Investors were breathing a sigh of relief at the close on Friday. After a week of extreme volatility with multiple 200+ digit swings on the Dow the indexes closed the week with gains. Those gains were minimal but the Dow closed +325 points off its lows for the week.

Market Statistics

The Dow declined -504 points from its high for the week at 17,629 on Monday to the low of the week at 17,125 on Wednesday. The +325 point rebound off that low suggests buyers are starting to nibble at stocks again.

Friday's economics were slightly positive and not really a driver for the market. The late week rebound was more a result of seller exhaustion after the Chinese devaluation of the yuan caught everyone off guard. Wednesday's dip was seen as somewhat of a capitulation event and retest of the July lows.

The Producer Price Index for July rose +0.2% after gains of 0.4% in June and +0.5% in May. The decline in wholesale prices was blamed on the -20% decline in oil prices from the June high of $63.12. Final demand for goods declined -3.7% year over year while demand for services rose +0.6%. Core processed goods declined -3.1% and core unprocessed goods fell a whopping -30.7%. That is a direct result of the decline in oil and other commodities.

The weak PPI report could cause the Fed to rethink their plans to hike rates in September. However, the Fed has been steadfast in claiming that the drop in commodity prices was transitory and would not impact inflation long-term. The current set of inflation numbers could cause them to reevaluate their view of the "transitory" concept.

The Industrial Production report for July showed a rise of +0.6% compared to estimates for +0.3%. The reason for the stronger rise was purely auto related. Durable goods production rose +1.2% but inside that category was a +10.6% rise in motor vehicles and parts. That came after a -4.3% decline in June. Several domestic automakers either shortened the annual summer shutdowns or cancelled them completely. This caused a monster spike in auto production. Normally the seasonal adjustments level out the July/August period and the plant shutdowns.

In the bad news section, there were downward revisions to May and June that pushed the annualized production rate down from -1.4% to -2.0%. Overall, the report was disappointing.

The first consumer sentiment reading for August declined slightly from 93.1 to 92.9. The internals components barely changed. The present conditions component declined from 107.2 to 107.1 and the expectations component declined from 84.1 to 83.8. As Obi-Wan Kenobi would say, "Nothing to see here, move along." (FYI - there is a strong rumor of an Obi-Wan Kenobi movie spinoff from the Star Wars series)


The economic calendar is pretty busy next week but the two main events will be the FOMC minutes on Wednesday and the Philly Fed Survey on Thursday. The minutes will be under a magnifying glass for clues about a September rate hike. I doubt there will be any real clues but you can bet the market will become jittery ahead of the release.

The Philly Fed Manufacturing Survey is a proxy for the national ISM Manufacturing due out two weeks later. This is the first look at the August manufacturing conditions.

The new residential construction and existing home sales reports will be of interest just to make sure sales did not fall off a cliff in August. Since sales and construction both decline in late summer and into the fall these reports are just a pass-fail test for the sector. It would take a material decline in the numbers to produce a market response.


There were no stock splits announced last week. We are still waiting on the UnderArmour board meeting to set the date on their previously announced split.


The earnings calendar is finally shrinking. The material earnings for next week are primarily in the retail sector. Walmart, Target, Staples, Sears, Gap Stores, Home Depot, Limited, Disks Sporting Goods, Hibbett Sports, Lows, Foot Locker and Urban Outfitters are the best known.

SalesForce.com, Deere and Agilent are the non-retail headliners.


El Pollo Loco (LOCO) was road kill on Friday with a -21% drop. Earnings of 18 cents were in line with expectations but down from 22 cents in the comparison quarter. Revenue of $89.5 million missed estimates for $93 million. Guidance was also weak. The CEO said we "kind of lost the value focus" in the first half of 2015 and put too much emphasis on the higher dollar items. Same store sales of +1.3% fell short of estimates for +3.2%.


Nordstrom (JWN) rallied after posting earnings of $1.09 compared to estimates for 90 cents. Total revenue also rose +9.1% to $3.701 billion. Same store sales at Nordstrom's rose +1.1% while the Rack stores rose +13%. Nordstrom online sales rose +20% and NordstromRack.com/HauteLook sales rose+50%. The combination of all of the above pushed Nordstrom's total same store sales to +4.9%. Total stores rose +13 to 304. Eleven of those new stores were the Rack stores, which are in high demand today. The company raised guidance from 7-9% sales growth to 8.5-9.5%. Earnings per share guidance rose from $3.65-$3.80 to $3.85-$3.95.


Sysco Corp (SYY) surged +7% on news Nelson Peltz's Trian fund had acquired a $1.6 billion, 7.5% stake and intended to go active against the board. Announcing the 42 million share stake gives Peltz one week to nominate individuals for a board seat. The nominations close on August 21st. Judging from the stock chart the news of his position was leaked. Shares rebounded from $35.73 the prior Friday to $38.50 this Friday before the headlines broke. Once the news was reported on CNBC shares rallied +$3 to close at $41.39 and an eight-month high. Volume was eight times normal.


Lumber Liquidators (LL) rallied +8% after news broke that Julian Robertson's Tiger Management had acquired 238,000 shares. LL was crushed after a 60 Minutes report claiming their flooring had a hazardous level of a cancer causing chemical. LL has reportedly denied the allegation but more than 10,000 customers have filed claims to get their floors replaced. 60 Minutes will be rerunning that broadcast on Sunday evening.


Twitter (TWTR) shares were up slightly after a rumor that the CEO search would end next week with the announcement that co-founder Jack Dorsey would be named CEO again. Sun Trust analyst Robert Peck believes Dorsey will get the CEO role and join product head Adam Bain and board member and co-founder Evan Williams as the "triumvirate of leadership." Peck said given the tough road ahead the guidance of this triumvirate might be the best solution.

However, other analysts were not as confident. Dorsey is CEO of Square, a payments company that is expected to IPO soon. Previously the board of Twitter said they would not consider a dual CEO role where the CEO still occupied a position elsewhere. Dorsey has said he wants to remain at Square.

This will give Twitter traders indigestion and should that announcement occur the stock could trade in either direction. Dorsey has his fans but Twitter investors were hoping for new blood that could hit the door running and turn the company around. It might be time to add some December $32 calls and some September $28 puts as insurance.


Whole Foods Market (WFM) was initiated with a sell rating by Pivotal Research. The analyst said in every single market Trader Joes is gaining market share against Whole Foods. Also, Walmart and Kroger have added numerous organic products at a much cheaper price. The individual store category is also getting crowded with Fresh Market (TFM) and Sprouts Farmers Market (SFM) also gaining share. With Whole foods, jokingly referred to as Whole Paycheck and the most expensive of the various other options, it is the most at risk.


Shake Shack (SHAK) finally floated enough stock to qualify for options. The rules require a 7 million share float in order to list options. Puts were trading at a higher cost than calls. Apparently, existing shareholders were looking for a way to protect against further downside. Traders were also looking for a way to profit from further declines. Puts down to $47.50 for August with only five days remaining were being bought with the stock at $55. The most active call was the September $65 with 711 purchased. Multiple analysts expect to see SHAK trade down to the IPO lows at $40.

The stock has a cult like following but it is really a very small company. They have 71 stores and plan to add 12 per year up to a target of 450. That would take them about 35 years at the current pace.


Tesla (TSLA) announced a secondary offering of 2.1 million shares earlier in the week at a price of $242. On Friday, they raised the offering to 2.7 million shares. Underwriters have an overallotment option of another 400,000 shares. Tesla shares did not decline because Elon Musk said he would buy $20 million of the shares being offered or roughly 82,645 shares. Musk already owns 28,288,697 shares worth $6.874 billion. What is another $20 million when you are hyping your own offering?


Alibaba's Jack Ma now owns the most expensive home in China. According to a report in the South China Morning Post, Ma bought a luxury home in Hong Kong for $193 million. On a square foot basis that is the second most expensive home in the world because it only has 9,890 square feet. At that price, you would expect a lot of drive up appeal but the street view of 22 Barker Road on The Peak is severely lacking. However, the opposite side has panoramic views.



Jack Ma better start worrying about Alibaba's share price or several million investors will be hunting him down. Shares traded at a historic low at $72 on Wednesday after the company reported its lowest revenue growth as a public company at +28% to $3.3 billion. Operating profits declined -25% to $832 million. Slower economic growth in China and stronger competition are hurting the Alibaba fan base. Rival Tencent said revenue rose +19% to $3.8 billion and net profit rose +25% to $1.2 billion. Jack's wealth declined by -$752 million on Wednesday. That has to hurt even for a billionaire.


General Electric (GE) signed a deal to sell GE Capital Bank's U.S. online deposits to Goldman Sachs (GS) for $16 billion. Goldman will acquire $8 billion in online accounts and $8 billion in brokered certificates of deposit owned by GE.

Also on Friday the company said it now expects approval of its deal to buy Alstom's energy business for $13.8 billion. The deal is backed by France and the EU Commission had some concerns. GE said they submitted a remedy package that addresses the commission's concerns and a speedy approval is expected.


John Paulson served notice that he was voting all of his 21.9 million shares in favor of the proposed merger of Mylan (MYL) with Perrigo (PRGO). He issued a press release that praised the deal. Shares of Perrigo rallied $3.50 on the news to close at $196.

However, Institutional Shareholder Services (ISS) recommended voting against the deal. Mylan has offered to acquire Perrigo for $75 in cash and 2.3 Mylan shares for each Perrigo share. As of Friday's close, that would value Perrigo at $200 per share.

ISS said the transaction would be "value destructive" and would incur significant dilution with no subsequent leverage. "Approving this proposal requires too heavy a belief that the 'real' synergistic opportunity is much greater than Mylan has been able to demonstrate." ISS also said it appears Mylan has been unable to win over the required 80% of shareholder approvals.

While the market appears to be expecting a Mylan win the analysts are far less hopeful. Mylan shares have languished at the $55 mark since Teva dropped its $40 billion hostile bid on July 24th and pursued a deal with Allergan for a similar amount.



Hercules Offshore (HERO) filed bankruptcy after revenue declined -67% because of the drop in oil prices and reduced offshore drilling activity. The company listed $1.3 billion in debt and $546.3 million in assets. The filing was done with the permission of the bondholders. Under the preapproved plan the bond holders will receive 96.9% of the company in exchange for the debt. Existing shareholders will retain 3% of the company plus receive some warrants. Under the plan, Hercules will receive $450 million in new debt financing. The money will be used to complete the construction of the new Hercules Highlander, which is currently under construction in Singapore. The jackup rig can operate in 400-feet of water and drill to 30,000 feet. The rig already has a five-year contract from Maersk Oil at a lease rate of $225,000 per day. Hercules operates 27 jackup rigs and 21 liftboats.


KKR's Samson Resources, a company they bought in a leveraged buyout in 2011 for $7.2 billion, is planning on filing bankruptcy by mid September. This was the largest LBO of an energy company at that time. The company has worked out a deal with lenders to turn over ownership to the debt holders. KKR had invested $4.1 billion in cash into the company. Samson will miss a bond payment due on Monday and use the 30-day grace period to try and seek broader creditor support for the plan.

Samson was primarily a natural gas producer and troubles started right after the LBO when gas prices fell to a decade low. Samson has been bleeding cash and has lost more than $4.5 billion since the buyout including $490 million in the first three months of 2015. Japanese firm Itochu Corp took a 25% stake in Samson for $1 billion and they are writing off the entire amount as a loss. Samson was debt free before the buyout but ended up with $3.6 billion in debt as a result of the LBO.

There will be more bankruptcies as the pain increases from oil prices remaining lower for longer than analysts had first predicted. Citigroup warned last week that prices would decline after Labor Day as demand slowed. Gary Shilling of Shilling and Company warned that prices could be headed for the $20s. However, other analysts believe Saudi Arabia has reached their pain threshold are could announce a cut in production in Q4.

There was a major development on Friday with regard to the exporting of U.S. oil. The Commerce Dept said it was "acting favorably" on a number of applications to export U.S. crude to Mexico in exchange for imported Mexican oil. The oil swaps involve licenses that are expected to be issued by the end of August and will last one year. Producers can ship light crude to Mexico in exchange for heavy crude from Mexico. Mexican refineries are old and they can process light crude easier. U.S. coastal refiners are better equipped to process the heavy crude, which they get from Mexico, Venezuela and the Middle East. Pemex said it was seeking to swap 100,000 bpd or 1% of U.S. production. While this event is not material for the price of oil it is the second such deviation by the Commerce Dept over the last year. This suggests the administration is becoming more open to ending the 40-year outright ban on exporting U.S. crude.

Oil prices declined to $41.35 on Thursday to a 6.5 year low. Energy stocks rallied +3% for the week. If you are looking for logic do not look in the equity markets. Energy stocks are so depressed that analysts are recommending them as a buying opportunity. Most carry decent dividends but most investors do not realize that these dividends are an endangered species.

With cash flows imploding, debt payments coming due and drilling expenses a daily occurrence, the odds of dividend cuts are very good. I wrote a couple weeks ago that I did not want to try and catch the falling knives in the energy sector.

Oil prices "should" continue lower because the fall maintenance season begins in about two weeks. Refiners will begin shutting down for maintenance and conversion to winter blend fuels. During this period, oil demand will decline about 1.5 mbpd at the peak and that will allow inventories to begin rebuilding again. Once the summer driving demand ends with the Labor Day weekend those crude inventories should rise quickly. Prices should continue to fall as inventories rise.

Active rigs were flat at 884 for the week ended on Friday. However, there was an addition of 2 oil rigs and decline of 2 gas rigs. As long as oil rigs continue to climb we should see oil prices continue to weaken.



The decline in oil prices plus the sudden drop in agricultural commodities pushed the CRB index to new 13-year lows. This will definitely give the Fed something to worry about with their "transitory" view of lower inflation.


Markets

Wednesday's dip and rebound caught a lot of traders off guard. Volume of 8.2 billion shares was 1.2 billion more than Tuesday's decline. Despite the sharp drop at the open to 2052 and a six-week low, advancing volume was higher at 4.32 billion shares compared to declining volume at 3.66 billion. There were plenty of buyers waiting for a dip to that level. There had been some heavy selling on Tuesday and Wednesday and I am sure the short interest increased significantly. Those shorts were squeezed hard on the rebound and were unable to reestablish enough positions to push the indexes back lower by Friday.

The S&P rose on Friday to close just under Thursday's high at 2091. If you look at a daily chart, it is still ugly. Friday's green candle is miniscule compared to the long candles for the last two weeks. However, there were some positive points.

The 200-day average at 2076 was broken severely on Thursday but the rebound back over that level kept it in play. The long-term horizontal support at 2075 was also in play all week and there were no closes under that level. While I may be grasping at straws here, the S&P appears to be setting up for a stronger rebound.

However, the S&P faces serious resistance at 2100 and 2110 and it will take more than a few dip buyers to push it higher ahead of the Fed meeting in September. If we look back to March the S&P has been stuck in this 2040-2130 range for the last six months. We have crossed the 2100 level dozens of times in both directions without a lasting move.

While it may appear that the S&P is setting up for a continued move higher, that move is probably not going to retest the highs. That 2100-2110 resistance is likely to remain firm and the index will continue to fluctuate in its current range. The expression "buy the dips and sell the rips" comes to mind. Traders employing this strategy over the last six months would have done well.


What I find amazing is that the percentage of stocks in the S&P with a bullish chart has not changed over the last two weeks despite all the volatility. We are stuck in the 52% range. Also, the AAII Investor Sentiment Survey confounded expectations last week with a surge in bullish sentiment. This is for the week ended on Wednesday. With Thr/Fri from the prior week and Tue/Wed all showing significant declines in the market you would have expected a surge in bearish sentiment and no gain in bullish sentiment.

Apparently, the big gains on Monday and the strong +275 point rebound from negative territory on Wednesday were enough to turn some people bullish. There was an increase in bearish sentiment as well so at least some traders were worried about the big drops. Neutral sentiment declined a whopping -10.6% so the big swings in both directions definitely polarized some opinions.



The Dow remains the weakest chart but the drop to 17125 on Wednesday could be seen as a retest of the February lows and traders definitely rushed to buy those stocks. The rebound slowed just under 17500 and the chart is still in a decline. While the dip recovery was amazing, it did not correct the trend in the chart. Resistance at 17500, 17600 and 17775 remains strong. The Dow is well under its 200-day average at 17821 but the Dow is not very reactive to averages because of the slim 30-stocks composition.

The 50/200 death cross last week is normally a sell signal but Bespoke was out with some analysis last week showing that the Dow has not followed that pattern either over the last 60 years. It was up after the cross about as much as it was down in the weeks that followed. I chalk this up to the lack of average reaction as I stated above. A death cross on the S&P would be more critical. That could also come in the next couple of weeks.

The Dow stocks were mostly neutral on Friday. There were no big winners or losers. With total market volume of only 5.17 billion shares it was the lightest volume day in 2015. Traders were exhausted from the huge moves over the last two weeks and they probably left early to try and squeeze one more weekend into their summer. There was a definite lack of conviction by both buyers and sellers.



The Nasdaq punched through support at 5000 on Wednesday but recovered to close back above that level. Thursday's rally failed at 5070 and collapsed back to 5033 at the close. Friday's +15 point gain closed at 5048 and failed to return to Thursday's highs. This is actually negative compared to the Dow and S&P. It would appear that the Nasdaq is nursing some weakness. This came from the biotech sector.

The Biotech Index declined hard the prior week and was down slightly by -1% last week. The index broke below its 100-day average and is struggling to hold over support at 4000. The biotech bubble may be bursting after the recent flurry of M&A sent stocks to nosebleed valuations. A sustained dip below 4000 would be a real drag on the Nasdaq.


Like the Dow the number of big winners/losers were limited on Friday. Most of the stocks on the top of the list were names most traders do not know and they had very little impact on the Nasdaq because of their small capitalizations.



The Russell 2000 barely hung on to the 1200 level last week. The index broke below that level on Thursday before rebounding and then dipped back to test it at 1199.46 on Friday. This is the critical level for the index and the market. A close materially below 1200 would be negative for market sentiment. The Russell index is in decline and while I would like to point to the support test last week as a material event, I do not want to recognize it as such until a couple days have passed. The Russell could still go either way.


The Vanguard Total Stock Market Index ETF (VTI) is still neutral. The ETF shows the same rebound as the other indexes with support at $106. At some point soon there will be a test of down-trend resistance and possibly a retest of that 106 level. The VTI is right in the middle of its range since March and approaching a decision point for direction.


While there were encouraging signs over the last couple days, it is too soon to make a judgment call over market direction. We are still in the summer doldrums and market volume will continue to slow over the next two weeks. Fund managers are not likely to be making major purchases ahead of the Labor Day holiday and the FOMC meeting but they may be interested in taking profits to raise cash for a post Fed dip. With the year rapidly slipping away those managers will be dumping underperforming positions in hope of snagging some winners with enough beta to lift their sagging returns before the year expires.

Morningstar reported that equity fund outflows for the first seven months of 2015 exceeded the entire year for every year since 1993. In July alone $14 billion flowed out of equity funds and that followed an $8 billion withdrawal in June. More than 56% of the S&P stocks are in a correction. More than 60% of the Russell 3000 stocks are in a correction. This is the most hated bull market in history. Despite the withdrawals, the S&P has remained within 3% of its historic highs. That is very good relative strength and it can be chalked up to stock buybacks. Companies have already bought back more stock in 2015 than in all of 2014.


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Random Thoughts


The Atlanta Fed's real-time GDPNow projection has sunk to +0.7% growth for Q3 compared to the 2.7% average forecast by the private sector. The Fed has got to be wondering how they can justify a rate hike in September with their own numbers showing less than 1% growth.

I believe the Fed is stuck between a rock and a hard place. The current zero percent interest rate was put in place as an emergency backstop to the financial crisis. After six-years, the low rate is no longer having any impact on the economy. While the U.S. is not growing at its full potential it is growing. However, as each day passes we near the next recession. Regardless of how well the Fed manages the economy the seven-year cycle will eventually bring us a new recession. If interest rates remain at zero the Fed will be left with few options to provide stimulus when that recession appears. They have to raise rates even though the economy is not strong enough to justify it.

The Fed has another problem that is rarely discussed. They continue to buy treasuries each month as securities in their portfolio mature. Basically this is QE light since they are maintaining the size of their balance sheet and keeping interest rates artificially low. They have two ways to deal with this. They can quit replacing maturing securities and let the portfolio decline over the next 5-7 years. That would be the preferred method. If they are forced to sell treasuries into the market the interest rates will rise possibly more than they would like.

The Fed is facing numerous options and headlines as the current recovery ages. If a recession appeared over the next couple of quarters, there would be some very tense discussions in the halls of the Fed. Since the Federal Reserve has never successfully unwound a period of monetary stimulus and they have never had a stimulus program this large, the long-term outlook for the markets is negative. There is always a first time for success but I doubt this is it.


In a survey by the WSJ, 82% of economists questioned expect the Fed to raise rates in September. Another 13% said the Fed would wait until December. WSJ Survey


Between March 2014 and May of this year China reduced its holdings of U.S. treasuries by -$180 billion. China's appetite for U.S. debt peaked at $1.65 trillion in 2014. Despite their reduced appetite for U.S. debt, the interest rates on treasuries have remained low. Mutual funds, institutions, insurance companies and other countries are picking up the slack. Bond funds have seen major inflows of cash seeking a return safe from the equity market's fluctuations. Major dealers have even said there is a shortage of quality securities in the market. The current uncertainty about China, Greece and Russia has increased the appetite for treasuries.

Overseas investors and institutions now own about $6.13 trillion in U.S. treasuries. That is up from $2 trillion in 2006. China owns roughly $1.47 trillion today. Japanese investors sold $9.4 billion in treasuries in June. That is the most in two years.

With political candidates constantly warning about the nearly $19 trillion in U.S. debt and the potential for it to rise to $25 trillion by early next decade the overseas appetite may be shrinking. Source


A couple of weeks ago China said it was going to support the stock market until the Shanghai Composite Index returned to 4,500. I said at the time this was a suicidal admission since naming a specific index level would only mean that investors would sell whenever the index neared that level. I said they would have to modify their support claims to a more generic form without specific numbers to prevent that from happening.

China realized the error of its admission. On Friday the China Securities Finance Corp (CSFC), the market regulator, said "for a number of years to come, the CSFC will not exit the market. Its function to stabilize the market will not change." The CFSC was tasked with buying shares in the market in order to end the collapse. The regulator was given a credit line of up to 3 trillion yuan ($500 billion) to halt the market collapse.


Jeff Hirsch at the Stock Trader's Almanac said August was proceeding as expected. The first nine trading days were down as is normally the case. The middle of the month surrounding option expiration was slightly more bullish with a cluster of 4-5 trading days with market gains. However, expiration week has been negative 3 of the last 5 years. The week following expiration was down more often than not.


Apple is reportedly farther along than expected on its self-driving electric car program. Emails acquired under a public records act request show that Apple was negotiating for test time at the GoMentum Station. This is a 2,100 acre former naval base near San Francisco that contains 20 miles of paved highways and city streets. The base is closed to the public and guarded by the military. The military claims it is the largest secure test facility in the world for testing CV and AV technologies. CV means connected vehicles and AV means autonomous vehicles. Mercedes and Honda have already used the facility to test their self-driving cars.

Apple is known to have hired dozens of automobile engineers and large-scale battery technicians. Tim Cook has toured various auto-manufacturing plants and Apple held discussions a couple years ago about buying Tesla. Apple Building a Car


Iran has as much as 50 million barrels of crude oil stored on tankers in the Persian Gulf. If sanctions are lifted this would allow them to put up to 500,000 bpd of crude oil on the market by mid 2016. This would force prices lower once again. Iran Hiding Oil


This year's El Nino could be the strongest since records were started 60 years ago. El Nino, begins with warmer than usual water temperatures in the Eastern Pacific. This modifies weather patterns around the entire world. In the U.S. it can bring heavy winter precipitation to California and the south. That would be great news for the drought stricken region. However, it can also bring warmer weather around the world including droughts in Australia, hurricanes in the pacific and a warmer planet in general. Since 2015 is already shaping up to be the warmest year on record we really do not need to see hotter weather ahead. Mother of all El Ninos


 

Enter passively and exit aggressively!

Jim Brown

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