Worries over potentially weak Q3 earnings weighed on the market ahead of reports from Intel and JP Morgan after the bell. The opening dip was bought but resistance held and sellers appeared almost immediately.

Market Statistics

The largest acquisition in 2015 could not hold up the markets at the open. Anheuser Busch InBev (BUD) finally convinced SABmiller to merge. The acquisition is valued at $106 billion and will merge the two largest beer brands in the world. Having Budweiser and Miller under the same roof may not happen. Analysts believe the companies will have to divest the Miller brand and Molson Coors (TAP) will be the beneficiary of that divestment. BUD shares only rose +2% on the news but Molson Coors shares spiked +10% on the potential to acquire the Miller brand.


There were no economic reports to move the market at the open. Wednesday will be different with the Fed Beige Book, Retail Sales and the Producer Price Index. The Beige Book is likely to show that the economy is still growing at a "moderate pace" in the 12 Fed regions. This is probably not going to be a market mover unless it is significantly more negative than in the past.


Dow component Johnson & Johnson (JNJ) reported adjusted earnings of $1.49 compared to estimates for $1.44. Revenue of $17.1 billion missed estimates for $17.41 billion. The company blamed the strong dollar for knocking -16% off international revenues. Drug sales declined -7.4% to $7.7 billion after sales of Hep-C drug Olysio declined -90%. Sales of Motrin and Zyrtec declined -7.7% to $3.3 billion. Sales of medical devices declined -7.3% to $6.1 billion.

JNJ announced a $10 billion stock buyback program and that probably helped shares avoid a sharper decline.


After the bell, Intel (INTC) reported earnings of 64 cents that beat estimates for 59 cents. Revenue of $14.47 billion beat estimates of $14.22 billion. Shares spiked on the initial news but then declined after the company guided mostly in line with analyst estimates for Q4. They guided to revenue of $14.3-$15.3 billion with analysts expecting $14.83 billion. Analysts believe Intel is going to face some competition from Qualcomm, which just announced a "datacenter on a chip" for enterprise servers. Qualcomm is thought to be targeting massive server users including Facebook, Google, Amazon and Alibaba. Shares of Intel dropped more than $1 in afterhours.


JP Morgan (JPM) reported earnings of $1.32 compared to estimates for $1.37. Revenue of $23.54 billion missed estimates for $23.69 billion. The bank is struggling to cut costs as much as possible with the employee count down more than -10,000 year-to-date. The CFO said the summer conditions were "generally quite challenging" and led to a decline in trading revenue. Lower commodity prices forced the bank to raise loan loss reserves to cover loans to oil and gas companies. Shares declined more than $1 in afterhours.


CSX Corp (CSX) reported earnings of 52 cents that beat estimates for 50 cents. Revenue of $2.94 billion missed estimates for $3.04 billion. The railroad said low commodity prices were the biggest challenge causing fewer shipments. Coal demand continues to decline as coal fired plants are closed because of the new EPA rules. Shipments declined -10% in 2015 and are expected to continue declining in 2016. The company also reported significant declines in fertilizers, industrial metals and housing construction materials. Shares of CSX rose fractionally after the report.


Earnings for Wednesday are highlighted by Netflix, Wells Fargo and Bank of America. The banking trend continues on Thursday with Citigroup, Goldman Sachs, US Bank and Schwab.


Twitter (TWTR) shares rose sharply at the open to $30.68 after the company said it planned on cutting 8% of its workforce in order to become more streamlined. That equates to about 336 workers and the news had been leaked. The late afternoon Nasdaq decline pulled shares back to $29.

The company also said it saw revenue in Q3 at the high end of prior guidance of $545-$560 million. Analysts were expecting $559.46 million.


After the bell, Bloomberg reported that SanDisk (SNDK) had hired bankers to explore a potential sale after it received interest from Micron (MU) and Western Digital (WDC). Since SanDisk shares manufacturing plants with Toshiba it would need Toshiba's approval to enter into an acquisition. Micron is a current competitor to SanDisk flash technology. Western Digital may want to add flash memory to its disk drives to speed up access. Shares rallied about 10% on the news.


Crude prices continued to decline even though Tuesday is normally a short covering day ahead of inventories on Wednesday. However, that report has been delayed until Thursday by the holiday. Driving them lower was the fading headlines from Syria and news that the IEA has lowered its demand growth forecast again. The IEA said demand growth will slow from its five-year high of 1.8 million barrels a day (MBPD) in 2015 to 1.2 mbpd in 2016. The agency said long-term price support was likely to fade in 2016 despite a drop of -500,000 bpd in non-OPEC supply. At the same time OPEC supply is expected to grow by 1.0 mbpd as Iranian sanctions are removed. Global supply was 96.6 mbpd in September.


Markets

With the democratic debates tonight there is a good chance Hillary will again repeat her plan to have the government control drug prices. That worry caused the biotech sector to crash again with a -3.1% decline ahead of the debate. That decline tanked the Nasdaq and pulled the Russell and S&P lower.


The Nasdaq lost nearly -1% or -42 points to close at a three-day low thanks to the biotech decline. However, there is significant worry over the Netflix earnings due out after the close on Wednesday. The market will likely follow whatever happens to Netflix shares post earnings as that will be a sentiment indicator.

The Nasdaq chart did not change much despite the drop. The mid morning recovery spiked the index to a three week high but resistance held and the decline began at 11:AM. Support remains 4,740 and 4,715.



The S&P tried to break through resistance at 2,020 this morning but despite a +2 point move over that level it was only a temporary gain. The selling began at 11:AM and we closed right at the low of the day and right back at prior resistance. We should see that 1990-2005 level now serve as support but a decline under 1,990 could set off some chain reaction selling.



The Dow tried to extend its gains this morning but the seven-day streak ended with a minor -49 point loss. With JNJ, INTC and JPM expected to open lower on Wednesday the Dow will start off in a decline. Depending on comments in the debate tonight, the healthcare sector could also be a drag on Wednesday. Lower drug prices would be positive for them but there may also be comments about lowering insurance premiums as well.

The Dow closed well over 17,000 and above what should be support at 17,050. The low for the day came at the open at 17,034 and it was quickly bought. Let's hope the same is true on Wednesday.



The Dow Transports ($TRAN) collapsed with a -2.2% decline after Ryder Systems (R) posted a big earnings warning on Monday evening. The transports fell back below their long-term downtrend resistance despite falling oil prices for the last two days. This is a negative sentiment indicator for the market if the sector does not improve.


The Russell 2000 small cap index gave back -1.4% and the third largest index decline after the Biotech and Transport indexes. Resistance at 1,165 held firm and the index closed under prior support at 1,150. This was most likely related to the crash in the biotechs because the Russell has a significant number of biotech components.


Is there a Black Swan event in our near future? Option traders definitely expect something in the next 30 days. The CBOE Skew Index ($SKEW) measures far out of the money options on the S&P-500. The concept is to watch the tail risk from heavy buying of options well out of the money in order to determine market sentiment and the likelihood of a major market move.

The Skew Index has risen 30% just in October and spiked +10% on Monday alone. The index closed at 148.92 on Monday and that is the highest level since the index was created in 1990.

That is higher than the run-up to the 2008 financial crisis, higher than the Ebola crisis, higher than the budget crisis in 2011 and higher than the 1998 Long Term Capital Management crisis that nearly crashed the financial system.

Currently the Skew Index is pricing in a 15% chance of a two standard deviation move in the S&P over the next 30 days. Using the SPY as a proxy for the S&P a 2SD move would be roughly -20 to -23 points. The S&P closed at 200 today so that suggests a potential drop to 177-180.

This corresponds to the massive put buying in the S&P that I wrote about a couple weeks ago. At the time, the trade discussed was the purchase of 90,000 June $184 puts for roughly $1,100 per contract. I checked again today and now there are many more at various June strikes.

180 = 21,000
182 = 46,000
184 = 92,000
185 = 56,000
190 = 29,000
195 = 13,000
200 = 16,000

There are similar quantities in the March and January strikes with a huge increase in the December strikes with some having well over 100,000 in open interest. The December $185 put has nearly 150,000 active contracts.

As I discussed in my prior commentary I thought the large put buys in June were portfolio insurance against a Q4 decline. Premiums would not decline rapidly in case of a rally and portfolio managers could exit with minimum expense.

The large open interest in the December strikes is likely more of the same but with a lot of speculation buys from traders who expected a new market low in October. Remember, just two weeks ago on September 29th the indexes were trading back at their August lows and the sentiment was very bearish.

Planning for a black swan event would be the equivalent of betting on a specific number on the roulette table. Your chances of success would be exceedingly low. The definition of a black swan event is something "unexpected or unpredictable" that rocks the markets. To claim those large put positions were predicting a black swan event would mean it was expected. Obviously, traders and portfolio managers can expect a market decline without it being a black swan event. Markets decline for dozens of reasons and buying a lot of puts does not mean Russia is about to launch an attack on the USA.

While we cannot rule out an "unpredictable" market event over the next couple of months, I think we need to assume the majority of those high open interest puts on the S&P are simply hedges as a form of portfolio insurance.


The market is facing a lot of weakness in the upcoming earnings reports. Intel and JP Morgan both traded lower tonight but not that much lower. In both cases, the damage was limited to about $1. If that continues to be the trend, the earnings cycle will turn out ok and investors could but the dip. However, in both of those reports the bad news was expected and priced into the stocks.

We may find out that most of the negative earnings are already priced in and/or the bad news may not be as bad as analysts expect.

I am in the buy the dip camp until proven wrong. If the S&P does dip back below 1,990 I would probably refrain from an instant buy and wait to see what the market gives us. There are two weeks left for fund managers to window dress their portfolios for the end of their fiscal year. They "should" be buying performance in hopes of adding a few dollars to their gains before the end of October. Time will tell if that is going to happen this year.

Sometimes the best trade is the one you do not make.

Enter passively, exit aggressively!

Jim Brown

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