Friday the 13th bought a continued market decline and bad luck for investors. Was it really bad luck or do fundamentals suddenly matter?

Market Statistics

With economics and earnings turning progressively lower I suspect the market decline was the return of fundamental worries. I wrote an article on Thursday questioning whether the U.S. was entering into a recession. I will summarize that again later in this commentary.

Friday's continued decline came after some ugly earnings in the retail sector, weak guidance from Cisco Systems and some negative economic reports. The snowball of negative headlines appears to be gaining speed as it moves down hill.

The Retail Sales report for October came in at +0.1% compared to estimates for a +0.3% rise. Revisions to prior months were mostly negative. Building supply stores saw a +0.9% rise and nonstore retailers (led by drug stores) rose +1.4%. General merchandise stores, gasoline stations, food and beverages, electronics and appliances and motor vehicles & parts all posted declines.

Year over year sales were down -1.7% over October 2014 levels. Sales in the prior two months were revised down to zero gain. Analysts remain confident that the strong housing sector will continue to power consumer spending as they furnish those new homes. Auto sales are also above trend and are providing significant support for the overall retail sales or the numbers would be much worse.

The last two times retail sales have been this bad we were already in a recession. Analysis

The Producer Price Index for October declined -0.4% compared to estimates for a +0.2% gain. There is no inflation at the producer level and after the -0.5% decline the prior month, there is some significant deflation at work.

It was not all related to energy, which was unchanged for the month. Food prices declined -0.8% for the second consecutive month. Core prices fell -0.3% and services prices fell -0.3%.

Prices have declined -1.7% since October 2014. Over the last three months alone prices have declined -3.6% on an annualized basis. Intermediate processed goods have declined -7.6% and unprocessed goods have declined -23.6%.

This is going to make it very hard for the Fed to make a "data dependent" case for hiking rates in December. They may hike anyway to rescue their credibility after targeting December in their last statement but it will not be because the data is supporting the decision. They may hike 25 basis points but then reduce their guidance for anticipated hikes in 2016 to end the year at 1.0%.

Hedgeye Cartoon

Business inventories for September rose 0.3% compared to estimates for no gain. That suggests either the pace of sales has slowed or there was some build in inventories ahead of the holiday season. Manufacturing inventories declined -0.37%, retail inventories rose +0.79% and wholesale inventories rose +0.50%. The largest subsector gain came from vehicles & auto parts with a +1.4% gain. Total sales growth was nearly unchanged for the second month. The inventory to sales ration has returned to 1.38 and the highest level since the recession.

While economic reports are printing new lows, the Consumer Sentiment report for November rose +3.1 to 93.1, up from 90.0 in October. The present conditions component rose from 102.3 to 104.8 and the expectations component rose from 82.1 to 85.6. Falling gasoline prices were credited with the gain in sentiment.


The economic calendar for next week has a lot of reports but only two are potential market movers. The FOMC minutes on Wednesday are always a problem for the market because we do not really know what the FOMC members were thinking at the last meeting. There is always a surprise of some sort. This is the last Fed update before the December Fed meeting in four weeks.

The Philly Fed Manufacturing Survey on Thursday is the most important regional report for the month. Analysts pay the most attention to it as a proxy for the ISM Manufacturing two weeks later.


On Thursday, I wrote an article on the potential for a U.S. recession. I got a lot of feedback on it and apparently, many readers feel the same way. Link to full article

The basic points are as follows:

First, the Fastenal CFO, Daniel Florness, warned "The industrial environment is already in a recession. I do not care what anybody says, because nobody knows the market better than we do." Fastenal (Nasdaq:FAST) sells wholesale industrial and construction supplies like bolts, nuts, screws, etc, which are used in manufactured products in the U.S. and internationally. They should know if manufacturing is slowing because demand for components is slowing.

Secondly, the Railway Supply Institute (Rsiweb.org) said third quarter railcar orders declined -83% to hit their lowest level in 27 years.

Third, FBR reported that orders for class A trucks declined -45% in October. In addition, BB&T reported that production of railcars, trucks and trailers would likely fall -20% to -35% in 2016 according to preliminary estimates.

That brings us to a warning from Wells Fargo. After the order data was released the bank said over the last 45 years ANYTIME orders for machinery and transportation equipment declined, as is happening today, a recession followed. The bank said the risk of a recession was accelerating as we head into 2016.

We had another confirmation today when the US Steel (X) CEO, Mario Longhi, said we are definitely in a recession, "it is happening now and it is more than just a recession."

Industrial production has fallen in 7 of the last 9 months. The ISM Manufacturing PMI for October was 50.1 and a 30-month low.

Joe LaVorgna, Chief Economist at Deutsche Bank, said a confirmed downturn was in progress and the dollar strength was becoming critical. As the Fed gets closer to hiking rates, the dollar is only going to get stronger and the impact on the U.S. economy even worse. The dollar index is hovering at six-month highs.


Add in the drop in commodity prices as a result of low demand and the recession or even deflation picture is pretty convincing.

Commodity Index

Analysts are blaming the Thr/Fri market decline on the implosion in the retail sector. They are worried that consumers are not spending money. The S&P Retail ETF (XRT) declined -8.5% last week alone. Macy's (M) declined -20%, Kohls (KSS) -8%, Nordstrom (JWN) -20%, Fossil (FOSL) -40% and JC Penny (JCP) -15% for just a few examples.

On the earnings front Nordstrom reported earnings of 57 cents compared to estimates for 72 cents. Same store sales rose only 0.9% compared to year ago levels of +3.9%. The company projected revenue growth of 7.5% to 8.0% and $3.40-$3.50 for earnings. Prior expectations were for 8.5% to 9.5% growth and $3.70-$3.80 on earnings. Shares were crushed for a -15% decline on Friday.


JC Penny's (JCP) reported a loss of -47 cents that was better than analysts expected at -58 cents. Revenue of $2.9 billion also beat estimates for $2.86 billion. Same store sales rose +6.4%. However, despite the earnings beat the company kept its lowered forecast for full year sales of 4-5%. Analysts were quick to caution that by not raising estimates they were actually warning that they expected additional weakness. Shares fell -15% on the news.


Fire protection and security company Tyco International (TYC) reported earnings of 61 cents and revenue of $2.51 billion. Earnings were in line with estimates but revenue missed estimates of $2.54 billion. Tyco failed to impress on its conference call and shares declined -3%.


Eagle Bulk Shipping was listed as an earnings reporter on Friday but there was no release. Shares crashed -10% on no news. Eagle is a dry bulk shipper. With the Baltic Dry Index of shipping rates nearing a post recession low the sector has declined sharply over the last week.



Fossil (FOSL) reported earnings of $1.19 compared to estimates for $1.13. Revenue of $771.3 million missed estimates for $784.8 million. The earnings were not the big problem. The company lowered its full year forecast suggesting it was preparing for a weak Q4. Fossil cut its full year outlook from $4.80-$5.60 to $4.15-$4.75 per share. Analysts were expecting $5.14. They projected earnings for Q4 of $1.40-$2.00 and analysts were expecting $2.15. They also projected sales to decline up to -11%. Shares fell -36% on the news.


Cisco Systems reported earnings on Thursday after the close. The company beat expectations but provided weak guidance for the current quarter. Cisco said it expected a +2% rise in revenue in Q4. However, they said macroeconomic conditions were challenging and overseas orders were slowing. Shares declined -6% on the report.

Late Friday news broke that Cisco was going to buy Ericsson (ERIC) and shares of ERIC spiked from $9 to $10.15. Within minutes, Cisco denied the report saying they were only in partnership with Ericsson and there were no plans to buy the company. They had announced the production partnership earlier in the week.



The Nasdaq big caps were down hard on Friday. Priceline continued its post earnings plunge with a $16 drop to a five-week low. Amazon (AMZN) gave back -$23 on no news. Alphabet (GOOGL) lost -$19.


Oil prices fell to $40.73 for a loss of -8.5% for the week. U.S. inventories rose +4.2 million barrels to 487.0 million. That is only 3.9 million barrels below the historic 80-year high of 490.9 million.

The IEA released its monthly report (Link) saying global oil inventories were near 3 billion barrels and at record highs. Those inventories were rising at +1.6 million barrels per day and would accelerate when Iran and Iraq increase production in early 2016. Iran is expected to add 500,000 bpd to start and raise that to 1.0 million bpd by July. Iraq is pumping the most oil since 1962 and expected to increase production further in Q1.

Furthermore the IEA said global demand growth was slowing. The IEA said demand growth would slow to 1.2 mbpd for all of 2016 compared to the 1.8 mbpd growth in 2015. Global production rose to 97 mbpd in October. OPEC supplied 31.76 mbpd despite temporary declines in Iraq and Kuwait. Libya, Saudi Arabia and Nigeria produced more than the prior month.

There are currently 19 million barrels of oil headed from Iraq to the USA. Ten tankers are currently headed for U.S. ports carrying Iraqi oil. That is the most in one month since June 2012. Iraq sold its heavy crude to the U.S. at a -$5.85 per barrel discount to the benchmark compared to the Saudi price of -$1.25 off the benchmark. This means we are going to see some big inventory gains in the weeks ahead.

Bloomberg Chart

There is a record tanker backlog in Houston of 39 tankers waiting to unload. In the fall when cold air hits the warm water Gulf they have a serious problem with fog, which shuts down tanker movement until it clears, sometimes for days.

China has filled up all available storage. Tankers have been sitting at terminals for weeks waiting to unload. In addition, there is now more than 100 million barrels of oil in storage on tankers with no place to go.

U.S. production rose again last week with a +25,000 bpd gain. Production of 9.185 mbpd was a nine-week high while active rigs continue to decline. Technology is winning the battle over reduced drilling but the rise helped push prices lower. There is a good chance we will see prices under $40 next week.


Active rigs declined -4 to 767 and another decade low. Oil rigs rose +2 to 574 and gas rigs declined -6 to 193. The number of active rigs is down -1,164 from the peak of 1,928 in September 2014. Oil rigs alone have declined -1,035.


Copper was in the news a lot last week as prices plunged to a post recession low at $2.16 per pound. Slowing demand and the rising dollar along with dumping due to margin calls is powering the decline. Copper is seen as a primary indicator of global economic activity. Copper goes into anything electrical as well as wires in homes, buildings, cars, planes, etc. There is about 55 pounds of copper in a new car and 400 pounds in a new home. With all the uses for copper and the falling demand, it is easy to deduce that global manufacturing and construction activity is slowing.


Markets

It was the second worst week of the year for the equity markets. The attacks in Paris was not initially reported until after the markets had closed or the decline would have been a lot worse.

The Dow lost -665 for the week, NYSE -358, Nasdaq -219, S&P -76, Russell 2000 -53, Dow Transports -231. There were no bright spots but the biotech sector tried to rally more than once to post a six-week high on Wednesday and managed a 35 point gain on the $BTK on Friday. However, it still lost -1.3% for the week to post the smallest loss of all the indexes.

Whenever we get a significant decline, we always try to look for any good news. Sometimes that search ends up grasping at straws but we still need to look. The Friday close on the S&P at 2,023 was exactly on the 38.2% Fib retracement. It was also only 2 points above the reaction high of 2,021 on September 13th and the 2,019 resistance on Oct 12th. If there were a logical rebound point, this would be it. Unfortunately, logic is rarely found in the equity market.


Support for Monday would be 2,020 followed by 1,985. Resistance is 2,060, 2,085 and 2,115.


The percentage of S&P stocks over their 200-day average declined from 56% to 39.2% in just a week.


I showed this chart last week and warned that the MACD and RSI were about to turn negative. That turn is complete and it would appear there is no relief in sight.


The Dow only had four components in positive territory and 12 that lost more than $1. The Dow is still well above strong support around 17,130. There is a support band from about 17,050 to 17,200 but I doubt it will be strong enough to stop the Dow's decline if the selling is as pronounced as it was on Thr/Fri.

The carnage in the Dow stocks was extreme. For instance Home Depot (HD) fell -3% on no news. The building materials sector was one of the strongest in the Retail Sales report. There was no reason for HD to crash.


IBM is in plunge mode with a -$20 decline since it posted earnings on October 19th. This is a major impact on the Dow because of its weighting in the index.


Even the banks were declining over the last two days despite the chance of a Fed rate hike in four weeks. I scanned the charts of the Dow 30 and it does not look good. It would take a major market reversal to turn the Dow around.



The Nasdaq Composite has reached decent support in the 4890-4925 range. This was a challenge to break through when it was a resistance and hopefully it will be decent support on the way back down.

Apple (AAPL) was a major drag on the Nasdaq with a -$9 drop for the week. However, on Friday Amazon, Cisco and Facebook were the biggest weight on the Nasdaq. The graphic below shows the point impact on the Nasdaq 100 from the 10 losers on Friday. Link to complete list


Point losses on the losers are far larger than the gains on the winners.



The Russell 2000 small caps were hammered but no worse than the rest of the indexes. That is small consolation. The -4.4% loss for the week was right in line with the Nasdaq and only slightly higher than the Dow and S&P at -3.7%. The Russell came to a stop on support at 1,145 that held in late October but it may be wishful thinking that it will hold again.

A continued decline would target 1,102 after a possible pause at 1,136. In theory, the small caps should be in favor over the next four weeks but theory has had some problems with reality in the recent past.


Historically the first week of November is normally the strongest week in the fourth quarter. That trend failed this year. Normally, the second week of November is bearish as fund managers undress those positions they added for window dressing at the end of October. I think we can safely assume the amount of selling was heavier than simple window undressing BUT the volume on Thursday was only 7.0 billion shares and Friday was 7.6 billion. That is moderately strong but the average over the last three weeks has been about 7.1 billion so there was no panic selling last week.

In the five minute chart of the S&P there was an initial drop at the open on the Cisco earnings, retail earnings from several companies and negative economic reports. About noon, there was a concerted buying spree in the energy stocks with several up more than $2 intraday. At 12:30 that buy program ended and the index began to trend lower. However, note that the trend was slow and there was solid support at that Fib retracement level at 2,023. The lack of heavy volume and the slow pattern of selling suggests we could see a bounce next week. However, the S&P did close right on the support lows.


I wrote last week that I was in buy the dip mode. I wrote midweek that I would buy the dip down to support at S&P 2,060. That support broke at the open on Thursday. Now I am in a quandary. The individual Dow charts are ugly and do not suggest a rebound is near. There may be a short squeeze in our immediate future and I would welcome one on Monday just to relieve the selling pressure. However, at this point I would be cautious about adding to existing longs. If that 2,023 level on the S&P holds and we rebound back over 2,040 then I would feel better about adding to long positions with that 2,023 level my exit point. If 2,023 fails I would be flat or short.

Strong Octobers tend to produce weak Novembers and that is one historical trend that has come true so far. The last 12 November Friday the 13ths have been down 8 times and up 4 times. Out of the last 144 Friday the 13ths November is the worst in terms of performance.

The third week of November has been up in 16 of the last 21 years. It is also option expiration week and after the big market decline that should have a bullish bias.


Random Thoughts


The terrorist attack in Paris is a tragedy but unfortunately one they are likely to relive multiple times in the years ahead. The influx of a million refugees, 85% of which are young men, has allowed an untold number of terrorists to infiltrate into Europe.

Personally, I am surprised we have not experienced the same type of attacks in the USA. The FBI currently has more than 1,000 active investigations into ISIS activities in the USA. We know there are sleeper cells in the U.S. and even with 1,000 active investigations, we know there are active individuals we do not know about. The border patrol finds Korans and prayer rugs along the border trails all the time. They are here whether the government wants to admit it or not.

America is a free society. We go to sports stadiums, movie theaters, malls, etc, completely unaware of our surroundings. We have never had to be threat aware. Eventually, terrorists are going to take out some theaters or shopping malls and the American lifestyle is going to change forever.

ISIS said last week, "American blood tastes the best and we will taste it soon."


Rogers Kiffen Worldwide warned that online retailers were stealing the business from brick and mortar retailers. Previously when you went to the mall you visited 5-6 stores and "shopped." Today a consumer may visit 3 and just buy. They already shopped online and they know what they want. They just go in the store, find the right size, buy and leave.

Steve Odland, former Office Depot CEO and now CEO of the Committee of Economic Development, said this holiday season is going to be a bloodbath. "Inventories are up, sales are down and that is causing a big problem for margins." The holiday sales are going to start out as clearance sales rather than holiday discounting. The lower price retailers are the only ones succeeding in this environment.


Mario Draghi went from super dovish to extremely dovish last week in what appears to be plans to add stimulus in December at the same time the Fed is likely to hike interest rates. The Fed has not hiked at the same time Europe was easing since May 1994. Nelson Mandela was the first black president of South Africa and Beverly Hills Cop 3 was showing at the movies. The Euro and the ECB did not exist.

Greenspan raised the rate from 3.75% to 4.25% and the Bundesbank cut rates from 5.0% to 4.5% to spur expansion in Germany. Full Bloomberg Article

Why Europe will Cut Rates


The World Gold Council said U.S. demand for gold bars and coins surged +207% in Q3. The interest in gold is at levels not seen since the financial crisis. Gold Eagle sales at the U.S. Mint surged to nearly 400,000 ounces last quarter, the highest level in five years. The -1,000 point drop in the Dow in August caused a flurry of buying in precious metals. The stronger dollar makes gold and silver cheaper and consumers are taking advantage of the trend. Americans Buying Gold



I would not want to be on a U.S. carrier in a war with China or Russia. China has a new supersonic carrier blaster that can be launched from hundreds of miles away, travels above the atmosphere and then comes straight down at 3 times the speed of sound from directly above the carrier. It can also be nuclear armed.

Last week Russia aired on TV plans for a long-range nuclear torpedo that can destroy ships, harbors or important economic installations. The torpedo's range could be up to 6,000 miles. The airing was accidental when a news crew was filming a meeting between Putin and his generals in Sochi. Putin said he was taking steps to prevent future accidents that release secret data. I would not put it past Putin to stage the entire event just to cause the U.S. to worry about what he might be doing. The government newspaper Rossiskaya Gazeta called the torpedo a mini robotic submarine. Nuclear Torpedo, OOPS!


 

Enter passively and exit aggressively!

Jim Brown

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Veteran's Day Reflections:

"Semper Fidelis" - Always Faithful - U.S. Marine Corp
"Semper Paratus" - Always Ready - U.S. Coast Guard
"Non sibi sed patriae" - Not for Self but Country - U.S. Navy
"Aim High, Fly, Fight, Win" - U.S. Air Force
"This we will defend" - U.S. Army