The Dow and the Russell 2000 dropped into correction territory with more than a -10% decline since their recent highs. The Nasdaq is only 13 points away from a correction with a -9.75% loss. The S&P still has more than 50 points to drop to qualify.

Market Statistics

The Dow has declined -1,853 points (-10.12%) from the 18,132 closing high on May 19th.

The S&P has declined -160 points (-7.51%) from the 2,131 closing high on May 21st.

The Nasdaq Composite has declined -509 points (-9.75%) from the 5,218 closing high on July 20th. The Nasdaq 100 ($NDX) has declined -478 points (-10.22%) from the 4,679 closing high on July 20th.

The Russell 2000 has declined -140 points (-10.8%) from the 1,296 closing high on June 23rd.

The Dow decline last week was the worst week since August 2011 when it fell -2,120 points in ten days from the 12,724 high.

More than 31% of the S&P-500 stocks are in a bear market with more than a 20% decline. More than 70% are in a correction with declines of more than 10%. More than 85% of the energy sector stocks are in a bear market, 40% of tech stocks and 43% of materials stocks.

Multiple factors powered the market decline. The primary factors came from China. The Shanghai Index fell -11.2% for the week after China's Caixin Manufacturing PMI for August fell from 47.8 to 47.1 and a 6.5-year low. The Chinese equity market has lost the equivalent of $5 trillion since peaking in June at 5,166. It closed on Friday at 3,507 for a -32% decline from the June high. Conditions in China are deteriorating faster than most analysts have been expecting. Chinese auto sales are expected to decline for the first time in 17 years.

Global commodities are imploding. Jim Chanos pointed out that the global capex for mining was only $14 billion a year in 2000. After the market crash, companies went on a spending spree to explore, mine and produce commodities to fuel China's growth that was adding 1% to their GDP every year. The GDP went from 9.1% in 2002 to 14.2% in 2007. Commodity producers were scrambling to mine, grow and produce as much as possible to feed this growth giant. In 2012, the annual capex for mining companies peaked at $125 billion and almost 10 times the $14 billion in 2000. It takes 10-15 years to find, develop and produce a hard commodity like copper. All of those efforts were just reaching full production in 2012 as China's GDP was collapsing. Today the "official" GDP is 7% but nearly every reputable analyst believes it is closer to 5% or less if you overlook the government "adjustments."


Today commodities have no place to go. Producers are slashing production but there are still more in the pipeline than there is demand to consume them. In some commodities like copper, there is a growing lack of storage space. To make the situation worse the commodities already delivered to China were being used as collateral for loans. With the sharp drop in prices, those loans are being called and forcing speculators to sell other assets like stocks to cover the shortfall.

The CRB Index declined -5.54% last week alone and closed at a 13 year low. Note that the post recession peak in 2011 corresponded with the sharp decline in China's GDP that began after 2010.


China's panic move to devalue their currency the prior week has set off a chain reaction in all emerging markets. Currencies are plunging all over Asia.

Kazakhstan shocked the markets by allowing its currency to free float in order to remain competitive with China. The tenge fell -22% almost immediately.

Vietnam devalued the Dong for the third time in 2015 because of the yuan drop.

Over the last week the Russian ruble fell -5%, Belerusian ruble -4.5%, Seychelles rupee -4.4%, Zambian kwacha -3.7%, Rwandan franc -3.7%, Ghana cedi -3.6%, Mexican peso -3%, Turkish lira -2.9%, Liberian dollar -2.9% and the Columbian peso -2.8%. This represents a race to the bottom in order to remain competitive in the market. It also means that any goods priced in dollars, euros and Swiss francs are suddenly a lot more expensive in emerging market countries. Sales will slow.

Globally there are a lot of bear markets. Russia is down -40%, Brazil -25% and Taiwan -22% name a few.

The MSCI Emerging Market Index fell -5.7% for the week and the biggest drop since May 2012. Hong Kong, Indonesia and Taiwan saw their stocks enter a bear market. Brazil and the Philippines are very close to bear markets.


The Stoxx Europe 600 Index lost -3.3% on Friday and -6.5% for the week for the biggest weekly loss since 2011. It is now down -13% from the April high and now in correction territory. This is a result of the decline in currencies making the euro worth more and damaging exports to emerging market economies.


The U.S. markets were plagued with narrowing breadth for the last several months. This has been pointed out here many times in the past. A smaller number of big cap stocks were supporting the market. The Fab Five including Netflix, Facebook, Google, Amazon and Apple finally saw the adoring crowds flee their high prices stocks. More than $97 billion in market cap has been erased in those five stocks alone. The Nasdaq 100 lost -7% in just the last two days and the worst drop since 2008. Apple shares closed in bear market territory at $105.76 with a -20.5% decline from the recent high at $133. This should be major support for Apple.



Friday was option expiration. Higher volume was expected but nothing like the 10.5 billion shares that traded. Normally on opex we see 7-8 billion shares. This was also a summer Friday and volume should have been less than average. Volume began to rise on Wednesday with 7.0 billion then 7.9 billion on Thursday. I doubt anyone expected the blowout on Friday.

The term capitulation was being tossed around by the talking heads on TV. Normally a "classic" capitulation event has declining volume at roughly 10:1 over advancing volume. Friday was 8:1 declining over advancing volume. In a capitulation, there are normally 5:1 or higher decliners to advancers. On Friday, it was slightly under 4:1 in favor of decliners. Yes, even on Friday when the Dow was down -530 points there were still 1,497 advancing stocks to 5,754 declining stocks. Roughly 25% of stocks were still advancing in a very ugly market. While there is no official definition of a capitulation day, Friday could still qualify since the volume spike was off the scale. The fact that a lot of investors were buying the dip at correction levels probably kept the internals from being even worse. There were 45 new 52-week highs and 1,494 new 52-week lows. However, only 15 of the S&P-500 stocks closed positive. The majority of the gainers were in the small cap space because of their limited exposure to China and currencies.

There were no new highs on the S&P-500 on Friday. That is the first time since August 8th, 2011 when the last correction occurred after S&P downgraded the U.S. credit rating.

The Volatility Index ($VIX) spiked 46% on Friday alone and +100% since Tuesday's close at 13.79. If you ever thought about shorting some VIX calls this would be the time to do it. That is the second highest reading in three years. You have to go back to November 2011 for a higher reading. The VIX has risen 10% or more per day for the last three days. That has only happened twice in its 21 year history. Those were in March 1994 and October 2014.


The global market crash and currency implosion caused a huge flight to quality. The yield on the ten-year treasury declined to a three-month low at 2.05%. Just a few weeks ago, it was right at 2.5% on expectations for the Fed to hike rates. Yields go down when there is a high demand for treasuries. Today a secure investment is more important than worry over what might happen in the future. Investors overseas want to be invested in dollar denominated securities that will not devalue overnight.


With the global markets crashing and emerging market currencies in free fall, the odds are good the Fed is not going to be raising rates three weeks from now. The Fed's Jackson Hole seminar is next weekend and you can bet they will be discussing the global events. However, if the market were to rebound from the lows and add a significant number of points next week the pressure to do nothing could ease. The futures are projecting a 34% chance of a September rate hike, down from 48% the prior week.

The index to watch will be the S&P-500. The index crashed through support at 2040, 2000 and 1985 to close at 1972. While a -131 point decline in only four days is a major move, it only managed to push the S&P to -7.5% below the recent highs. In order for the S&P to enter correction territory, it would need to trade at 1,918 or another 54-point drop. While the Dow is already in correction territory, the real benchmark for the market is the S&P-500. In October the S&P declined -9.4% from the high close at 2010 to an intraday low at 1820 but only -7.4% on a closing basis after a 42-point afternoon rebound.

In theory, Friday's decline on the S&P to a -7.5% level could be seen as a buying opportunity for next week. Capitulation levels were reached in volume and internals and the Dow and Russell 2000 hit correction territory. It has been 1027 days since the S&P experienced a correction. It would not be a stretch of the imagination for anxious dip buyers to call this a bottom and jump in on hopes of an October repeat.

In October, the S&P rebounded from the low at 1820 to 2075 in only six weeks. That was a +255 point rebound and a +14.1% gain. Big market moves like that tend to be remembered with the mindset of "I sure don't want to miss it if that happens again." Remember, most analysts are still expecting a lot higher finish for the S&P in December. The average end of year target is 2231, which would be a +260 point rebound from here.



There were no economic reports of note on Friday. Next week will have several Fed surveys and a chance to see how the U.S. economy is doing regionally. The Richmond survey on Tuesday is the most important of those reports.

The GDP revision on Thursday is expected to rise from 2.3% to 3.0% growth. I would not hold my breath on that one. The odds of that consensus target being reached are slim in my opinion. However, the Q3 forecast by the Atlanta Fed is just over 1% growth. Did Q2 growth suddenly spike only to crash again in Q3? We will not know that for several months.

The Atlanta Fed GDPNow product at the end of the quarter predicted 2.4% growth for Q2 and that was only 0.1% off of the last revision by the BEA. Of course, the government has announced a new GDP calculation since then that is supposed to level out the peaks and valleys and that could make the Fed's calculation obsolete. Without the new calculation method, I would be betting on the Fed's number. What I am trying to say is that I would bet on a number lower than the consensus but not by much. As long as it is just a couple tenths of a percent, nobody will care. However, too bearish of a number and analysts will begin to doubt the Q3 estimates. Too bullish of a number and the Fed will be back in play again for a September rate hike.


Skechers USA (SKX) announced a 3:1 stock split for October 15th. Given their recent chart, I think this stock could have a split run once the market calms. I would sure like to buy this back around the $120 level.


We are still waiting on the UnderArmour board meeting next week to approve the split and set a split date.


Hewlett Packard (HPQ) was one of the few big name stocks with a gain on Friday. The company reported earnings of 88 cents that beat estimates for 85 cents. Revenue of $25.35 billion declined -8% and missed estimates for $25.64 billion. Much of that revenue decline was due to the strong dollar.

Shares declined in the Thursday night session after the company guided for earnings in the 92-98 cent per share range for the current quarter. Analysts were expecting $1.00. Shares were up on Friday after Meg Whitman went on CNBC and talked up the coming split into a PC focused company and an enterprise focused company. Whitman was applauding the enterprise company saying post split it will have some real strength. She said the PC company will be dependent in the short term on how Windows 10 is received by the public. Shares were up +$2.50 from the lows after Whitman's appearance but faded to close with only a 12 cent gain in an ugly market.


Salesforce.com (CRM) reported earnings of 19 cents that beat estimates by a penny. Revenue rose +24% to $1.63 billion. The company raised full year forecasts for the third time this year. Revenue is now expected to be between $6.6-$6.625 billion compared to the prior forecast for $6.52-$6.55 billion. Analysts were expecting $6.55 billion.


Deere (DE) reported earnings of $1.53 that beat estimates for $1.44. However, sales declined -20% to $7.6 billion. The company said demand was declining for agricultural and construction equipment. They lowered full year profit forecast from $1.9 billion to $1.8 billion and analysts were expecting $1.93 billion. Shares fell -8% for the day.


Earnings are winding down but there are still some notable companies reporting next week.


Spa operator Steiner Leisure (STNR) announced it was being acquired by private equity firm Catterton for about $834 million. The PE firm offered $65 for Steiner and a 15% premium to its prior close. Shares gained $8.25 to close at $64.78.


Crude oil dipped under $40 for a few minutes on Friday but rebounded on short covering going into the close. The outlook for crude oil remains bearish but it is significantly oversold. Crude has been down for eight consecutive weeks and that is the worst losing streak since 1986. Analysts are now starting to warn about oil prices in the mid $20s. That is a real stretch of the imagination but it is possible. Back in 1998 when Saudi Arabia tried this, "flood the market" stunt oil prices fell under $10 before the rest of OPEC agreed to cut production and not cheat.

Energy equities are in free fall after bouncing the prior week on some analyst recommendations. The Oil Exploration ETF (XOP) is now at post recession lows. Some producers are definitely going to have their loan base cut when they have to revalue their reserves based on current prices.



Active rigs rose +1 from last week to 885. Active oil rigs rose +2 to 674. Gas rigs were unchanged at 211. Offshore rigs declined -3 to 32. Active rigs are down -1,011 from this time last year.


Markets

The previously range bound markets decided enough was enough and exploded out of that range to 10-month lows in the case of the Dow and S&P. All the weeks of anguish we spent debating whether support from 2040-2050 would hold on the next dip are now history.

The market changed character in only three days and now we have a new set of support points to discuss. Several analysts immediately pointed out that the chart patterns today were eerily similar to the correction in August 2011. That correction did not rebound until October.

Back in 2011 the S&P made a new high in May and then attempted to retest that high in June/July but fell 10 points short. The last week of July and the first week of August saw the S&P lose more than -250 points in a very direct manner. The tone of the market changed from bouncing around in a trading range of 90 points for five months to plunge into correction territory in only two weeks.

I am not a fan of comparing years old chart patterns to current charts. There are so many things different today than in 2011 that it would be impossible to list them all. The macro world is materially different. Earnings are different, global trade is different, China's economy is different. The Fed is a cloud on the horizon, etc.



If we just analyze the current charts we will have plenty to worry about. The S&P closed at 1970.89 and -2 points below the December low of 1972.56. In theory the two numbers are close enough together that we can say the S&P closed on support. Whether that support holds depends on weekend events and specifically events in China. There is a lot of speculation that China will cut rates again on Sunday. If that were to occur, it could halt the decline at least temporarily.

We have the same problem in the U.S. today that China has had for the last several weeks. The severity of the decline has caused significant margin calls. Since much of the Friday decline came late in the afternoon, there will be another round of margin calls impacting trading on Monday. If China cuts rates and the futures rebound strongly on Sunday night that margin selling could be reduced. If nothing happens in China over the weekend and the U.S. markets open lower we could see a real capitulation day as stop losses are hit and margin calls accelerate.

The support at 1985 was strong. However, the S&P blew through that level like it never existed. If you just look at the S&P chart, the next material support is the October low at 1835. I am using the higher low from October 16th rather than the panic low of 1820 on the 15th. The higher low was the result of calmer heads buying the second dip and represents the real support level, in my opinion.

However, if we step back in time another six months there was another closing low at 1815 in April. That April low and the October low at 1820 are what I would call the worst-case scenario.

When markets change sentiment almost overnight it is normally because of some headline that appears out of the darkness like the yuan devaluation and the ripple effect around the world. We have numerous examples in the last 20 years where one event set off a chain reaction and lowered the market significantly.

Normally the severity of the plunge relates to the strength of the market before the event. If the case of the yuan devaluation the market had been weak for the last two months. Market breadth had been declining. New lows rising and the market was being pushed higher by only a few big cap tech stocks. Those few stocks began to falter a couple weeks ago after their earnings left more questions than answers. Earnings for the S&P were better than expected but revenue numbers were down sharply. Buybacks and dividends had been supporting the market.

With the market already weak, in the two worst months of the year for stocks and with the Fed ready in the wings to hike rates we were living on borrowed time. The yuan devaluation and subsequent ripple down in the emerging markets was just the last straw rather than an overriding event.

I always say if you want to know the market direction show the chart to a 5th grader. They are not biased because they do not have all the macro and fundamental "knowledge" most investors have today. A 5th grader would look at the chart below and say the market is going lower. I would like to believe we will see an oversold rebound on Monday but that may be a glass half-full view rather than an objective view of the chart. I have been warning about weak economics and revenue for several months now. When the markets change direction on an external event sometimes those internals factors suddenly make a difference where they were previously ignored.


The Dow was ugly on Friday with more than half the components losing $2 and several losing a lot more. The Dow was already the weakest index because of the impact of the strong dollar on the international stocks. With emerging market currencies crashing those companies will be impacted even more.

However, with the potential for a Fed rate hike rapidly evaporating the dollar fell off a cliff last week. After setting a three-month high in early August at 98.34 the dollar index collapsed back to 95 on Friday. That is a big move for the dollar especially when the emerging market currencies were plunging. That should have made the dollar more valuable.


The Dow is in free fall with 16,000 clearly the next target. More than half the Dow stocks are in a correction and many are already down more than 20%. I have pointed out the weakness in the individual components over the last couple of months and nothing has changed. Some of those already deep into correction territory collapsed last week and they are probably starting to look like bargains. However, the macro environment could keep investors from bargain shopping until something changes.

Support is 16,350 and then 16,000. Resistance at 17,150 is out of range until we see a multi-day rebound.

The Dow closed on the lows of the day with a -2% decline or more on the last two days. That is the first time that has ever happened.



The Nasdaq declined -171 points on Friday. That number should take your breath away. All the big tech stocks were crushed by people racing to get out of the market. The general weakness in AMZN, GOOGL, NFLX, AAPL, etc over the prior two weeks turned into a full-fledged rout on Friday. Those stocks are officially broken. Analyst suggested buy points are now well above current levels and everyone that bought the dip on the way down has lost money. Those stocks bought on margin were being liquidated in mass on Friday as stop losses were crushed.

On the positive side the Nasdaq has decent support at 4545-4605 and only about 100 points below Friday's close. That could suggest the carnage in the tech sector is about over. However, should those levels break the next support is well below at 4133.

The Nasdaq Composite is -9.75% off its highs and right on the verge of a correction. Unfortunately, directional moves on the Nasdaq typically overshoot by a wide margin. Traders get caught up in the momentum of the move and technical levels can be bypassed.

Personally, I think the damage is overdone. For instance, Apple closed right on support at $105. This stock was at $133 just four weeks ago. The $105 level "should" be at least a pause point if not a rebound level. However, should it trade below that level we could easily see $98. Apple is being hurt by the surge in other smartphones in China and now with the yuan significantly cheaper those high dollar iPhones and iPads are even more expensive.


If Apple shares do pause at $105 the Nasdaq could take a breather. However, Amazon, Netflix, Google, Gilead and Facebook are still very extended and could continue lower.


I would look for the Nasdaq to pause around 4600 but the eventual direction will be driven by the overextended Fab Five stocks.



I was encouraged by the Russell 2000 on Friday. The R2K declined the least (-1.34%) of any of the major indexes with the Russell Microcap ($RUMIC) declining only 0.6%. Normally in a capitulation flush the small caps are the stocks hurt the worst.

In this case the small caps are not impacted by the strong dollar and emerging market currencies. The index came to a dead stop right at strong support and even tried to rebound late in the afternoon.

We are playing a long call on the Russell IWM ETF this weekend on the possibility for the small caps to lead any future rebound.


There is a monster short squeeze in our future. Whether it comes on Monday or later in the week is unknown. The market is extremely oversold but nothing prevents it from becoming even more oversold.

Friday's capitulation flush was heightened by the option expiration. Art Cashin said there was $2.5 billion in market on close orders on the sell side. All the various factors seemed to appear on the same two days and there was never any doubt about direction.

Next week there will be doubt. There are traders at home this weekend pouring through hundreds of charts and building their shopping list. However, having a list is only half the battle. The market needs to provide an entry point. Traders will want to see a pause in the selling and at least a minor rebound before they decide to take the plunge. Nobody ever made a living buying stocks in free fall. Wait for a bottom to form. I would rather be a few points late in a bullish entry than a lot of points early.


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Random Thoughts


Interesting commentary from Barry Ritholtz. Is the Bull Market Over


How fast is China really growing? Gordon Chang believes there is ample proof that it is closer to 2% than the officially reported 7%. Steel demand, rail freight and electricity consumption are all showing big declines. Reportedly the private sector believes growth is around 2%. Full Story

Jim Chanos said regardless of how bad you think it is, in reality it is worse. "People are beginning to realize the Chinese government is not omnipotent and omniscient." Worse than you think


How low can we go? Bespoke said since the bull market began there have been 14 declines of 6% or more. On average those 14 declined have averaged 9.1% and lasted 31.6 days. The current decline is 92 days old. There were only two declines of 10% or more since this bull market began in 2009. How low can we go?


China tested its most powerful nuclear weapon last week. The DF-41 ICBM is capable of carrying 10 nuclear warheads, each independently targeted to different locations. The DF-41 has a range of up to 7,456 miles. This is the fourth time they have tested this missile in the last three years and suggests they are ready to deploy it. This is a road-mobile ICBM and not capable of being targeted by offensive missiles from another country. The test contained two independently targeted dummy warheads that confirm the MIRV capability.

A MIRV missile is generally considered a first strike weapon designed to take out multiple targets with one shot. The independently directed warheads are more survivable from anti-missile missiles since the one main missile subdivides into 10 individual missiles. An antimissile missile may only take out one or two of the warheads with the others continuing to their targets. China Missile Test


 

Enter passively and exit aggressively!

Jim Brown

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"Saying 'Death to America' is easy. We need to express death to America with action."

Hassan Rouhani, President of Iran, May 8th, 2013

 

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