After a week of economic misses, lowered guidance and downward revisions to earnings estimates the markets began to give back some of their record gains. Does this mean that investors are suddenly deciding that fundamentals matter or did the market just pause to consolidate?

Market Statistics

The Dow gave back -81 points on Friday and the Nasdaq -24 with the S&P losing -6 and closing at 2,104. After trading at new highs most of the week it was only natural for the indexes to suffer from profit taking on a Friday afternoon. The declines were minimal and given the ugly economic data I think the losses could have been a lot worse. Friday was also a rebalance of the Morgan Stanley indexes at the close and that could have also created some volatility.

The ISM Chicago or Chicago PMI as it was called in the past declined from December's 59.4 to 45.8 in January. This was a five year low. Analysts were expecting 58 based on a Bloomberg survey. The new orders, production and employment components all posted double digit declines. Analysts blamed the sharp downturn on the weather and the port delays on the west coast which prevented Chicago manufacturers from receiving parts. There is no way to accurately determine how much of that impact was real versus imagined. Access to the internals details are subscription only for a high fee.


The Q4 GDP was revised down from +2.64% growth to +2.19% and that was down from +4.97% in Q3. The revisions were led by inventories and exports. The contribution from inventories declined from +0.8% to +0.1%. Net exports reduced growth by -1.2%, which was more than the -1.0% in the prior estimate. Consumer spending was the strongest category with a rise from +2.2% to +2.8%.

The personal consumption expenditures (PCE) showed deflation of -0.4% in Q4 compared to +1.3% inflation in Q3. The Fed will not be glad to see that number. Real disposable income rose from +2.4% in Q3 to +3.8% in Q4.

Analysts were expecting a decline with some expecting under 2.0% so the market damage from the GDP was minimal.


The final revision of the Consumer Sentiment for February rose slightly to 95.4 from the initial reading at 93.6. This is still a relatively small decline from the 11-year high at 98.1 in January but it was the biggest point decline in 16 months. The present conditions component declined from 109.3 to 106.9 and the expectations component declined from 91.0 to 88.0. The revised report was ignored.


The Pending Home Sales Index for January rose +1.7% to 104.2 to erase December's -1.5% decline but it was far short of the expectations for a +3.4% rise. This is the fifth consecutive miss on forecasts. Analysts were quick to blame the weather because I guess it never snowed in January before. The Northeast posted a gain of +0.1% after a -3.6% decline in December. It was the Midwest with a -0.7% decline that weighed on the index. The South rose +3.2% and West +2.2%.

Next week is a big week for economic reports. The ADP and Nonfarm payrolls will be the most watched with the two ISM also providing key details on the current state of the economy. The Fed Beige Book on Wednesday could be a challenge with the regional manufacturing reports trending lower it could be reflected in the Book. This would be a serious hiccup for the street because the general consensus is that the economy is chugging right along at a 2.5-3.0% growth rate.

There are multiple factors that could have impacted economics over the last month. The weather was certainly a concern followed by the rapid slowdown of activity in the energy sector and the port slowdown. This could have impacted multiple Fed regions and the book should give us the details. The key will be how the market reacts to it since all those factors are already common knowledge.

The ADP payrolls are expected to be flat with last month at +210,000 jobs. The Nonfarm payrolls are also expected to be nearly flat with only a 7,000 job decline to +250,000. I worry that all the factors I mentioned above may have put a crimp in hiring for February. That is especially true for the Northeast where the winter weather was especially severe. Unless you were hiring for snow shoveling positions there was probably not much activity.


Two new splits were announced last week with South Jersey Industries and Magna Intl. Neither is expected to produce a split run like we are seeing in HBI and Visa.


Fed Vice Chair Stanley Fischer was interviewed late Friday and he said it was about time for the Fed to raise rates and he expected it to happen in June or September. Other than that he repeated the party line about data dependence and at least two meetings with no change as long as the word patient was in the statement. The market took a dive about the time of the Fischer interview so his blunt answers may have been a minor concern.

It has been 9 years since the Fed has announced a rate hike.

The Fed wants to raise rates but before they can do that they want to see GDP growth, earnings growth, job growth and inflation growth. The economy is just not cooperating.

For the month of February 38 economic reports missed estimates and came in weaker than expected and only six reports came in better than expected.

The FDIC created some news when it prematurely announced that the Doral Bank in Puerto Rico had failed and the assets had been sold to Banco Popular de Puerto Rico. The news was released at 3:03 PM and normally the announcements are made after the close of business, which in Puerto Rico is 6:PM. The FDIC sent another email claiming the release had been sent in error. An appeals court determined this week that Doral was not owed a $229 million tax refund by Puerto Rico's Treasury, overturning a verdict favoring the bank. Earlier in the week a former Doral executive was arrested for allegedly defrauding the bank of $2.3 million in a procurement scheme. It was not a good week for Doral.

Doral Bank had $5.9 billion in total assets and $4.1 billion in total deposits. Banco Popular will buy $3.25 billion of Doral's assets. The FDIC said Doral's 26 branches would remain open for normal business under new names starting on Saturday. Banco Popular would operate 8 of them and three other banks acquired the rest. Shares of parent company Doral Financial (DRL) declined -46% into the close. Shares of Banco Popular (BPOP) rose on the news.



In stock news Monster Worldwide (MNST) shares rallied +13% after reporting earnings of 72 cents compared to estimates for 59 cents. Revenue of $605.6 million also beat estimates of $585 million. The company is expanding its distribution partnership with Coca-Cola and that allowed them to expand sales in both domestic and international markets in Q4. They launching new drinks and they look unstoppable.

The company said the deal with Coke was still set to close in Q2. Under that deal Coke will buy the non-energy drink brands from Monster for $2.15 billion in cash. Coke will transfer its own energy drinks to Monster. Monster will also get to use Coke's international distribution infrastructure. Some analysts believe Coke will eventually end up buying Monster.


JC Penny (JCP) shares declined -7% after reporting zero earnings when analysts expected 11 cents. Revenue of $3.89 billion did beat estimates of $3.68 billion. Shares had been trading over $9 at a five month high in expectations that the company was succeeding in their comeback from the Ron Johnson disaster. He tried to remake Penny's and failed badly with shares trading as low as $5 and investors worrying they would file bankruptcy. Shares declined sharply at the open to $7.88 and rebounded to nearly $9 intraday. When the markets began to roll over the rebound faded.

Penny's is making good strides. Same store sales rose +4.4% but the company only projected 3-5% for 2015 and down from their last projection. The operating income of $63 million was not much but it ended a streak of 13 straight quarterly losses. However, after raising $3 billion in 2013 the company said free cash flow in 2015 would be flat. While that is better than burning cash it is not very encouraging.


Weight Watchers (WTW) no longer needs to go on a diet after shares lost -35% with very weak guidance and earnings miss. The company reported adjusted earnings of 7 cents compared to estimates for 8 cents. The company guided for full year earnings in the range of 40-70 cents and analysts were expecting $1.43. The -35% decline was the largest single day drop in 13 years. This was on top of a -78% decline over the last three years. Since America is the most obese nation the WTW guidance is not because people don't need to lose weight. They are simply not doing it with Weight Watchers.


Tetra Technologies (TTI) reported earnings of 9 cents compared to estimates for 8 cents. Revenue of $315.9 million missed estimates for $321 million. Shares jumped +20% after the company said sales in its fluids division rose 24% in Q4.


Horizon Pharma (HZNP) reported earnings of 27 cents that beat estimates by a nickel. Full year revenue spiked +300% to $297 million and a profit of 95 cents compared to a loss of 58 cents in 2013. They raised revenue guidance for 2015 by $25 million to $475 million. The +8% jump in the shares closed at a new high.


Nimble Storage (NMBL) lost -8% after beating earnings but guiding below consensus. The company posted a loss of 13 cents that beat estimates by a penny. However, they guided to a loss of 13 cents in the current quarter and that was below analyst estimates. The company said it was reaching an inflection point as enterprises of all sizes are starting to justify the risk of moving away from long standing vendor relationships. In theory that means Nimble should seen improving profits but they are not promising that today.


Key earnings for next week include Costco, Palo Alto networks, Staples, Abercrombie & Fitch, Caesars and Ctrip.com. The number of big name companies are disappearing fast as the small caps take over the end of the earnings cycle.


How do you play a stock that has 320 million shares outstanding but has 2 billion shares coming out of lockup in the coming months? Alibaba (BABA) currently has 320 million shares available to trade with an average volume of 14.9 million per day. On March 18th another 429 million shares come out of lockup and are available to trade. Shares are already only a couple dollars off their historic low but the stock is not declining as you would expect with another 429 million shares about to drop on the market. I looked at multiple option strategies but the potential for a big move has inflated the premiums.

While I don't expect a monster drop on the 18th there may be weakness. Since every BABA shareholder knows the share expiration is coming they should have already sold or protected themselves with options. I know the market always assumes there will be heavy selling when these lockups expire but that rarely happens because the event is so well telegraphed. This suggests we should look for some bullish trades but the expiration cloud is still clouding my judgment.

To make matters worse on September 20th the lockup will expire on another 1.2 billion shares. With the shares available to trade more than doubling on March 18th you would think that the lead up to the September event could be really ugly. The better trade may be to wait for BABA to bounce and then buy long term puts after the option premium fades. With Jack Ma cutting bonuses and complaining about revenue I don't see a flurry of earnings surprises in the near future.


Crude oil lost $1.58 for the week despite a counter trend short squeeze to $51.28 on Wednesday. There was no reason for the spike since oil inventories rose +8.4 million barrels to 434.1 million and another 80 year high. There was a rumor that the OPEC president was thinking about calling an emergency meeting "in several weeks" if prices did not stabilize. U.S. production rose slightly to 9.285 mbpd and another post 1972 high.

I have written about the coming lack of storage capacity several times in recent weeks. There is a limit to how much oil can be stored. On Friday an analyst at Bank of America noted that storage was becoming critical and could run out by the end of March. When that happens it will be a bidding war to sell for any price to anyone with available storage.

Normal buying patterns are already in disarray. For instance, Mexico is shipping oil to South Korea and Japan for the first time in more than 20 years. Typically those countries buy from Middle Eastern producers like Saudi Arabia. Mexico is so desperate to sell its oil that it severely discounted it in order to get it sold. Mexico is selling its oil for the lowest price in nearly 20 years. Mexico has oil to sell because the U.S. is producing almost 4.2 million barrels per day more now than we produced in 2008. In January 2008 the U.S. only produced 5,028 mbpd compared to the 9.285 mbpd we are producing now. This has significantly disrupted the import patterns. For the week of June 25th, 2004 we imported 10,591 mbpd and that has declined to an average of about 7.2 mbpd for February. That means roughly 3.4 mbpd that we used to import is now competing for market share somewhere else in the world.

Oil prices should not have risen on Wednesday's inventory data. I believe traders were so short that even a little headline caused a knee jerk reaction and a short squeeze. On Friday when the rig data came in with fewer rig declines than expected the price dipped to $48.50 but then a flurry of buying hit as traders took profits ahead of the weekend.

Active rigs declined -43 to 1,267, now down -664 rigs from the 1,931 high in September. Oil rigs declined -33 to 986 and gas rigs declined -9 to 280 and a new 18 year low.

If you are paying attention we have lost -664 rigs since September but oil production set a new 43 year high last week. Oil production will eventually decline but it could be another 3-6 months because wells already drilled still need to be completed and connected to the pipelines.

While I believe we are setting up for another decline in oil prices we are seeing very stubborn support at $49. Since consumption rises in early May as refiners begin pushing summer gasoline blends into the system the price of crude also rises. The $64 question is whether consumption will begin before storage capacity runs out. Stay tuned.



Markets

I don't think we should take Friday's decline too seriously. The rebalancing of the Morgan Stanley indexes, fear of holding gains over the weekend and normal month end profit taking were probably the reasons for the weakness. The markets made new highs and the Nasdaq moved to within 11 points of 5,000. It was still a good week.

When you consider the overextended nature of the indexes we are due for a rest. If the Dow had closed over 18,206.58 it would have had the biggest one-month point gain in history. It traded over that level to 18,213 intraday but ended up giving back -81 points to close at 18,134 for a +970 point gain for the month. We can't complain about an 81 point loss.

The S&P struggled the last two days because Apple was struggling. The stock closed -$5 off its highs for the week. That is not a big loss but it was enough to drag down the S&P and Nasdaq. The 2,120 level proved to be short-term resistance for the S&P 500. Thus far the big cap index is only down nine points from its high. The pullback may not be over yet. Watch for potential support near 2,104 and 2,090.

The Nasdaq has been levitating higher all month with the 5,000 mark acting like a magnet. We almost got there on Thursday with an intraday high of 4,989. Potential support looks like 4,950 and 4,900.

The small cap Russell 2000's dip on Friday snapped a ten-day winning streak. Small caps could definitely see more profit taking. Short-term support is probably the late December highs near 1,220.

My bullish bias hasn't changed. I cautioned readers on Tuesday that we were due for a dip. This dip may not be over yet. On the plus side the first few days of a new month tend to have a positive bias as fund managers put new money to work. We will have to see if investors are still in a buy-the-dip mood.

Enter passively, exit aggressively!

Jim Brown