After declining -1,089 points intraday on Monday and suffering through a very volatile week, the Dow rebounded to actually gain +183 points. The Nasdaq gained +122 to 4,827 despite crashing below 4,300 on Monday. That was a +535 point rebound or +12.5% from the Monday lows.
Analysts are calling last week a "flash correction." If you blinked or hesitated, you missed it. However, as I warned about in my earlier commentary, corrections are very rarely "V" shaped and that is especially true in the August/September period. Historically the vast majority of late summer corrections last for weeks. They begin with a high intensity bottom and are followed by an oversold bounce. Once the bounce fades the sellers come back and new lows are created but with a lot less volatility.
I would also like to remind everyone that historical norms are just historical long-term averages. Past performance is no guarantee of future results. Anything is possible we could still go either way in the coming weeks.
The Dow had just broken into positive territory on Friday when Fed Vice Chair Stanley Fischer was interviewed on CNBC. That interview prompted a -105 point decline from the high as Fischer put September back on the calendar for a potential rate hike.
While he did not say the Fed would hike rates he was positive on the economy and data dependent but the data was improving to the point where the Fed could make a decision. Fed heads are masters at talking around the subject and leaving all their options open but Fischer seemed to suggest the Fed was closer to hiking rates than the market expected. He said the China situation and the market volatility was a challenge but the Fed would not let volatility deter them from making a decision.
Fischer said the Fed officials realize that they need to act before the data requires them to hike rates to alleviate inflation. He said, "When the case is overwhelming, if you wait that long, you will be waiting too long. There is always uncertainty and we will just have to recognize that." When we do hike, "We will be adjusting the knob slightly." Before the recent market volatility, "there was a pretty strong case" for a rate hike at the September meeting. Today his "confidence is pretty high" that inflation will head toward the Fed's target of 2%.
The key will be his comments in the Jackson Hole keynote speech on inflation on Saturday. How he phrases his comments will be important for market direction next week.
One of the factors in the Fed's decision is inflation. The PCE Deflator released on Friday showed that inflation rose +0.1% in July. The cost of durable goods declined -0.2% while nondurable goods rose +0.1%. Housing rose +0.2% as a result of higher rents. The Core PCE excluding food and energy rose +0.1%. These numbers indicate the Fed is a long way from their 2% target.
The trailing 12-month PCE is only +0.3% and the Core PCE only +1.2% compared to a +1.3% rate in January. Now eight months later the Fed may be confident that inflation is rising but the gains are at a snail's pace and it could be another year before that 2% level is reached. Inflation is hardly rising at a rate that the Fed should be worried. With low commodity prices, I would be more worried about deflation.
Personal income rose +0.4% in July and the same pace as the prior three months. This was also led by a rise in rental income and proprietor's income rather than from wages.
Personal spending rose +0.2% driven by a +2.6% rise in motor vehicles and parts, +1.0% in household furnishings and +1.3% in recreational equipment. Summer is a big spending period on boats, jet skis, motorcycles, campers, etc. Spending in August will likely decline as the impact of China on the equity markets makes consumers less confident about their net worth if they own stocks.
The revision in Consumer Sentiment for the last half of August saw the headline number decline -1 point from the initial estimate to 91.9. That is down from 93.1 in July and a three-month low. Present conditions declined from 107.2 to 105.1 and the expectations component declined from 84.1 to 83.4.
We have a full calendar for next week with the ISM reports and the employment reports. The Fed Beige Book with the economic conditions in all 12 Fed regions will also be released. That is just in time to let us see what the Fed knows about U.S. economic growth. This will be a foundation to whatever decision they make at the September FOMC meeting.
The forecasts for the nonfarm payroll report on Friday are relatively flat with only a +4,000 job increase. However, the ADP forecast is for an increase of +20,000 jobs to +205,000. For the nonfarm report, a 225,000 job gain would be the Goldilocks number. If the report did come in hot at 275,000 it would almost certainly guarantee a rate hike in September. This makes Friday's report critical for Fed forecasting.
The ISM Manufacturing report is expected to be flat at 53.0 and that may be optimistic after several regional reports declined sharply. With 50 the dividing line between expansion and contraction the pace of growth is very weak and should give the Fed some cause for concern. The Kansas Manufacturing Survey last Thursday fell deeper into contraction territory at -9, down from -4 in July. The Kansas region has been in contraction since March. The prior week the New York Empire survey declined from 3.9 to -14.9 and deep into contraction.
There were no stock splits announced last week. However, Under Armour (UA) approved their 2:1 split. Unfortunately, the board elected to postpone the split until 10 days after the class action suit filed by shareholders complaining about the new share structure. The suit was filed in June and it could be a very long time before there is a ruling. Google was also sued when they created their new share class.
The 2:1 split will be one share of Class C nonvoting stock for every share of Class A or B stock currently held. The Class B stock has ten times the votes as a Class A share. Founder and CEO Kevin Plank owns 16.8% of all shares outstanding and 67% of voting shares. By creating a new class of stock, it allows the company to expand stock based compensation and make acquisitions with a stock that does not dilute Plank's voting rights. Any shareholder with voting rights today will retain those rights regardless of the outcome of the suit. Only new shareholders of Class C shares will have no rights.
Because of the delay until the suit is settled I have removed the Under Armour split from the calendar.
The Skechers 3:1 split on October 15th has the best chance for a pre-split run because of its positive trend. Medivation (MDVN) is in a downtrend so that would have to reverse before there is any chance of a split run.
Reynolds American (RAI) splits 2:1 on Monday.
Friday was really light on stock news. I think everyone was still shell shocked from the volatility and were happy to just get out of the week alive. Next week should be even lighter since the vast majority of traders, portfolio managers and corporate executives will be on vacation. This is the last weekend of summer and nearly everyone takes advantage of it.
Shares of Autodesk (ADSK) lost 5% after reporting earnings of 19 cents that beat estimates by 2 cents. Revenue fell -4.3% to $609.6 million and missed estimates for $612.4 million. The company cut the full year forecast for the second time. The new forecast for 60-72 cents was well below the analyst forecast of $1.04. They cut the revenue forecast from $2.56-$2.61 billion to $2.47-$2.50 billion. Analysts were expecting $2.59 billion.
The company is struggling through its conversion to a subscription model rather than upfront pricing. While that produces a steady revenue stream over time, they give up the current model where large upfront payments are received for sales. Licensing and subscription revenue declined -17% in the quarter.
Big Lots (BIG) reported earnings of 40 cents compared to estimates for 34 cents. Revenue of $1.21 billion also beat estimates for $1.19 billion. The company forecast full year earnings in the range of $2.90-$3.00 per share. Same store sales rose +2.8% and the sixth quarter of sales growth. Shares spiked +16% on the news suggesting there were a lot of shorts that lost a lot.
Smith & Wesson (SWHC) reported earnings of 32 cents that easily beat estimates of 22 cents. Sales rose +12% to $147.8 million after a +6% rise in the prior quarter. Profits rose +23%. The company said firearms demand was strong but accessories sales were stronger with a 29% increase. The company raised guidance for the current quarter to 19-21 cents on revenue of $135-$140 million. Full year guidance was raised from $1.02-$1.07 to $1.14-$1.19 per share.
Gamestop (GME) shares fell -8% after the company reported earnings of 31 cents that beat estimates for 24 cents. Revenue of $1.76 billion also beat estimates for $1.73 billion. Same store sales rose +8.1%.
Gamestop guided for current quarter earnings in the range of 53-60 cents on revenue of $2.09-$2.18 billion with same store sales (SSS) up 1-4%. Analysts were expecting 59 cents on revenue of $2.16 billion and SSS of 4.5%. Analysts called the targets conservative and felt the company would exceed them. Investors thought otherwise and shares declined. Benchmark cut their rating from hold to sell and that accelerated the decline. The analyst said the company's core business is being displaced by digital games with streaming capability rather than console games.
Aeropostale (ARO) shares fell -27% after the company reported its 11th consecutive quarterly loss. The company reported a loss of 56 cents on a -17.5% decline in revenue to $326.9 million. The loss matched Wall Street estimates. For Q3 the company expects to lose 30 cents. I would recommend shorting them except that they are already under $1.
Activision Blizzard (ATVI) gained +5% after S&P announced they were replacing Pall Corporation (PLL) in the S&P-500 at Friday's close. Pall is being acquired by Danaher.
United Continental (UAL) is also joining the S&P-500 after the close on Wednesday when it replaces Hospira (HSP), which was bought by Pfizer.
Facebook (FB) said it hit a new milestone. More than one billion people logged in on a single day on Monday. That is the equivalent of one-seventh of the world's population. Facebook now has nearly 1.5 billion members that log in at least once a month. While that is a lot of users Google services more than 100 billion searches every day and that means more than one billion people use Google every day.
Most of the one billion that logged into Facebook on Monday reside outside the USA. More than 83% of Facebook users are outside the USA. Since China blocks Facebook, the majority of users come from Europe, India and South America. The company is planning on expanding to 200 more countries in 2016. Japan will launch on September 2nd.
The number is even more amazing when you realize that about 5 billion people do not have access to the Internet.
It would be hard to bet against Facebook because they are increasing their ad reach on a daily basis and they have not even started to monetize WhatsAp yet and Instagram is just in the beginning stages. Facebook bought Instagram for $1 billion in 2012. Instagram now has more than 350 million users and WhatsAp has more than 800 million. As Facebook completes the advertising integration into those services, their revenue is going to explode. Facebook had $12 billion in revenue in 2014 and revenue rose +43% in Q2 to $3.8 billion. It will continue to soar for years to come. There are currently more than 2 million active advertisers on Facebook. Facebook shares are going well into the triple digits. It is only a question of when. Twenty-two analysts raised their price targets on Facebook after Q2 earnings. Piper Jaffray has the highest target at $146.
Freeport McMoran (FCX) rallied +29% from the Wednesday lows of $7.76 after Carl Icahn announced he had taken an 8.5% stake in the company worth $900 million. Icahn said he planned to hold talks with the company about cost cutting and capital expenditures and may seek board representation. The company had already announced plans for a 25% cut in capex from $5.6 billion to $4 billion and would cut production at some mining operations.
Icahn filed a notice with the SEC that he intended to buy as much as 25% of the company. Shares of Freeport had declined -66% year to date on the decline in copper prices and the drop in oil. Freeport has a significant investment in the energy sector through the acquisition of McMoran Exploration and Plains Exploration. Freeport planned on spinning off the oil assets but the drop in oil prices killed that idea. I think Icahn picked the bottom perfectly on Freeport given their recent announcements.
Mylan (MYL) shareholders approved the hostile pursuit of Perrigo (PRGO). Mylan raised its offer in April to $232.23 in cash and stock or about $34.1 billion for Perrigo but was rejected. Since April, Mylan's stock has declined and the offer is worth about $190 today. After the shareholder approval, Mylan said it would launch a formal offer for Perrigo in the coming weeks. Analysts believe Mylan was pursuing Perrigo in order to avoid being acquired by Teva Pharmaceuticals (TEVA). However, Teva broke off its pursuit and bought the generics business from Allergan for $40.5 billion. On Friday, Perrigo completed a $200 million acquisition of GlaxoSmithKline's over-the-counter brands business. Most analysts believe there is little chance of Mylan acquiring Perrigo.
Investors are running for cover. According to Bank of America Merrill Lynch investors pulled out $29.5 billion from equity funds over the last week. On Tuesday alone, they withdrew $19 billion. That was the second largest one-day withdrawal since 2007. Equity funds have about $10.5 trillion under management. Bond funds saw $11.7 billion in outflows and the most in two years. However, treasury funds saw inflows of $1.7 billion. Money market funds saw inflows of $22 billion to bring their total cash hoard to $2.7 trillion according to ICI. Precious metal funds gained +$1.1 billion. July and August could mark the first consecutive monthly outflows since late 2008.
Through July equity funds had outflows of more than $78.7 billion. That is worse than during the financial crisis. In fact, that number is more than any full year dating back to 1993. Outflows in July were $20.3 billion. Over the 12 months ended on July 31st more than $158.6 billion flowed out of funds. That is even more confusing because the market traded at historic highs in May, June and July.
Several days last week, the market sold off hard at the close. Jack Bouroudjian, CEO of Index Futures Group, said the billions in market on close sell orders were likely from sovereign wealth funds. Nine of the top ten countries with sovereign wealth funds are oil producers. With oil hitting a six-year low at $37.75 on Monday and the market in a dive, he believes the massive selling was from those funds. They have lost their oil revenue and need to raise cash. Jack used to handle trades for several of those funds and he recognized the pattern. While he cannot prove it, he was pretty sure they were liquidating.
Crude prices exploded higher on Thursday and Friday for multiple reasons. News reports of Saudi Arabian ground troops entering Yemen and seizing control of multiple areas in Saada province caused massive buying in crude. Pictures of long lines of Saudi tanks moving into Yemen caused oil traders to immediately begin covering shorts and there were a lot of shorts. By invading with ground troops, it is likely to make the Houthi rebels desperate and they could strike back at Saudi oil installations. Whenever there is a ground conflict in the Middle East the price of oil soars.
Add in the approach of Hurricane Erika towards the Gulf of Mexico and there was a monster short squeeze. Oil prices soared from the $37.75 low on Monday to close at $45.33 on Friday for a +20% gain. On Wednesday the weekly inventory numbers showed an unexpected decline of -5.5 million barrels.
Sometimes you just cannot get a break when you are on the wrong side in a market. Oil shorts were definitely on the wrong side for good reason. The fundamentals support declining oil prices for the next couple months so once the Yemen news fades this should be another shorting opportunity.
Active rigs declined -8 last week but they were all gas rigs. Active oil rigs rose +1 to 675 and gas rigs declined -9 to 2002. That is a new 18 year low on gas rigs. Offshore rigs declined -2 to 30 and the lowest level since July 3rd. That is 36 below year ago levels.
What can I say except, wow! More than 55 billion shares traded hands over the last five days. Monday was the largest at 14 billion with Tuesday, Wednesday and Thursday at 10 billion each. Friday, normally a very slow end of summer Friday with barely 5 billion shares saw almost 8 billion traded. Where Monday appeared to be a capitulation day to the downside, Thursday appeared to be a strong reverse to the upside with strong conviction. Advancers were 5:1 over decliners and advancing volume was 12:1 over declining. Traders worried over the nearly -300 point decline from the highs in the afternoon but another surge of buyers erased that decline to close at the high of the day. Life was good or so many thought.
Friday rekindled doubts in many minds. The internals were still positive but the gains minimal. The Dow closed down -11 after a week of monster moves. The S&P gained only 1 point and the Nasdaq +15, thanks mostly to biotech stocks.
While every investor is hoping the rally will continue next week, I would not hold my breath. The rebound stopped right on decent resistance at 1,985 and the intraday range was very narrow compared to the big swings over the past week.
There is a resistance range from 1985-2005 that could easily halt this rally in its tracks. The Fed is back in play for September and while China posted gains on Friday, their market is far from healed. Their manufacturing PMI to be released on Monday night could be another nail in their coffin.
I do not want to curse this rebound but there is a very good possibility we could see further declines. That is the normal series of events for an August/September correction. With equity outflows occurring at a record pace there may be something under the surface we don't know about. If sovereign funds are indeed liquidating to raise cash then there could be tens of billions of additional repatriation.
The bull case starts with the high intensity plunge on Monday followed by two days with Dow declines intraday of -650 points each without that Monday low being broken. That is a strong case but it only covers the reaction period. That is the period where panicked investors dumped stocks and then bought stocks without applying too much thought. Dang it everything is crashing, sell everything. Dang it, I sold at the bottom, buy it all back quick. Now that the smoke has cleared we hope that calmer minds will prevail next week. However, a calm mind may start to worry about the historical pattern of August/September corrections and begin to take profits from the rebound.
You could make up a hundred potential scenarios and they could all be wrong. We are always at the market's mercy and we need to trade what we see rather than what we hope to see. We want to see a continued rebound but we need to be ready for the alternative as well.
I looked at the chart for each of the Dow components and there were some really ugly charts. Unfortunately, there was not a single one I would buy today. That may be the overriding worry for trading next week. Every single chart had either rebounded from the panic low to close right at resistance OR they failed to even reach resistance. It was a depressing exercise.
Here are three examples. Would you buy these charts?
The 20% rally in oil prices helped to lift the Dow thanks to Chevron and Exxon. Unfortunately, the rest of the group remains lackluster. There are no momentum stocks like Netflix or Amazon. Apple was the leader for a while but even that company has lost its luster. If the Fed does hike rates we could see gains in the financials but that may not erase the potential declines ahead of the FOMC meeting on the 17th.
My historical bias may be getting in the way of my analysis this weekend but I am not hopeful that the Dow is suddenly going to soar for another 1,000 points. The rebound cured the seriously oversold conditions and now we have to depend on fundamentals for motive power.
The Nasdaq is showing a little more encouragement. The lows were not as low as those on the Dow and the rebound brought us back to within 400 points of the recent highs. We saw a range of more than 500 points last week alone. While I do not expect to just race back the recent highs there were a lot of gainers in the Nasdaq Composite on Friday. Biotechs are back and the Biotech Index ($BTK) gained +136 points for the week to close at 3,909 after hitting 3,412 at the Monday low. That is a +15% rebound!!
There is plenty of overhead resistance and the 4,900 level on the Nasdaq could be a problem. If the tech stocks continue to move higher, it might trigger some buying in the broader market.
The Russell Microcap Index ($RUMIC) was the biggest gainer on Friday with +1.33% followed by the Russell 2000 at +0.8%. If funds are buying small caps, they are not afraid of a future market decline. However, this could still be short covering since the small caps were heavily shorted.
The R2K did manage to close well above decent support at 1,150 and that could give us a cushion on any further market weakness.
After looking at all the individual stocks on the Dow, I have a negative bias for next week. Obviously, that bias and $5 will only buy you a cup of strong coffee at Starbucks. I would be careful about loading up on too many long positions. I recommended buying "decent" dips last week. We definitely had several. I would continue to recommend buying decent dips to obvious support levels. While we could see lower lows ahead, I do expect to see higher highs as well once we are out of September.
If you missed the correction and did not buy anything on the quick drop, be patient. You may still get your chance. Build your shopping list and put in some buy orders at ridiculous prices. You may actually get filled in the weeks ahead.
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Marketwatch put together a really good summary of recent comments by all the Fed heads. This should give you a much better idea about the outcome of the September meeting. Fed Member Positions on Rates
Fortune ran an article this weekend on the 5 reasons the Fed will not raise rates in 2015. I am going to list the reasons but the entire article is worth reading. Five Reasons
Recent stock market volatility
Slowing global growth
China's economic wildcard
Strong U.S. dollar
Very low inflation
Bespoke said the volatility last week was the worst in 75 years. The S&P closed more than four standard deviations below its 50-day average for three consecutive sessions. This is only the second time ever that this has happened. The other one was May 15th, 1940. The crash of 1987 was not as bad as the crash last week. Worst in 75 Years
Since 1950 September has been the worst performing month of the year for the Dow, S&P and the Nasdaq since 1971. Fund managers coming back from vacation after Labor Day tend to clean house as Q3 comes to a close. They are preparing on taking advantage of any buying opportunity in October. The first half of September has a positive bias but the last half of the month is normally negative as the quarter ends. Remember September
Monday could be called the Great ETF Crash of 2015. Large portions of the ETF market saw declines of 30% to 43% on sketchy volume. When some individual stocks failed to open on time on Monday the pricing algorithms for the ETFs went awry. The S&P Smallcap 600 (IJR) fell -30% while the Smallcap 600 Growth (IJT) declined -34%. The Nasdaq 100 (QQQ) declined -17.25% at its lows when the underlying index only declined -9% intraday. The S&P 500 equal weighted ETF (RSP) fell -43% and took more than 30 minutes to recover. The moral to this story is to not use stop losses on ETFs because in fast markets they can be significantly mispriced. Great ETF Crash
Understanding the ETF Crash
With the bankruptcy and shutdown of the Molycorp Mountain Pass rare earth mine, China now controls more than 95% of the supply of rate earth minerals. It takes 920 pounds of rare earths to build an F-35 fighter and 9,200 pounds to build a Virginia class nuclear submarine. Without rare earths, guided missiles are unguided. China in Control
Moody's reduced its growth forecast for the global economy to 2.8% for 2015, down -0.3% from the prior forecast just two weeks ago. The company said China's problems are going to make a bigger dent in the global economy than previously expected. They are projecting only 6.3% growth for China in 2015 compared to the official government projections for 7.0%.
Citigroup cut world growth estimates for 2016 from 3.3% to 3.1% and that was the third time the bank has cut the forecast this year. Citigroup said the greatest risks to the growth forecast were to the downside.
Fitch Ratings warned that China will likely grow well below 7% for a "prolonged period of time."
Add in the severe recession in Russia and Brazil and the rapid decline in emerging market currencies and global growth is in a downward spiral.
Global Growth Declines
Trading curbs on individual stocks halted trading more than 1,200 times last week on the NYSE. More than $2 trillion in market cap was erased since the end of July to the lows on Monday. Unless the market soars over the next 5 weeks, the correction will knock most equity funds into losses for the quarter and possibly for the year. The Investment Company Institute said more than $94 billion had been pulled out of equity funds in the month of August. Rout Ruins August
David Woo, BAML head of global rates and currency research, said the rise in yields in U.S. Treasuries during a period of equity market volatility was contrary to historical norms. Yields normally decline as investors flee to treasuries. He said the reason treasuries sold off was redemptions from China. In order for China to support its currency and its equity market it was forced to sell treasuries and convert those proceeds from dollars to yuan. In a period when investors flee to the safety of bonds, the biggest holder of U.S. treasuries was selling. China Selling Treasuries
China Sells $100 Billion in Treasuries - Bill Gross
Apple finally announced the date for their next product announcement. On September 9th, the event will be held at the Bill Graham Civic Auditorium. Analysts are expecting a major revamp for the iPhone 6S camera system to 12 megapixels and 4K video recording, stepping up from the 1080p in the iPhone 6. The new phone will also have front flash support for the camera. There will also be a faster A9 processor. The next generation Apple TV could also be announced.
The AAII Investor Sentiment Survey for the week ended on Wednesday showed a very surprising gain of +5.7% to push bullish sentiment to 32.5%. Yes, bullish sentiment rose in an ugly week. Apparently, investors felt the bad news was over. However, bearish sentiment also rose +4.9% to 38.3%. I guess that is a sentiment battle between the daredevils and the scaredy cats.
Enter passively and exit aggressively!
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"Everything possible today was at one time impossible. Everything impossible today may at some time in the future be possible."