Tech stocks were an anchor for the market on Friday as disappointing earnings knocked the Dow and Nasdaq down about 75 points at the open. The Dow recovered to close positive.

Market Statistics

Friday Statistics

A combination of negative earnings from Google, Starbucks, Microsoft and Visa knocked the markets lower at the open. GOOGL lost -42 for the day, SBUX -3 and MSFT -4 to push the Nasdaq 100 down -67 at the close.

The Dow shook off the $4 drop in Microsoft and a nearly 75-point drop at the open to close with a gain of 21 points. The Russell 2000, S&P-600 and the Dow Transports were the biggest gainers with a 1% gain each.

The strength in those indexes suggests we could see the markets try to rebound again next week.

There were no economic reports on Friday. I would like to review the Philly Fed Manufacturing Survey from Thursday. Analysts were all excited after the positive +12.4 print in the headline number for March. Some of the components were also positive. For April the headline number reversed to -1.6 and the material components turned deeper into negative territory with the exception of new orders. Everything in orange is negative. This represents the manufacturing sector in the Philadelphia region. It has been negative for most of the last year. We care about the Philly Fed because it is a proxy for the national ISM report due out in two weeks.

The two components that actually rose were prices paid and received. That means inflation is finally filtering through the system but the actual business components are falling deeper into contraction. This brings back fears of stagflation where the economy is stagnant but inflation rises. That is very tough for the Fed to combat because raising rates to slow inflation also slows economic activity.



The Atlanta Fed GDPNow is forecasting growth at 0.3% for Q1. Note the shaded blue line and the rapid decline. This is the average of 20 forecasters and their outlook is dropping fast.

The Fed cannot raise rates with GDP at zero regardless of how much they think they should. Moody's is predicting a -0.1% decline in GDP for Q1.


The Fed meets this week and they are expected to be neutral for the short term but still claim they intend to raise rates later in the year. They have to say this or there would be no volatility in the bond market and actual interest rates would sink even farther. The market expects a rate hike in June but analysts believe there is only a minimal chance. The CME Fed Watch Tool is showing only a 21% chance of a hike in June.


There is a full calendar of economic reports next week but other than the Fed and the GDP, the most important is the numbers from Japan. We get the full boat of data on Wednesday and then the BOJ monetary policy on Thursday. Last time they met the rates went negative but the yen spiked contrary to what they thought would happen. Analysts believe they may try to tune the negative rates at this meeting or even apply them to bank loans. More than likely, they will ramp up purchases of Japanese equity ETFs in an effort to enhance the wealth effect and make the Japanese consumer fell better about spending money.

If the Fed produces a dovish statement and the BOJ goes even deeper into negative territory and ETF purchases we could see the flight to quality trade on U.S. Treasuries continue to reverse. With fears over China easing, we have seen selling in treasuries with the yield on the ten-year rising from 1.68% to 1.89% over the last two weeks.



The market recovered from some of the bad earnings on Friday partly because of comments from the Caterpillar CEO. He said do not expect a hockey stick rebound like in 2010 but sales in China actually improved in Q1. This is the first time in three-years that sales have improved. He believes the global economic bottom is either behind us or occurring now but the rebound out of the trough will be slow.

Despite his optimism, the company posted a 68% decline in earnings to 67 cents that was in line with estimates and in the middle of CAT's guidance of 65-70 cents. Revenue fell -26% to $9.461 billion and missed estimates for $9.499 billion as a result of currency translation issues. Latin America is crashing with a -43% decline in sales there. This is the second company that warned on an implosion in Latin American economics. CAT still made $1.04 billion in profits even with the sharp declines in sales. They ended the quarter with $5.9 billion in cash. Order backlogs at the end of the quarter were $13.1 billion.

CAT guided slightly lower for all of 2016 with revenue estimates declining from $42 billion to $41 billion. Earnings are now projected to be $3.70 compared to earlier projections for $4.00. CAT shares declined slightly from resistance at $80. If you are a long-term investor with the CEO calling a bottom in the Asian economy, I would look to buy CAT with a move over $80. CAT shares already posted a 35% rebound from the January low so I would wait for any post earnings depression to fade before adding it to the portfolio.


Who knew breakfast was such a powerful marketing tool? McDonalds (MCD) saw same store sales rise +5.4% in the U.S. because of 24-hour breakfast menu. This is the third consecutive quarter that sales have risen. MCD also introduced the McPick 2 value deal to attract cost conscious consumers. They abandoned the dollar menu because the margins were too small. The McPick 2 is any two premium items for $5. The company also raised prices by 3% during the quarter. McDonalds now has 14,200 domestic stores and they are currently selecting underperforming stores to be closed.

Global same store sales rose +6.2% with China rising +3.6%. Earnings were $1.23 and beat estimates by 7 cents. Revenue of $5.9 billion also beat estimates. Shares declined slightly but they have been rising steadily since August last year. Expect some further profit taking.


General Electric (GE) reported earnings of 21 cents that beat estimates for 19 cents. They have 9.3 billion shares outstanding so it takes a lot to add a penny to earnings. Revenue rose 6% to $27.6 billion and in line with estimates. However, GE met estimates because they completed the acquisition of Alstom during the quarter. Without that acquisition revenue would have declined -5.3% to $23.1 billion. Order backlogs increased 18% to $316 billion. GE returned $8.3 billion to shareholders in dividends and buybacks in Q1.

GE is on track to exit the financial services business with $166 billion in deals signed and $146 billion closed. The company has already submitted an application to be removed as a "systemically important financial institution" or SIFI and expects that to be granted soon.

The biggest problem for GE in the quarter was the oil and gas division, where profits are expected to decline 30% in 2016. Despite that drop, the company reaffirmed full year guidance of $1.45-$1.55 with 2-4% organic growth. They plan to return $26 billion to shareholders this year.


AutoNation (AN) reported earnings of 90 cents compared to estimates for 93 cents. The earnings miss came from a $6.8 million loss from "epic biblical hail" that damaged vehicles in Texas. Revenue of $5.1 billion missed forecasts for $5.29 billion because thousands of cars could not be sold because of hail damage. The Insurance Council of Texas said there was more than $1 billion in damage from a couple of major hail storms that produced hail as big as cantaloupes. The company also said 25% of sales come from markets that depend on energy and profits were down 20% in those areas because of depressed oil prices.

The CEO said automobile manufacturing has to be cut back significantly. The low gas prices has seen consumers flood into pickups and SUVs and there is a shortage in that category. AutoNation cut back on orders for cars in Q1 and is reducing orders again for Q2.

Shares dipped sharply at the open to $45.50 but rebounded $4.00 after the CEO said he was still optimistic on the business pointing to a recent acquisition and $371 million spent on buybacks in Q1. He still expects the U.S. to sell more than 17 million vehicles in 2016.


Google and Microsoft reported earnings on Thursday after the close and Friday was a bad day. Eight firms cut their price targets for Google and four cut targets on Microsoft. Google lost $42 on Friday and Microsoft lost $4. Combined, those drops erased $53 billion in market cap.


Earnings just kicked into high gear with close to 750 companies reporting next week. The highlights are Apple, Facebook and Amazon. On the second tier are Twitter, Linkedin and Ebay followed by the major oil stocks, BP, Exxon, Conoco and Chevron. Dow components include AAPL, DD, MMM, PG, BA, UTX, CVX and XOM.


Apple had a bad week after being downgraded more than once and news broke they were cutting production by 30% in Q2 following a similar cut in Q1. According to researcher TrendForce, Apple is now expected to have shipped only 42 million iPhones in Q1, down from 61.2 million in the year ago quarter. That is a 31% drop in shipments and suggests Apple is going to have an ugly earnings report.

For the full year, TrendForce expects Apple to ship 213 million phones, down -10% from 2015. At the same time Samsung is expected to ship 316 million units and about the same as 2015. The Apple Watch has been a flop even though they are expected to sell about 4 million. The iPhone grew to 68.1% of Apple's revenue last quarter and while the watch may be producing some nice pocket change, it is the iPhones that drive the bus.

Part of the problem for Apple and Samsung is that the global smartphone market has reached a saturation point. Phones are lasting longer and the refresh cycle is becoming stretched. Consumers do not need to buy another expensive phone every two years and the upgraded feature list is not enough to convince them their old phone is obsolete. A $700 phone is a huge expense for consumers outside the U.S. and sometimes it equates to several months wages.

Credit Suisse is not expecting as dire a quarter but cut their iPhone estimates from 55 million to 48 million. Piper Jaffray cut estimates from 62.5 million to 55 million. TrendForce is more bearish because they are deeply involved in the entire market where bank analysts have other tasks besides predicting iPhone sales.

We also learned on Friday that Apple's mobile entertainment services in China had been blocked. The online book and film service was censored by the Chinese government for providing access to content that might promote some independent thinking by consumers. China is Apple's second biggest market by revenue and this is a blow to Apple. In March, China introduced strict rules for online publishing, especially by foreign companies.

Much of these negative expectations have already been baked into the price on Apple shares but depending on the actual units sold, we could retest the support at $92. The guidance is also critical since they have already ordered production cuts for Q2.


Another stock that could face problem next week is Twitter (TWTR). The company is expected to report earnings of 10 cents but that will be of less importance than the monthly average users (MAU). Revenues are expected to increase 39% to $605 million. The MAUs are expected to come in at 317 million. Last quarter users were flat at 320 million. Twitters problem is that it cannot grow the user base. You are either a tech savvy extrovert or you are not. Twitter is an instant gratification or instant embarrassment tool depending on which side of the tweet you are on. Twitter is having trouble keeping users after they are deluged by negative tweets responding to something they said. There are more than 500 million inactive users that only view tweets without actually logging in. Twitter has been changing its ad format to capture more revenue from these "drive by" readers.

Marketbeat.com reports there are 17 buy ratings, 25 hold and 3 sell ratings. CEO Jack Dorsey is under the gun to do something that will revolutionize Twitter and make it more "sticky." Earnings are not the problem. They beat estimates by 46% last quarter and have averaged a 28% beat over the last four quarters. If Dorsey has been able to significantly increase the MAUs in Q1, he will be a hero and the stock will react strongly. Most investors believe Twitter will be successful but their patience is wearing thin.


Linkedin (LNKD) reports on Thursday and they need some love too. They were crushed after guiding for revenue of $820 million in Q1 and significantly under the $867 million analysts were expecting. They guided for the full year to $3.60-$3.65 billion and analysts were expecting $3.91 billion. The company said online ad revenue growth slowed from 56% to 20% for the quarter. More than $11 billion in market cap was erased from the stock. At least nine brokers cut the stock from buy to hold saying the lofty valuation was no longer justified. More than 36 brokers cut their price targets. Pacific Crest cut their target in half to $190. The analyst average is now $188. Shares closed Friday at $119. The weekly options that expire on Friday are extreme with near the money puts/calls trading at $8. Obviously, some traders are betting on a big move.


Contrary to reports last Tuesday that Yahoo (YHOO) received only two bids from Verizon and YP Holdings, Bloomberg reported at the close on Friday that the company received 10 bids ranging from $4 billion to $8 billion for the core business. Yahoo executives are spending the weekend working on the list and will narrow the second round to 7 buyers. Those selected will receive access to internal documents and access to management.

Reportedly, some of the higher bids were from PE firms and companies that had not spent much time with Yahoo and executives are trying to find out how much analysis they did and how did it in order to come up with a number. Secondly, Yahoo executives are trying to understand all the various deal structures to decide which makes sense and has the best chance of succeeding. Bidders are not allowed to talk to other bidders because of non-disclosure agreements they signed.

SoftBank has said it has no interest in making a bid but it does want to talk to prospective bidders about buying back its stake in Yahoo Japan from whoever wins. Verizon has already held talks with SoftBank.

Yahoo said a decision on a winner is probably at least a month away.


More than 26% of the S&P have already reported earnings and 76% have beaten estimates with 55% beating on revenue. The current blended earnings growth is -8.9%, a slight improvement from the -9.4% a week ago. Of those companies that have reported, 10 have issued negative guidance and 10 issued positive guidance. FactSet said Apple is projected to be the largest contributor to the decline in S&P earnings. Earnings are expected to decline from $2.33 to $2.00 with several estimates sharply lower than the consensus.

Despite the high profile declines in the Nasdaq stocks on Friday the market has been rewarding those companies that beat even slightly and not punishing those that have missed estimates slightly. There are examples in both directions but mostly investors just seemed relieved the earnings have not been worse.

Currently the decline in revenue growth is -1.2%. If the quarter ends negative it will be the first time FactSet has seen five consecutive quarters of revenue declines since they began tracking the data in 2008.

In the strange but true section today, oil prices rose after there was no agreement in Doha despite very high short interest ahead of the meeting. I wrote several times that the expiration of futures on Wednesday would give those shorts only two days to cover before expiration and we could see prices rise. However, I expected prices to decline once the futures rolled over. Instead, prices continued to rise to touch $44.45 on Friday.

Since Russia, Kuwait, Saudi Arabia, Iraq, Iran, the UAE and Libya have all stated their intent to increase production and therefore increase the current glut, the rise in prices makes no sense. Last week we had a flurry of analysts, CEOs and "experts" all making calls for $65 to $85 oil by the end of 2016. Each had their own reason but none made much sense. I guess it is possible for all the producers to get together and continually "say" the glut is disappearing and prices will be $100 in December. There is a large contingent of traders that would believe them and buy oil regardless of whether it was true. Some of our political candidates have been making a lot of wild claims about what they will do when elected. Those claims have no basis in fact and no chance of happening but voters are delirious in their support. The same thing can happen in the oil market. Say something enough and maybe enough traders will believe you and oil prices will rise.

We are approaching the magic number where rigs will be put back to work in the USA. That number is $45. It will take more than a couple weeks at that level but once cash starved producers believe the number will stick they will give the orders and rig activity will spike. I seriously doubt OPEC leaders want to see that activity but they need the higher price for oil so maybe they take a deep breath and let it happen.

We are approaching that part of the year where inventories begin to decline as gasoline production increases. Oil prices typically rise in May through August and maybe this historical trend is encouraging investors to buy crude.

Goldman Sachs changed from bearish to neutral on crude prices. They said the lows are behind us. Of course, the lows were $26 so we could fall significantly and not retest the lows. Goldman said, "While this recent rally has the potential to run further to the upside, we believe that it is not yet driven by a sustainable shift in fundamentals. It is premature to embrace these green shoots."

Analysts said producers would not hesitate to hedge future production once prices rise enough. That will provide them some cash and some comfort for their banks. However, even with the rebound in current prices to $44 the price for December 2017 crude is only $48. That is hardly a strong incentive to rush out and hedge a million barrels when they really need $60-$65 to make it worthwhile. If they hedge at $48 and prices really did rally over $70 by December they would be looking to take a dive off a high bridge.


Active rigs declined -9 to 431 last week. Active oil rigs fell -8 to 343 and gas rigs dropped -1 to 88. Those are new 65-year lows.


Markets

It was not a big week in the markets. The first three days were positive and the last two days negative and the Dow only gained .6% for the week and S&P .5%. The Nasdaq lost .6%. Those numbers do not indicate that the Dow hit a nine-month high and the S&P traded at a 5 month high. Resistance in both cases held and two days of declines appeared.

The S&P came to a dead stop at 2,111 at 3:PM on Wednesday and the decline was sharp. The low on Friday was 2,081 for a -30 point drop from the high.

In reality, this is just a normal hiccup. We should not try to assign too much importance to the minor decline. With the S&P rebounding +10 points on Friday to close positive, we should be looking it as a potential short-term buying opportunity. This is even more appropriate given the gains in the small and midcap indexes.

However, just because the S&P paused and rebounded slightly ahead of weekend event risk does not mean there is a new rally ahead. We may be assigning too much value to the late Friday short covering that brought the S&P back to positive territory.

Keith Bliss from the Cuttone Company was interviewed on Friday and he said their research had shown that last week was the strongest week in Q2 dating all the way back to 1957. This is the ramp up into the first surge of earnings from the bluest of the blue chips. After last week, the market tends to fade into June as the sell in May cycle takes hold. He said the markets "ebb" into June, not crash into June.

The remaining earnings cycle will still provide sticking power for the markets. The coming week is the busiest week of this cycle and a lot of investors placed their bets over the prior weeks. It is after the peak in earnings in the coming week that excitement begins to fade. We call it "post earnings depression." Stocks typically fade after they report earnings as traders take profits from an earnings run and move on to something else. This is true even when the company posts an earnings beat. Sometimes a major disaster like Starbucks or Netflix attracts buyers at the bargain price but shares could linger at the lows for days to weeks before rebounding. Those who were holding when the disaster occurred are looking for any bounce to sell at a better price.

The purpose for explaining the earnings reactions is to enforce the reason the market may begin to fade soon. Add in the strong resistance and the seasonal factors and we could see some weakness.

Offsetting that post earnings depression this year is the new high syndrome. We are close enough to new highs that traders may want to stick around until those highs are hit. Whether we continue to make higher highs is another problem. Then you have to take into account the Fed's potential rate hikes, the Brexit vote in June, the quality of the earnings, the price of oil and the political campaigns leading up to the summer conventions. All those things can and will impact the market. One analyst said this could be an especially severe sell in May cycle.

The S&P needs to exceed 2,134.72 to make a new intraday high and 2,130.82 for a new closing high. We still have some significant resistance to cross to get to those levels.


The Dow was the closest to a new high on a relative basis with a print at 18,167 and right at the top of the current resistance band. At Friday's low, the Dow had declined -258 points from that Wednesday high. With half the Dow components already reported, there will be less uplift from future releases but it is always possible for somebody to blowout earnings and rocket the Dow higher for a single day. Dow components reporting this week include AAPL, DD, MMM, PG, BA, UTX, CVX and XOM. Apple could be a major drag ahead of Tuesday's night's release and afterwards if they gap down significantly.

Chevron and Exxon have such low expectations they could actually beat and possibly provide some lift.

Dow support is about 17900-17875 and then it drops a lot lower to about 17,500 and 17,400. Resistance remains the band from 18,110 to 18,165.



The Nasdaq cannot seem to get away from the 4,950 level after spending 7 days trading in that range. Friday's 39-point drop took it back to 4,900 and a level that has been resistance in the past. The real resistance is still the 5,100 to 5,160 level and the index has not even come close since failing there in December.

If the tech stocks are going to continue missing earnings it may be really difficult to reach that level and even harder to punch through it. Critical earnings next week are FB, EBAY, AMZN, TWTR, AMGN, AAPL, AKAM, PNRA, SNDK, LNKD, SWKS and WYNN. The elephants in the room are Apple, Amazon and Facebook.

Real support on the Nasdaq is back at 4,831 and 75 points below Friday's close.



The Russell 2000 had a good week with a +1.4% gain and closed at a three-month high at 1,145. That is still 20 points below strong resistance at 1,165 but it is the relative strength that matters. The S&P-400 Midcap index closed at an eight-month high and just over resistance at 1,473. The S&P-600 Small cap index closed only 10 points below strong resistance at 712 but it was still a five-month high.

The relative strength in the lower end of the market capitalization is bullish for sentiment. These indexes are telling us the broader market could move higher.




The Dow Transports broke through resistance at 8,000 once again and this time the retracement used that 8,000 level as support. If the transports can mover 8,300 this would be another bullish event. The transports rose even though oil prices were rising.


The Volatility Index ($VIX) dipped to 12.50 on Wednesday and that is a level that equates to an overbought market. As you can tell by the chart, it can remain at that 12 level for some time before a volatility event sends it soaring. The 12 level also signals market complacency. Investors are so confident the market is going up they are no longer buying puts to protect their positions. This is dangerous when a volatility event appears because there is little downside protection in place and investors tend to hit the sell button quicker rather than ride it out.


The dollar halted its decline last week and rebounded to 95 on the Dollar Index. When the dollar was falling, equities and commodities were rising. If the dollar is done going down, those same sectors are not likely to rise. The dollar impacts earnings for the S&P-500 and reduces revenue by 3% to 12% depending on the company. With Japan likely to enact some more stimulus next week, the dollar could continue to rebound. However, if the Fed statement is ultra dovish that could weaken the dollar.


The Apple earnings are going to be the focus for the week. As the biggest stock in the Dow and the Nasdaq, any movement is going to be felt in the indexes. Because of the fear over Apple earnings there could be a cloud over the market on Monday/Tuesday. That goes double for fear of the Fed but at least you have the normal pre announcement bullish bias on Tuesday. That could offset some of the pre Apple announcement bias to the downside.

I think we need to be careful being "too long" over the next couple of weeks. With the potential for a retest of the highs, there is incentive to try and remain long. We just need to refrain from getting married to those long positions because of the historical May weakness. Everyone is looking for a top to appear so they can set up for the next directional move lower. Unfortunately, when everyone is looking for a particular direction to appear, a move in the opposite direction appears with annoying frequency.


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Random Thoughts


Baltic Dry Index

I have been having some running conversations with several readers about the sudden rebound in the $BDI. The shipping index has rallied +135% since mid February and there is no apparent reason. This is the cost to ship a freighter of dry goods like corn, coal, beans, iron ore, cement, etc, from one country to another. Analysts blame this on the Chinese New Year. In four of the last five years, the month of February was the weakest month for Chinese imports, especially iron ore.

Bloomberg pointed out that the low price for iron ore makes it less desirable to scrap the older antiquated freighters. However, 163 dry bulk freighters have been scrapped so far in 2016. That leaves 9,484 still in service.

When rates were high several years ago all the shipping companies ordered brand new ships. Rates fell and those ships are now being delivered. Since December about 2.8 million tons of shipping has been added or the equivalent of one Capesize freighter every five days. That size freighter is currently renting for about $6,000 a day and more than $1,000 below the cost to operate it. Bloomberg said shippers burned through $12 billion in cash in Jan/Feb and it will take 2.5 years for the excess capacity in the market to be eliminated.

Meanwhile, China has increased imports slightly. Copper and iron prices are rising. Maybe these are the green shoots of a rebound in the global economy.



The advance/decline line on the Dow has gone to extremes. This is the highest level since the financial crisis. The previous high was 188 back in December 2014. Exactly how much more overbought can this get?




The Carlucci indicators are all pinned to their upper maximums indicating extreme overbought. This is another graphic representation of our overextended market. Nothing prevents it from becoming more over extended but we are in nosebleed territory.



The bulls are starting to turn frisky but the bears are holding their own. The bullish sentiment rose +5.6% to 33.4% but most of it came out of the neutral camp. This is the new high syndrome at work. Investors do not want to be left out if the market breaks out to new highs and continues to rally.



The bullish percent index on the S&P has broken out to two-year highs at 78.4%. This means 78.4% of the S&P-500 stocks have a buy signal on a Point and Figure chart. It also means the rally may be nearing a top.


The percentage of S&P stocks over their 50-day average reached 95% before the earnings cycle began. That has declined to 80% just since the beginning of April. Not all stocks are continuing to rise.



One final thought from Hedgeye ahead of the Fed meeting this week.



 

Enter passively and exit aggressively!

Jim Brown

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"It ain't what you don't know that gets you into trouble. It's what you know for sure that just ain't so."

Mark Twain