Earnings reports continue to be a drag on the market but lackluster volume suggests there is no conviction in either direction. IBM subtracted about 60 points from the Dow but United Technology and Travelers added +48 so the net result was a -13 point loss for the day.

Market Statistics

IBM posted its 14th consecutive quarter of revenue declines with hardware revenue falling -40%. Earnings beat the street by 4 cents but revenue of $19.28 billion missed estimates for $19.62 billion. They also guided lower for future quarters. Shares fell -$8.58 on the news to drag the Dow lower. Berkshire Hathaway lost more than $500 million on IBM's decline.


Rescuing the Dow from a bad day were Travelers (TRV) and United Technology (UTX). Travelers closed near a new high at $109 after reporting operating earnings of $2.93 per share that beat the consensus estimate by 32.6% and up +12.3% over the comparison quarter. Revenue of $6.8 billion beat estimates for $6.6 billion. The company bought back 7.3 million shares in the quarter to raise the total to 21.5 million year to date. They have $4.3 billion in outstanding authorizations.


United Technology (UTX) reported earnings of $1.67 that easily beat estimates for %$1.54. However, revenue of $13.788 billion missed estimates for $14.593 billion. Aerospace orders rose +8% at Pratt & Whitney division. The company sold its Sikorsky unit to Lockheed Martin for $9 billion in cash and that is expected to close this year. UTX authorized a new $12 billion stock buyback program, in addition to the existing $6 billion authorization, using the proceeds from the Sikorsky sale. The company expects to buy back $16 billion in shares through 2017. Shares rallied +4% on the news.


Sonic (SONC) reported earnings of 43 cents that beat by a penny but revenue of $175.3 million missed estimates for $176.5 million. The CEO said McDonald's "all day breakfast" was no big deal. "We have been doing all menus, all day, forever." He said made to order food with menu options that crossed all meal schedules would always beat fast food from a rigid menu. When customers are offered choices, they are happy to buy your food. Same store sales were up +4.9%. Shares rose +8% on the news.


Harley Davidson (HOG) ran off the road after reporting earnings of 69 cents that missed estimates for 78 cents. Revenue of $1.14 billion also missed estimates for $1.21 billion. Harley lowered guidance for shipments in 2015 from 276,000-281,000 to 265,000-270,000. Harley sold over 52.4% of all motorcycles sold in the USA, down from 56.3% a year ago. The company is planning on an unspecified number of job cuts in an effort to lower costs. In July, the company issued a recall for 312,000 of its most popular motorcycles. Competition is coming from Polaris owned Indian Motorcycles. Shares crashed -14% on the news.


After the bell, Yahoo (YHOO) reported earnings of 15 cents that missed estimates for 17 cents. Revenue of $1.23 billion missed estimates for $1.26 billion. Shares were volatile after the report but settled near unchanged after the company said it signed a search advertising deal with Google. Google will provide Yahoo with search ads, while Yahoo can select which search queries it sends to Google.

Yahoo's CEO said the Alibaba spinoff was on track to take place in January. Yahoo cut its revenue guidance from $1.2 billion to $1.16 billion. Unfortunately, analysts were expecting $1.33 billion. Search revenue rose +2% to $870 million but traffic acquisition costs soared from $54 million to $223 million. They are being forced to buy more traffic rather than produce it organically.


Chipotle Mexican Grill (CMG) reported earnings of $4.59 that missed estimates for $4.64. Revenue of $1.22 billion barely beat estimates for $1.21 billion. Same store sales rose +2.6% compared to estimates for +2.5%. Operating margin fell -50 basis points to 28.3% and they opened 53 stores in the quarter. For the full year, they are now predicting 215-225 new stores compared to prior guidance of 190-205. They continue to blame the earnings problems to supply challenges of getting high quality ingredients. After a severe shortage of pork earlier in the year they are now offering carnitas in 90% of the stores and expect to raise that back to 100% in Q4. Chipotle share fell -$50 in afterhours. While researching these earnings I found this. Enjoy! Double the size of a Chipotle burrito for free.


VMWare (VMW) reported earnings of $1.02 on revenue of $1.67 billion. Analysts were expecting $1.00 on revenue of $1.66 billion. While the results were technically a beat, shares declined -$3.50 after the report. Bookings, a measure of future results, rose only +3%. Analysts were expecting an 11% increase. VMWare said it would form a new cloud computing business with EMC that would be marketed under the Virtustream brand. It will be 50% owned by VMWare and 50% by EMC. We learned last week that EMC would be bought by Dell for $67 billion. EMC owns 80% of VMWare.


Intuitive Surgical (ISRG) reported earnings of $5.24 compared to estimates for $4.26. This was a monster beat on earnings but revenue of $589.7 million barely nudged over estimates for $583.7 billion. Shares rose +$37 in afterhours.


With 71% of the S&P beating on earnings and only 50% on revenue, we are in a revenue recession. This is not a one-quarter event. In Q1 revenue declined -2.9%. In Q2 it fell -3.4%. Q3 is now forecast to decline -3.4% and Q4 is expected to decline -1.8% but that number is still falling.

If revenue is declining and earnings are to rise, then companies have to continue cutting costs. That only works in the short term. You cannot cut your way to profitability forever. Eventually revenue must rise or profits must fall.

With earnings under pressure in Q3 and currently expected to decline -4.1% this could be the quarter where trouble begins. Since we are already in a revenue recession, the advent of a profit recession could trigger a significant market decline. I am not predicting it this week but the long-term outlook is worsening. The earnings and revenue forecast for Q3 is the worst EVER for not being in an economic recession. Can an economic recession be that far away?

Two Dow components report on Wednesday. Those are American Express and Boeing. We will also hear from SanDisk (SNDK) and more about its acquisition talks with Western Digital (WDC). Ebay, Texas Instruments and Biogen round out the list of high profile companies. Thursday is the big day and there is sure to be some post earnings volatility.


The only material economic report for today was New Residential Construction for September. Housing starts rose +6.5% from 1.126 million to 1.206 million and +17.5% higher than the same period in 2014. However, permits declined -5% to 1.103 million. Starts in the Northeast rose +25.7% and +25.4% in the West. The South suffered a slowdown with a rise of only +0.6%. The Midwest saw starts decrease -12.2%. This report was ignored by the market.

There are no major reports due out on Wednesday.


If you do not live in a cave, I am sure you heard that Disney released the trailer for the new Star Wars movie, "The Force Awakens," that opens on December 18th. Along with the trailer, the advance ticket sales began and set records worldwide. Trailer: The Force Awakens

AMC Entertainment sold out more than 1,000 shows in the first few hours. Fandango sold more than 8 times as many tickets as it did for the prior record holder "The Hunger Games." Ticket demand crashed several online ticket sales websites including Fandango and MovieTickets.com. Analysts are expecting $250 million in ticket sales for the opening weekend. The movie will air on 5,500 screens. It will also be offered in RealD and Imax 3D.

Morgan Stanley is expecting global revenue of $1.95 billion for the Force compared to $2.8 billion for Avatar and $2.2 billion for Titanic.

Disney has already said there will be two additional episodes and a couple of spinoff movies based on Star Wars characters and events. Disney has an incredibly full calendar of movies due out over the next several years. Here is a "partial" list. There are another 10 from late 2017 through 2019 that do not have firm titles or dates. After the acquisition of Pixar, Marvel, Lucas Films and Star Wars, Disney has a constant stream of cash cows coming in the future.

Oct 16th, 2015 - "Bridge of Spies"
Nov 25th, 2015 - "The Good Dinosaur"
Dec. 18th, 2015 - "Star Wars: Episode VII - The Force Awakens"
Jan 29th, 2016 - "The Finest Hours"
Mar 4th, 2016 - "Zootopia"
April 15th, 2016 - "The Jungle Book"
May 6th, 2016 - "Captain America: Civil War"
May 27th, 2016 - "Alice: Through the Looking Glass"
June 17, 2016 - "Finding Dory"
July 1st, 2016 - "The BFG"
Aug 12th, 2016 - "Pete's Dragon"
Nov 4th, 2016 - "Doctor Strange"
Nov 23rd, 2016 - "Moana"
Dec. 16, 2016 - "Star Wars Anthology: Rogue One"
Mar 17th, 2017 - "Beauty and the Beast"
April 14th, 2017 - "Ghost in the Shell"
May 4th, 2017 - "Guardians of the Galaxy II"
May 26, 2017 - "Star Wars: Episode VIII"
June 16, 2017 - "Toy Story 4"
Mid 2017 - "The Incredibles 2"
July 17th, 2017 - "Pirates of the Caribbean"
Late 2017 - "Thor: Ragnarok"
Early 2018 - "Frozen 2"
May 4, 2018 - "Avengers: Infinity War - Part I"
2018 - "Untitled Star Wars Anthology Project"
May 3, 2019 - "Avengers: Infinity War - Part II"
2019 - "Star Wars: Episode IX"


Amazon (AMZN) said it was planning on hiring 100,000 workers for the holidays. That is a 25% increase from 2014. This is in addition to the 25,000 regular, new full time workers it just hired. Walmart is adding 60,000. Target is hiring 70,000. Macy's is adding 85,000 temporary workers.

Amazon has expanded same day delivery to 12 cities for Prime customers. Reportedly, the number of Prime subscribers is exploding as Amazon adds additional benefits to the membership besides free two-day shipping. Amazon earnings are Thursday.


Apple shares surged $2 to close over resistance at $112 after CEO Tim Cook made positive comments about multiple products. He said he would not reveal the exact numbers but they shipped a lot of watches in Q1, even more in Q2 and shipped an even larger number in Q3.

He said the new Apple TV would change TV viewing forever. It would be a foundation on which the company planned to build as it "modernized" the medium. Orders for the fourth generation Apple TV will open on Oct 26th with shipments starting on Oct 30th.

Cook said Apple Music now had 6.5 million paying subscribers and 8.5 million on free trial. While acknowledging there were challenges he said the 15 million current users was a good starting point for future growth. Apple earnings are next Tuesday.


Tesla (TSLA) shares lost -7% after Consumer Reports said the Model S was rated "worse than average" in reliability. Just a couple months ago, the consumer company gave the Model S a rating of 103 out of a possible 100 on drivability and broke the Consumer Reports rating system. Since then the consumer company surveyed 1,400 Model S owners who detailed an array of complicated maladies with the drive train, power equipment, charging equipment and center console view screen. They also complained about body and sunroof squeaks, rattles and leaks. As the cars age there are more complaints about the electric motors, charging systems and batteries that will not hold a charge.

Since Tesla has always held the highest rating for consumer satisfaction, the new report crushed the stock and the news could be a serious headwind for Tesla in the months ahead. Having a near perfect reputation was a big selling point for the high dollar cars.


Ferrari (RACE) priced its IPO after the close at $52 and the high end of the range. The company will raise $894.4 million with the sale of 17.2 million shares. For the six-months ended in June, the company had revenue of $1.6 billion and profits of $140 million. Rapid Ratings gave Ferrari 77 out of 100 for financial health based on 70 individual measures. The average rating for a U.S. company is 64.4.

Yum Brands (YUM) announced today it was spinning off Yum China in 2016 as expected after announcing the addition of activist investor Keith Meister to the board last week. He had lobbied for the spinoff. Yum China will become a franchisee of U.S. based Yum Brands. Yum China generated more than half the revenue and profit for Yum Brands but it has been challenged by food issues that caused consumers to stay away. Same store sales in China rose only +2% last quarter.

If Yum China, which will be run by Micky Pant in China, can resolve the lingering food issues the growth could skyrocket. They will open 700 new stores in China this year to total 7,500 and will eventually have 20,000 locations. Currently Yum Brands has 41,000 total stores and opens about 2,000 a year. The last food issue came from a supplier that shipped out of date meat to the Chinese stores. Before that, the bird flu caused consumers to avoid chicken restaurants.

The greater growth will come from Yum China but Yum Brands will become more stable once the Chinese stores are no longer causing extreme volatility in the earnings. Yum Brands said it was planning on selling the majority of the company owned stores to raise cash for expansion and would be 95% franchisee owned by the end of 2017. The spinoff is expected to be tax-free. Yum shares rose slightly on the news.


Markets

Volume was weak at 5.9 billion shares and buying interest was minimal. The momentum stocks were the hardest hit. If you are familiar with the FANG acronym, today the market was defanged. That stands for Facebook, Amazon, Netflix and Google. Those are the big cap tech stocks that kept the Nasdaq alive for months when the broader market was in distress. All of those stocks declined today.

This is concerning since you would expect those stocks to be on the fund manager shopping list for window dressing going into their fiscal year end on October 31st. Winners get bought and losers get sold.

The very low volume and almost dead even advancing/declining stocks was the only consolation prize. There was no conviction from buyers or sellers. The S&P gave back less than 3 points and the Dow lost only 13. That is hardly a negative day.

The S&P came within a fraction of touching the resistance at 2,040 before pulling back -10 points from the intraday high. Even with that drop, the close at 2,030 was still well over prior resistance at 2,020.

Since there was very little damage despite several large drops in high profile stocks, I think we are still in a buy the dip market.


The Dow retained its positive bias despite the huge drop in IBM, thanks to the big gains in UTX and TRV. Even Apple posted a decent gain on the Tim Cook comments. The Dow needs to pause to consolidate and we could get that on Wednesday when only two Dow components report. The big day is Thursday with four Dow reporters. After Friday, 18 Dow components will have reported earnings.

Resistance remains the beginning of congestion at 17,500 and all the way to 18,165. If we do move higher, it will not likely be in multiple triple digit sprints.



The Nasdaq moved +9 points over resistance at 4,900 intraday but could not hold it with the FANG stocks in decline. That level remains resistance but the close at 4,880 is well within range where a good day in the market could catapult us over that resistance level.

The big gain in ISRG after the close has pushed the Nasdaq futures into positive territory by +9 points. That could be erased by morning but it is a good start after a negative move today.



The Russell 2000 remains stuck under resistance at 1,165 but at least it is trying to break out. The intraday high was 1,169. If we do eventually see a breakout by the small caps, I think the large cap indexes will sprint higher.


We missed a good opportunity today for a decent dip on the IBM disaster. To end the day basically flat and with the futures positive overnight it confirms my belief that we are still in a "buy the dip" market until proven wrong.

Anything is of course possible but the market is not giving in to negative events. The earnings forecasts were too bearish and the slightly better results are providing support for the market.

However, we are eventually going to have to pay the piper for the current revenue recession. You cannot watch revenue decline forever without fundamentals eventually forcing a price correction. I think we are safe until the end of October but once into November we need to be more cautious.

Enter passively, exit aggressively!

Jim Brown

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