After an extremely volatile week traders closed out short positions ahead of the long three-day weekend and will enjoy the break in trading with a much needed rest. The volatility has been extreme with 30 point intraday swings on the S&P-500 instead of the normal 10 point ranges.

Market Statistics

Other than aftershocks from the 30% move in the Swiss franc the market was relatively calm on Friday. After an ugly week of triple digit moves to the downside the calm trading on Friday gave traders an easy exit from their shorts. Dip buyers were ready to buy any bounce and a short squeeze was born. Rising oil prices helped support the market with high profile energy companies rising sharply.

Fake tweets from hacked accounts tried to move the market with headlines saying Chinese warships fired on a U.S. ship and the Fed convened an emergency meeting because of the Swiss franc debacle. Neither was true.

Crude prices traded as low as $44.21 last week before rebounding to close at $48.48 on Friday. The black gold traded in an average range of $3.25 per day all week. That is basically a 7% range every day and extreme volatility. Positive crude prices were a calming influence on Friday's market. The +4.8% gain was due mostly to short covering ahead of the long weekend. The strong close pushed oil into positive territory for the week to end seven consecutive weeks of declines. The $50 level is now resistance.


On the economic front the Consumer Price Index (CPI) fell -0.4% in December and the biggest monthly decline since 2008. The biggest contributor to the decline was of course gasoline prices with a -9.2% drop. Overall the energy component declined -10.8%. The core rate, which does not include food and energy, was flat at zero compared to the average of +0.013% for the prior seven months.

The trailing 12-month number for headline inflation declined to +0.7% and down from +2.0% just last summer. Headline prices should continue lower in the months ahead as the impact of low energy prices work their way through the system into consumer prices. The Fed is really facing a challenge if they are planning a June rate hike we Yellen suggested. With inflation declining further and the dollar still rising the deck is stacked against a Fed rate hike.

The Industrial Production report for December showed a -0.1% drop after a +1.3% rise in November. However, the headline number is deceiving. The warmer weather in December caused a -7.3% decline in utility output and skewed the entire index. Manufacturing production rose +0.3% and mining output rose +2.2%. Because of the utility component the report was ignored.

Consumer Sentiment for January rose +4.6 points to 98.2 and an 11 year high. The present conditions component rose from 104.8 to 108.3 and the strongest since May 2007. The expectations component rose from 86.4 to 91.6 and the highest since January 2004. More than 66% of respondents say it is a good time to buy a major household item and more than 82% say it is a good time to buy a home.

Falling gasoline prices are a major part of this sharp gain in the sentiment index. The average driver is saving $750 a year in gas and the average household $2,125 a year. That is a huge raise and that money goes straight into other retail spending.


The calendar for next week only has one critical event and that is the ECB QE decision on Thursday. The ECB is expected to announce up to 500 billion euros of sovereign QE. Unfortunately Mario Draghi has failed to deliver so many times in the past that there is likely to be some extreme market volatility surrounding the event.

The Greek elections are next Sunday. If the ultra left Syriza party captures enough votes they could disrupt the bailout process, defy the EU over Greece's debt and possibly leave the eurozone. The anti-austerity movement is picking up speed and there could be an upset next week. This would be a major blow to the eurozone although everyone is trying to downplay the implications. Stay tuned as the headlines increase this week.

The following week the U.S. Fed will meet and we will hear their interpretation of the economic tea leaves and the fallout from the Swiss franc debacle.



In case you live in a cave without Internet or TV I will recount the news on Switzerland. On Wednesday morning the Swiss central bank broke the peg on the Swiss franc to the euro. The Swiss central bank had pegged the franc at 1.20 to the euro for the last several years. As recently as 10 days ago they affirmed that stance saying they had no plans to change it. On Wednesday they cancelled that peg to let the franc float to its own level. Immediately the franc soared 30% against the euro and 25% against the dollar. It was the largest single day movement by any currency since World War I. These are mind numbing moves since currencies normally moved in tenths of basis points not full percentage points anyone in the currency market surrounding the franc was wiped out.

The global currency markets were thrown into disarray with multiple FX companies being crushed. The most visible in the U.S. was FXCM Inc (FXCM), which is a currency trading firm for individual investors. The company disclosed it was owed more than $225 million by customers that had positions that were wiped out.

In the U.S. currency trading margin is 50:1. That means a $1,000 account can control $50,000 in currencies. Leverage is wonderful because a move to the upside can be huge because of the 50:1 ratio. However, in the currency markets they leverage works both ways. A -2% move against you would zero your account. A 30% move in the example above means you are suddenly -$15,000 overdrawn and that ringing phone is your broker telling you to deposit money immediately.

FXCM said blown up accounts now owed the company more than $225 million. This happened instantly when the Swiss bank announced the peg break. Since the broker is responsible to the exchanges for the user accounts FXCM was suddenly out that $225 million and in violation or regulatory capital requirements.

Shares of FXCM declined from $16.70 to $12.64 by Thursday's close. On Friday they were halted for trading all day as they negotiated with lenders for a loan to keep them solvent. Leucadia National (LUK) parent of Jefferies Group, agreed to lend them $300 million in two-year senior notes with a 10% coupon. However, if FXCM is sold to anyone else in that two year period LUK will receive 75% of the proceeds. Apparently Leucadia was concerned FXCM may not be able to recover that $225 million in margin shortfalls and would have to sell itself or liquidate to end the pain. FXCM has the right to sue the individual account holders for the margin shortfalls but individual investors with marginal accounts probably are not going to be able to come up with 15-20 times their original investment just to cover their overdrafts.

I remember back in the early 1980s when you had to trade through a real live person my Shearson Lehman broker called me four days in a row telling me I had to wire another $25,000 that day to cover a currency position that moved against me overnight. I know exactly how those investors feel this weekend.

Shares of FXCM opened late Friday and traded at a low of $1.50 before rebounding on the news of the LUK loan to close at $4.70. The company said it will resume business as usual next week.


Citigroup (C) said it lost up to $200 million on forex because of the Swiss move. Barclays said it lost $100-$150 million. More problems are sure to surface next week. European currency broker Alpari closed its UK arm saying "exceptional volatility and extreme lack of liquidity" resulted in the majority of their customers sustaining losses. "When a client cannot cover a margin loss, it is passed on to us. This has forced Alpari (UK) to enter into insolvency."

New Zealand foreign exchange dealer Global Brokers NZ was also forced to close its doors because of losses incurred in customer accounts.

This was a major story and it is going to be a major story for months to come. Many Europeans had secured mortgages in francs because the interest rates were very low and the currency stable. Today it will take 20% more to pay off those mortgages. Swiss watch makers are warning they could go out of business because their watches just spiked 20% in price because of currency translation issues. All exports from Switzerland will suddenly cost 20-25% more for Europeans and westerners.

Here is the problem for next week. The Swiss Miss as the franc event is being called has put even more expectations on Draghi to launch a major QE program to bail out Europe from the currency maelstrom and theoretically stimulate the economy. The more the expectations build for Draghi to do something big the better chance he will disappoint. Even if he does launch a big program the market may not be satisfied. If he tries to push the decision off to the next meeting or launches some complicated program of just a few billion then the market is going to be VERY disappointed. The big fear today is that Europe is sliding into deflation and it will drag the U.S. with it. Therefore, if Draghi does not halt that deflationary view the U.S. markets could sour.

The treasury markets are telling us two things. First, the U.S. is a flight to safety and all that European money is flooding into the USA. Second, there is real fear that bankers may not be able to keep the deflation monster away and the next year could be very volatile. Some fringe analysts are still expecting the Fed to be forced to launch another round of QE. While I think that is out of the realm of possibilities I could be wrong.

The 30-year treasury traded down to a 64-year low yield of 2.53% on Friday before profit taking began. It takes a lot of money to push yields lower at this level. It takes a lot of really scared money since the odds of yields dropping further are getting smaller every day.


The dollar is at an 11-year high and still rising. If Draghi launches QE the dollar will continue to rise and the euro decline. That means commodities will continue to go down and add to deflation worries.

Oil prices are also declining because the dollar it at the highest level since 2003. Since oil is priced in dollars it takes fewer dollars to buy a barrel than it did as recently as May. The dollar index hit a low of 78.90 in May. It hit a high of 93.00 on Friday. That is a 18% rise in 8 months. Crude oil was $107 in June and the rise in the dollar equates to a -$19.26 decline in oil prices even without the current surplus. That means one third of the -$59 decline was due to the rise in the dollar not the surplus production.


The dollar strength is going to be a serious headwind to international companies. With the earnings cycle heating up next week we should be watching for the impact of the dollar and the decline in the energy sector as factors in Q4 earnings. Companies not in the energy sector but making products and services that are used by companies in the sector can be impacted. This is a rare opportunity to see how the sector interactions impact the economy.

The earnings activity picks up next week and companies facing currency issues could include IBM, McDonalds, GE and Starbucks to name a few. The brokers should be watch for comments about losses related to the Swiss franc. Those include Interactive Brokers, Ameritrade and E*Trade. Numerous banks report next week but I won't list them here. There were easily 50+ smaller banks that I did not put on the list. With the financial sector reeling from the low rates and weak earnings we could a continued drag on the market.

The airlines including Alaska Air, United Continental, Delta and Southwest should post decent results as a result of the low fuel prices unless their hedges turned against them.

In an unusual move Cowen upgraded Netflix to outperform before their earnings on Tuesday citing strong user survey results, increasing original content and attractive valuation. Netflix is releasing 20 new original shows in 2015, twice the 2014 rate. Cowen raised the price target from $360 to $382. If Netflix trips over earnings and crashes the analyst will look pretty silly. If they beat and soar he will be a hero.


Goldman Sachs (GS) posted earnings of $4.38 compared to estimates of $4.32 but that was lower than the year ago quarter of $4.60. Net revenue declined -12% to $7.69 billion but that still beat estimates of $7.64 billion. Revenue from fixed income, currencies and commodities trading fell -29% to $1.22 billion. Investment banking revenue declined -12%. Shares declined slightly on the news.


Oil services firm Schlumberger (SLB) said it was laying off 9,000 workers roughly 7% of its workforce and taking a $296 million charge in order to slim down after the oil price crash. The company reported adjusted earnings of $1.50 that beat estimates of $1.47. Revenue of $12.6 billion was less than expected by -$100 million. During the quarter they repurchased $1.1 billion in stock (12.1 million shares) and that helped them post better than expected earnings per share. The company said it was reducing capex spending in 2015 by 25% from $4 billion to $3 billion. The company surprised investors with a +20% increase in its dividend from 40 cents to 50 cents. Shares rose on the combination of events.


Charles Schwab (SCHW) reported adjusted earnings of 25 cents that beat estimates by a penny. Revenue of $1.55 billion beat estimates of $1.53 billion. They ended the quarter with $2.46 trillion in client assets. If interest rates ever rise this will be a huge cash generator. Active brokerage accounts rose +3% to 9.4 million.

Shares rebounded slightly after crashing with the sector over the last two weeks.


When companies make announcements late on Friday night it is normally something they don't want you to see. AT&T announced late Friday evening a total of $10 billion in charges but they claim it won't impact earnings. More than $7.9 billion is related to actuarial gains and losses on pensions and post employment benefit plans. Another $2.1 billion is a charge for abandoning some copper lines it felt it no longer needed. AT&T plans to turn off its entire copper line network by the end of the decade. Both of the charges are non-cash and will not impact their adjusted earnings but they still announced it late on Friday so they were expecting some negative publicity. Shares dropped about 50 cents in afterhours.


Precision Cast Parts (PCP) warned it was facing weaker demand from the oil and gas industry. No surprise there. The company also pre-released its Q4 earnings estimate between $3.05-$3.10 but analysts were expecting $3.34. Revenue estimates of $2.42-$2.47 billion were also below analyst forecasts for $2.54 billion. The company said demand in its aerospace business continued to grow. Shares fell -9% on the warning.


Markets

I warned last weekend that the Nasdaq 100 ($NDX) was the one to watch for market direction for the week as it was leading the broader market. That was true all week with the NDX closing at a three-month low on Thursday and the biggest percentage loss of all the major indexes for the week. On Friday the index gapped down to 4,078 before rebounding +61 points to close at 4,140. It was still the biggest loser for the week but that was a decent rebound from critical support.

The 4,090 level has been support on the last three declines but even with the decent rebound on Friday the chart is still ugly. If selling resumes next week I would not expect that level to hold on the fourth retest. The Nasdaq big caps are eroding and unless this situation reverses immediately we are likely to retest 4,000.

Google is being downgraded almost every week. Apple is declining ahead of what could be fantastic earnings but expectations are too great. The tech earnings we have seen already were not exciting and that is weighing on expectations for future tech reports.


The Nasdaq composite is not much better. However, the low for the week of 4,563 was still above the December low of 4,547. Unlike the NDX it did not make a lower low. The Composite index did retest the January 6th lows of 4,567 almost to the penny on Thursday before rebounding on Friday.

The Composite chart is still bearish but not quite as bad as the NDX. Resistance is now 4,650 and support is that 4,547 level from December.



The S&P-500 dipped below 2,000 twice last week to hit 1,988 each time before rebounding. The average range on the S&P for the week was nearly 30 points per day. That is huge and shows how much indecision there was in the market. The 31 point rebound from Friday's low was probably a combination of dip buying and short covering. I am sure very few traders wanted to be short over a three-day weekend. Historically Friday's before a long weekend are positive 73% of the time. With the recent volatility and 300 point moves in the Dow nobody wanted to be faced with the potential for a triple digit gap open on Tuesday because of some European event on Monday.

Even with the decent rebound it is too early to call it the beginning of a rally. I did like the dead stop on 1,988 on Wed/Fri but it is not enough to call a bottom. We need a couple more days of gains on decent volume before we can say the January decline is over.

We did see some strong volume last week. Tuesday was 7.8 billion shares. Wednesday 8.1 B, Thursday 7.9 B and Friday 7.7 B. Since it was option expiration week we should have seen decent volume. I am just concerned that there was strong volume on the downside and weaker volume on the rebounds.

The line in the sand for next week is 1,985. That has been in play multiple times since June and I fear it will come back to haunt us again.


The Dow did something it rarely does and that is respect a moving average. In this case it was the 100-day at 17,309. It was more than likely coincidence rather than support but we will take the rebound regardless of the reason. The Dow did set a five-week low on Friday at 17,243. That was -19 points below the Jan 6th and 14th lows at 17,262. In Dow terms the three lows in January were close enough to be identical. In theory we could call is support but the real test will be next week. If those lows are broken we could easily test the December low at 17,067.

Several Dow components report next week and the European curse could exact a toll on their earnings. The strong dollar, weak European economy is going to weigh on the international blue chip companies in the Dow.

Support 17,262, resistance 17,915.



The Dow Transports fell below the 100-day average for only the second time in 16 months but rebounded back above that level at the close on Friday. I expect this average to be broken again and for the Transports to break below 8,500 in the near future UNLESS the airline earnings next week are blowouts.


The NYSE Composite is still very weak. The trend of lower highs is continuing with the threat of a lower low if the index drops below 10,360. This is already a very negative chart but that would be the kiss of death.


The Russell 2000 was the hero by far on Friday with a +1.9% gain of +22 points. The recent support at 1,150 held but the rebound stalled at resistance at 1,180. Even more surprising was the +2.0% gain in the Russell Microcap Index. I can't decide if this was purely a short squeeze or the dip buyers were flooding into the micros. Given the sentiment in the market last week it was probably a short squeeze.


With the market closed on Monday we will get our direction from whatever happens in Europe on Monday. I would love to believe Friday's rebound had legs but I think it was just short covering. This week is going to be very volatile with the ECB QE decision and the ramp into the Greek election next Sunday. I would recommend a continued cautious approach until we see what Draghi pulls out of his hat and how the earnings shape up on Tue/Wed. The market should have a direction by Thursday.

Random Thoughts

Mario Draghi is facing a daunting task in trying to keep the eurozone from falling into deflation. There are three things making his task harder and the ECB can only control one of them and then only marginally. The first challenge is an output gap across the single currency region. That means production is higher than consumption and there is considerable excess capacity. The ECB only has limited control over this problem and a QE program may not help.

The second factor causing deflation in Europe is the crash in commodity prices. This is good disinflation in some respects because it lowers the price on everyday items and may induce consumers to spend some of their hoarded cash. The last item is the change in economic direction in China. Previously China was consuming 50% of the world's commodities building highways, housing and huge cities that were never inhabited. China has more than 64 million vacant homes and apartments. The cost of the new housing built over the last decade is more than the average consumer can pay. Now China is moving to a consumer focused economy rather than an export economy. This is a long term change. It will take a decade or more to complete. China is no longer building ghost cities so the demand for commodities has fallen dramatically.

Draghi and the ECB have no power over China and their commodity demand and the drop in commodity prices are dragging Europe's inflation rate ever lower. Draghi has to announce a monster QE program, not because it will help the rag-tag collection of countries to rebound from the brink but because not announcing it will push Europe over the economic cliff.

The Goldman Sachs Commodity Index has fallen -42% since June. This compares to the -65% decline during the financial crisis. These are once a decade moves. Commodities are trading today at the same level as 2002 when the global GDP was $30 trillion. The global GDP today is $72 trillion. This appears to be extremely oversold to me and I would suggest long term long entries in a non leveraged commodity ETF. Commodities prices at this level are unsustainable in the long term but they could remain low for several more months. We are currently at or below cash production costs for oil and various metals. If prices don't rise production will decline sharply and will require a couple years to restart.



The World Bank cut its global growth forecast for 2015 from 3.4% to 3.0% and also lowered 2016 estimates. The U.S. may be the best house on a bad block but the other houses are on fire and the flames are getting closer.

In the U.S. hardly a day goes by without somebody getting hacked. On Friday the NY Post tweeted "Federal Reserve head Yellen announces bail-in in emergency meeting rumored negative rate to be set at 4pm EST today." The account had been hacked. That tweet was followed by "The Fed will peg the dollar to the Swiss franc" and "Chinese anti-ship missile fired at USS George Washington." The same tweets were seen on the UPI twitter account.

Active drilling rigs in the U.S. declined by -74 rigs to 1,676 for the week ended on Friday. This came after a -61 rig cut the prior week and brought the total to -255 since the peak of 1,931 on September 26th. That is a -13% decline and the biggest drop since the financial crisis. Oil production is going to slow dramatically if this rig decline continues. Some analysts are saying a minimum of 500 rigs must be stacked and others are looking for a 50% drop in active rigs to something in the 1,000 range by year end if oil prices remain this low.

Schlumberger announced 9,000 layoffs. Halliburton 1,000, Suncor -1,000, Shell -300, Apache -250. I am sure there are many more but the headlines are flying so fast it is hard to keep up. The real cuts will be announced with the energy earnings over the next four weeks.

The Dallas Fed expects Texas alone to lose more than 140,000 jobs from the oil crash. We are hearing from all over the country of layoffs of drillers, drivers for sand and water trucks, service contracts cancelled, vacancies in the oil worker housing in places like the Bakken. It is going to be increasingly depressing as the capex cuts for 2015 begin to take effect.

The world will consume 92.0 million barrels of oil per day in 2015. That is up from 89 mbpd in 2012 and will continue to rise about 1.0 mbpd for the foreseeable future. There may be an oil glut today but it will go away by 2016.

Venezuela may only be weeks away from a collapse. The food shortages are becoming worse. With nearly empty food stores guarded by the military a new plan was put in place last week. Consumers can now shop only two days a week and they can only buy two bags of groceries. That is almost laughable since they can rarely fill up even one bag. Opposition forces are working the population into some serious anger about the current state of affairs. The official inflation rate is 64% but the unofficial rate is well over 150%. The government is running out of money to acquire and distribute needed supplies. When the government can no longer pay the military it is going to turn ugly. Default is inevitable and will be followed by hyper inflation. Consumers are going to bear the brunt of this tragedy and will require massive relief supplies from outside the country once the government fails.

The Swiss stock market fell -13% for the week after the Swiss central bank dropped the peg on the Franc to the Euro. Instead of dropping from 1.2 to the euro to 1.10 to 1.15 as analysts expected it fell to parity at 1:1 to the euro. At one point the franc surged 41% against the euro. At the same time the bank cut the deposit rate to a negative -0.75% in hopes of slowing the influx of money into the country. The head of the Swiss bank said "markets tend to strongly overreact" to surprises. He expects the situation to correct itself once the panic has left the market. He may be surprised. I am sure there will be a lot of headlines next week regarding losses at other currency trading firms and the impact of the currency move on Swiss businesses. I suspect SNB President Thomas Jordan may be looking for a new job in the near future.

For instance the John Hancock $1.9 billion Absolute Return Currency Fund lost -8.7% on Friday. That is a huge decline and the most among more than 2,000 funds tracked by Bloomberg. The AMG FQ Global Alternatives Fund lost -8.3%. This story has a long way to go before it ends and the impacts may show up where we least expect it.

Enter passively and exit aggressively!

Jim Brown

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