the day.


Softbank (SFTBY), which owns 34% of Alibaba, fell -6% today despite the rise in BABA shares. The Softbank ownership in BABA is worth roughly $90 billion at today's closing price and SFTBY only has an $83 billion market cap and they own more than 1,500 companies. Unfortunately one of those companies is Sprint (S) and that is what dragged them lower today. Softbank had to lower annual profit estimates by -$879 million to $7.9 billion because of problems at Sprint. That was its first profit decline in 9 years. They acquired Sprint for $22 billion in 2013.

Sprint shares declined -16.4% to $5.17 after reporting an earnings miss on Monday and saying it was cutting 2,000 jobs. The carrier lost subscribers for the 11th straight quarter. Sprint warned it was slashing profit estimates by $1 billion to $5.9 billion for 2014. Mobile phone customers declined by -272,000 in during the quarter and worse than the -203,000 analysts expected. Sprint is going to slash $1.5 billion in annual costs. The company posted a loss of -$765 million.



Priceline (PCLN) was the biggest disappointment of the day with a -$100 drop after reporting earnings that fell short of estimates. The company reported adjusted earnings of $22.16 compared to estimates for $21.08. Revenue of $2.84 billion also beat. However, they guided to earnings of $9.40 to $10.10 for Q4 and analysts were expecting $10.91. Bookings in Q3 slowed from 34% growth to 28% growth. U.S. bookings collapsed from 20.6% to 9.9% growth. Shares were crushed.


After the bell today Activision (ATVI) reported adjusted earnings of 23 cents compared to estimates of 12 cents. Revenue rose +78%. They raised estimates for Q4 from $1.29 to $1.35 on $4.8 billion in revenue. They gained 7.4 million subscribers to World of Warcraft during the quarter. The latest installment of "Call of Duty" was released on Monday.


FireEye (FEYE) reported an adjusted loss of 51 cents for the quarter compared to estimates for a loss of 56 cents. They raised estimates for a Q4 loss in the range of 46-50 cents and analysts were expecting 56 cents. They revised the full year outlook to a loss of $2.05-$2.15 and analysts were expecting -$2.13. Q3 revenue more than doubled from $42.7 million to $114.2 million compared to estimates for $116 million. So they doubled revenue but still missed analyst estimates. Shares declined -$7 in afterhours to $27.


Potbelly (PBPB) reported earnings of 9 cents compared to estimates of 7 cents. Revenue rose +8.6% to $84.7 million and beating estimates slightly. They reaffirmed guidance for the full year at 18-21 cents compared to estimates for 19 cents. They plan on opening 40-48 new stores and see flat to low single digit same store sales. The lackluster forecast kept shares flat after the close.


TripAdvisor (TRIP) reported adjusted earnings of 48 cents that was well short of estimates of 60 cents. Revenue of $354 million did beat estimates of $347.7 million. Shares crashed -12% on the news.


Zulily (ZU) reported earnings of 2 cents compared to expectations for a loss of 4 cents. Revenues rose +71.5% to $285.8 million. Active customers rose +72% to 4.5 million. Orders increased +62% to 5.9 million. Nearly 50% of orders were placed from a mobile device, up from 45% in Q3-2013. Guidance was in line with estimates. Shares declined -$6 in afterhours.


Earnings out on Wednesday include Qualcomm, Tesla, Whole Foods Market, NuSkin, SolarCity and Symantec. The rest of the week is rather light since this is the last material week in the Q3 earnings cycle. Berkshire on Friday will be the highpoint.


Markets

The markets are performing a lot better than I thought they would when I wrote the weekend commentary. I was almost sure the Nasdaq would retreat from the Friday close and suffer several days of consolidation after a major run to a new high. The Nasdaq did decline but not nearly as much as I expected. However, the week is not over.

I chalked up the market strength on Monday to month end retirement funds being put to work. Today the tech sector had every opportunity to collapse with the big losses in PCLN, NFLX, WYNN, etc. A -15 point loss is not a collapse. Even with some of the big losses after the close the Nasdaq futures are only down -2 points. I would say that was pretty good relative strength.

We now have three bearish candles at the 4,625 level but the Nasdaq is still clinging to its highs. The intraday low was -30 points under the close so a decent rebound did occur. The Nasdaq dipped to 4,594 and well below Monday's high of 4,654. Is that enough for a consolidation event? It could be but we won't really know until the end of the week.

Round number support at 4,600 is the level to watch followed by 4,525. Resistance is Friday's high of 4,641.



The Dow is doing amazingly well. The index closed at 17,380 and only -10 points below Friday's closing high. The dip on Monday to 17,366 was minimal and today's intraday dip to 17,278 was quickly bought once it became apparent it was not going any lower. The biggest problem for the Dow was the drop in oil prices. That caused declined in Chevron, Exxon and Caterpillar. IBM continues to bleed points and led the losers list. JP Morgan came under fire from another regulatory issue on currency trading and the bank took another monster charge.

The relative strength in the Dow after the big two week gain is impressive. If it can hold it another couple days the buyers should gain confidence and come off the sidelines.

Initial support is 17,335 followed by today's low at 17,278. Any decline under those levels would probably test 17,000.



The S&P showed a little more weakness than the Dow simply because there are a lot more energy stocks in the S&P. That was the major drag and kept the index was recovering the 2,020 level from Monday. The drop in crude is overdone and we could expect to see at least a dead cat bounce in some energy names on Wednesday.

Like the other indexes nothing has really changed since Friday. We are poised on the cliff face and can either step off and sink or catch a bid and fly from here.

Support is 2003 and resistance the Friday close at 2,018.


Wednesday could be interesting depending on the election outcome and the worry over the ECB news due out on Thursday. Add in the ADP Employment numbers and we still have the potential for profit taking or for a breakout to the upside. The negative earnings on Tuesday have failed to depress the markets with the damage inflicted on single stocks rather than the market.

I would keep some cash in reserve in case we do see some profit taking. I believe the market will eventually move higher so I am in buy the dip mode until proven wrong.

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Jim Brown

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