The Dow closed at an 8-week low and the S&P closed only 6 points above critical support. There will be a test and I expect a failing grade.

Market Statistics

Friday Statistics

There was no apparent reason for the Friday decline other than economics came in better than expected and expectations rose for a Fed rate hike in June. Add in the destruction in the retail sector and investor sentiment took a serious hit. The retail ETF (XRT) has collapsed -11% in just over a week and we still have some major retail earnings next week. Somebody please kick me for not shorting it last week after Macy's warned their earnings would be weak.


On the economic front, we got a big surprise from the April Retail Sales report. April sales rose +1.3% after a -0.3% decline in March and twice what analysts were expecting. At 1.3% that is about 500% more than I was expecting. On a week when every major retailer is reporting sharp declines in same store sales of 2% to 5%, the economic report shows a 1.3% gain. Obviously, there is a catch.

The sales of autos rose 3.2% and gasoline rose 2.2%. Those categories supplied all the lift necessary to post an unexpectedly high number. Back in the real world sporting goods rose +0.2%, food service and bars +0.3%, general merchandising was flat, electronics and appliances +0.5% and home furnishings +0.7%. Building materials declined -1.0% to be the only drop.

I do not think we should be too excited by a 2.2% rise in gasoline sales since that is totally related to the higher prices at the pump. Also, the +3.2% spike in auto sales only offset the -3.2% decline in sales in March. If you average the two months you get zero. If you average the last five months you get -0.06%.

The euphoria over the stronger than expected retail sales was very misplaced especially when analysts were saying it put the Fed back into the picture for a June rate hike.

Also blamed for stimulating Fed worries was the +0.2% increase in producer prices. That was the biggest gain since last June but less than estimates for a +0.3% rise. This was only the second rise this year. The core rate excluding food and energy rose +0.3% and stronger than the +0.1% gain in each of the last four months. Some of the gains could be from the decline in the dollar over the last month. A cheaper dollar means commodity goods cost more.

There is still nothing for the Fed to get excited about. For the trailing 12 months the PPI is only up +0.1%, goods are down -1.9%, core goods +0.5% and services up +1.1%. That is hardly rampant inflation and the pace of the rise is miniscule.

Moody's Chart

The biggest surprise for the day was the nearly 7-point spike in Consumer Sentiment from 89.0 to 95.8 for May. That is the highest level since last June. The present conditions component rose from 106.7 to 108.6 but the expectations component rose from 77.6 to 87.5, a whopping 10 points. This was the first gain in the expectations component since November. Sentiment had been declining for the prior four months and this was a stunning rebound. There is a very good chance that we will see these numbers fade when the final report comes out at the end of June. You have to wonder if Trump becoming the presumptive republican nominee had anything to do with this spike. Blue collar workers taking this survey may have been feeling elated about the event. In an exit poll survey after the Indiana primary only 19% of college educated voters were for Trump but 83% of non-college educated voters did vote for him.


We have a busy calendar for next week and a several important events. The three housing reports will be closely watched for a rebound now that we are in the spring selling season. The Consumer Price Index is expected to show a big spike in inflation and that could aggravate expectations for the June Fed meeting. The Philly Fed Manufacturing Survey is the most important regional survey for the month and analysts are expecting a major improvement from 1.6 to 6.5 and that could also be Fed negative.

The FOMC minutes of the April meeting will be dissected for clues about a possible June rate hike.

This is also an option expiration week and volatility could be increased but I do not know how it could be worse than last week.


The destruction in the retail sector has called into question the health of the economy. The yield on the ten-year treasury declined to 1.7% at the close and very near a three-month low. This pressured the banking sector and Goldman Sachs (GS) was the biggest loser on the Dow.


Despite the apparent weakness in the economy, the expectations for a possible rate hike have pushed the dollar back up to 94.50 on the dollar index. This has weighed on commodities like oil and gold and on equities. The 15-month low the prior week has been erased and the return of a stronger dollar will depress Q2 earnings and raise prices for manufacturers. The celebration over the falling dollar was premature.


Apple (AAPL) broke below support at $92.50 on Thursday but held at $90. On Friday, Apple announced a $1 billion investment in Didi Chuxing which translates in English to Honk Honk, Commute. This is the Uber of China. They operate in 400+ cities, control 99% of taxi hailing in China and 87% of private car hailing. They also offer bus and chauffer booking services. They provide more than 11 million rides a day with 11 million registered drivers. The Didi Hitch service allows you to hail a designated driver that takes you and your car home if you had too much to drink. Uber only operates in 50 cities in China and does about one million rides a day. Didi recently paid $100 million to join the Lyft coalition so riders can use each other's networks when out of their home country.

Didi has a market cap of $20 billion, up from $6 billion a year ago. They have $3 billion in cash. So why is Apple making this investment? This is about appeasing the Chinese government more than investing for a future return. The Chinese government recently closed down the iTunes and iMovie services in China in order to reduce western influences. iPhone sales declined -11% in Q1 in China.

Apple needs to make friends with the government and they can do that by investing in Chinese businesses. Apple can also use its investment to learn how the ride share business works in China and possibly serve as a stepping stone when they eventually produce the iCar. Apple will also learn more about the buying and traveling habits of Chinese consumers.


Freeport McMoRan (FCX) cancelled leases on two drilling rigs owned by Noble Corp (NE) and agreed to pay Noble a $600 million termination fee. The cancelled leases covered the Noble Tom Madden and Noble Sam Croft, both ultra-deepwater rigs in the Gulf of Mexico. They were on 3-year contracts that expired in July and November 2017 and had $800 million in remaining payment obligations.

What is unusual about this cancellation penalty is that Freeport can pay using cash, Noble bonds and Freeport stock. Freeport can use stock up to 9.9% of its outstanding shares of stock. They can also pay with up to $200 million in Noble bonds due no later than December 19th, 2019. Apparently, Freeport believes they can buy Noble debt in the open market at less than face value and then tender it to Noble at face value.

Freeport also agreed to pay up to $75 million in contingent payments, depending on the price of oil over the next 12 months. Freeport cancelled the leases because current oil prices do not support deepwater drilling. If oil suddenly shot up to $75 a barrel then Freeport would owe Noble some additional money.

Freeport is saving about $200 million in cancelling the leases but they only had $224 million in cash at the end of Q1. That suggests they will have to issue stock to complete the payment. Shares fell -6% on news of the deal and Freeport's market cap sank by about $500 million on the drop. Sometimes you just cannot win.


Alibaba (BABA) was suspended from the International AntiCounterfeiting Coalition (IACC) only one month after it joined. This is a global nonprofit organization that fights counterfeit products and piracy. Alibaba has long been a site where just about any form of counterfeit product is available for sale. Alibaba says it has been working to reduce the number of counterfeit products (wink, wink) but other members of the IACC said it was not doing enough. The IACC includes companies like Nike, Apple, Rolex, etc. The IACC board also discovered a conflict of interest where the IACC president, Bob Barchiesi, owned Alibaba stock and had close ties to a company executive that used family members to help run the coalition. The board said they were not told about "certain aspects" of his conflict of interest. IACC had created a special category of membership just so Alibaba could join. That category is now on hold.

On a positive note, Alibaba teamed up with Japan's SoftBank to launch a cloud computing enterprise in Japan. The company will be called SB Cloud.


Herbalife (HLF) told investors in its earnings release that is was close to a settlement with the FTC over its marketing efforts. The company said it could be fined or sued but it expected a positive outcome. On Friday the National Consumers League (NCL) sent a letter to the FTC demanding "meaningful reforms and significant consumer redress" in any Herbalife settlement. The letter asked the FTC to insure that any injunctive relief addressed "persistent structural concerns." The NCL said "the threat of pyramid scheme behavior in the MLM industry is significant and persistent." Shares declined slightly on the news.


Allergan (AGN) was added to Goldman's conviction buy list with a $275 price target only a couple weeks after Pfizer ended their acquisition attempt. Goldman said Allergan had a "best in class" drug pipeline with 70+ unique drugs, an improving business model based on branded-growth pharma and a double digit revenue growth forecast based on volume-driving durable assets. They are going to deleverage their balance sheet when the sale of assets to Teva is completed for $40 billion and they authorized a $10 billion share repurchase.


Activision Blizzard (ATVI) and Electronic Arts (EA) are still gaining after strong earnings from both companies. However, NPD reported that video game hardware sales were down -23% in April and game software was down -21%. However, Activision just announced it had more than 9.7 million players testing its new game Overwatch, which is currently in beta. This is their biggest open beta debut ever. The game goes from beta to sales on May 24th and anyone wishing to continue playing will have to pay.

Activision also announced they were launching a new live-streaming video game platform in conjunction with Facebook. Activision acquired MLG.tv earlier this year. Viewers can watch live streams of other people playing games in real time. Viewers can learn the tricks and tips from watching and that improves their own game experiences. Amazon has a live stream gaming portal in Twitch.com and Google is trying to break into the space with YouTube Gaming.

Activision is going to be the winner in the gaming space with more than 500 million active gamers currently playing its games.


Sanofi (SNY) is planning on nominating 8 people to replace the entire Medivation (MDVN) board. Sanofi has been trying for months to buy MDVN for $52.50 a share but MDVN is not interested. They have held talks with Novartis, Amgen and Pfizer in an effort to find a better partner than Sanofi. Shares have rallied to $62 on expectations that somebody other than Sanofi will end up with a deal. Do not bother looking at the options because the premiums do not make sense.


Warren Buffett emerged as a potential bidder for Yahoo. Berkshire Hathaway is backing a consortium that is bidding the company's internet assets. The founder of Quicken Loans, Dan Gilbert, is part of the consortium. This group has apparently made it into the second round of bidding. Buffett's backing is a surprise since he is definitely not a tech person. It is also rare for Buffett to be bidding on a company where he cannot leave management in place. He is always a fan of companies with great management that can continue to operate without his involvement. Also, he never buys declining businesses. Former Yahoo president Sue Becker is on Buffett's board.

Verizon is still expected to emerge the winner because they have deep pockets and they own AOL. They could easily integrate Yahoo into their Internet portfolio. Other bidders still in the running include private equity firms TPG Capital, KKR and Bain Capital has partnered with Vista Equity Partners. YP Holdings is also a bidder.

The U.S. House of Representatives has blocked access to Yahoo Mail because of an increasing number of ransom ware attacks being spread through spam emails through Yahoo. Two individuals in the House fell victim to the attacks and had their files encrypted and held for ransom.

Reportedly, the bids are in the $4-$8 billion range. Yahoo currently has a $35 billion market cap but that includes $29 billion for its 15% stake in Alibaba and $8 billion for its stake in Yahoo Japan. The core Yahoo business is currently valued at less than zero because of the difficulty in splitting the various assets apart and the tax ramifications. I looked at several option combinations on Yahoo to capitalize on the rise or fall after the bidding process is completed. I passed because the prices do not make sense. In theory, any bid for Yahoo should make the stock rise but there is always the danger of a "take under" where the price is unexpectedly low because of factors unknown in the press. We do not know what skeletons they are hiding. For instance, they just lost a 15-year deal with AT&T that was producing $100 million a year in revenue. Are there more problems like that still being hidden?


In earnings news, JC Penny (JCP) reported a loss of 32 cents that was smaller than the 38 cents analysts expected. Revenue of $2.81 billion missed estimates for $2.92 billion. However, given all the retail results over the last week JCP came in at the top of the class. Penny still expects same store sales to rise 3-4% for the year. Penny reported only a 0.4% same store sales decline in Q1. The company said it was reducing its reliance on sales of apparel and moving more into appliances and other types of products. "We looked at our categories, and we look at what customers are spending." They are spending on entertainment, experiences and home beautification.

Penny got out of appliances some 30 years ago. Now they are putting appliances back into 500 of their stores. The CEO said one-third of our appliance customers are new customers and the average sale is $1,200. The company said they are also expanding its Sephora beauty shops and updating its salons now branded Salon by InStyle.

It is very strange that the company given up for dead over the last two years is now rebounding with an entirely new game plan that is beating companies like Macy's, Nordstrom's and Kohl's.


Nvidia (NVDA) reported earnings of 46 cents that beat estimates for 31 cents. Revenue of $1.31 billion also beat estimates for $1.27 billion. Nvidia is the leader in the high-end graphics processor market and they just keep getting better. I wrote several times last year that Nvidia was going to continue to exceed estimates because their technology is so far ahead of the rest of the pack. I said if you could only buy one chip stock this is it.

I had several readers email me back in January asking if I still liked the stock after it took an $8 drop in January along with the rest of the market. I told them to keep the faith, it will recover. Shares have nearly doubled since that January low.

Revenue from its GeForce graphics cards for PCs rose 17% to $687 million in Q1. Revenue from its datacenter business that includes Tesla processors, rose 62.5% to $143 million. They raised guidance and said they would return $1 billion to shareholders through dividends and buybacks.

Their newest high end gaming graphics card, the GeForce GTX 1080, has 8 GB of GDDR5X memory with 10 Gbps memory speed, 320 Gbps bandwidth, 2,560 CUDA cores, 1,733 Mhz cpu speed and supports monitor resolution of 7680x4320. I have been in computers since the mid 1960s and that much power in one card is beyond my comprehension. Nvidia said current high intensity graphics games will run 3 to 5 times faster with this card with significantly enhanced graphics.

Shares spiked 15% on the earnings and any pullback to $35 would be a definite buying opportunity.


Earnings are really slowing down next week. The large retailers Home Depot, Lowes, Walmart and Target will report. There will still be a few apparel chains reporting including L Brands, Stage Stores, The Gap and Ross Stores. Foot Locker closes the retail week on Friday.

The biggest tech stock to report is Cisco after the close on Wednesday.

After this week, there will only be a trickle of earnings reports until the Q2 cycle starts in July.


Crude oil rose to a six-month high at $47 on Thursday after U.S. inventories declined -3.4 million barrels for the prior week. This was due to the one million barrel production outage from Canada that flows into the U.S. pipeline system. It was also due to higher refinery demand as they ramp up for the summer driving season. Gasoline demand rose to 9.658 million bpd last week. That is the highest level since August 7th, 2015. We should continue to see inventory declines for the rest of the summer.

U.S. oil production declined another 23,000 bpd to 8.802 million bpd. That is down 808,000 bpd from the June 5th peak last year.


Active rigs declined -9 to a new record low at 406. That is down a whopping 1,565 rigs or -80% from the peak of 1,931 in early 2015. Offshore rigs fell -2 to a new multiyear low at 22. Gas rigs rose +1 to 87 and have been relatively stable in the upper 80s for several months now.


I reported last weekend that outflows from equity funds exceeded $16.9 billion the prior week and the most since the market crash last August. Bank of American said the outflows continued this week with $7.4 billion leaving equity funds. That brings the five-week total to $44 billion and the most since August 2011. This is also the 14th consecutive week of outflows and the longest run since February 2008. Money market funds saw inflows of $10.9 billion and the most in 13 weeks. Investment grade bond funds saw inflows of $3.2 billion.

Markets

The major indexes are teetering on the brink of a potential collapse. The sell in May cycle coupled with all the other negative headlines has pushed them back from their effort to make new highs on April 20th to making lower lows on Friday May 13th. There were no black cats or broken mirrors but simply a large outflow of cash for too many consecutive weeks.

Friday was more a lack of buyers than an abundance of sellers. Volume has been weak for the last seven sessions and Friday was no exception with 6.6 billion shares. Decliners were exactly 2:1 over advancers.

The earnings cycle is drawing to a close and the summer doldrums are rapidly approaching. Family vacations are being planned and schools begin their summer holidays in two weeks.

With the Fed lurking in the background, the UK Brexit vote in four weeks and weekly downgrades to the global economic outlook there is little reason to buy equities today.

Q2 earnings are not expected to be much better than the -7.1% we saw for Q1 and the rising dollar is going to continue depressing results. We should be buying trough earnings with a 6-9 month time horizon but in an election year, that involves a lot more risk. I think everyone would agree the current set of candidates are producing an abnormal risk environment with every sentence they speak.

Institutional investors are seeing the next several months as a risk off environment until the smoke clears and we have a better idea of what to expect in November and beyond.

While I do not believe the markets are going to go straight down in the months ahead, I do believe the bias will be negative and the market action choppy. The last two weeks have proven that point.

The S&P is poised to break below critical support at 2,040 and where that decline will stop is anybody's guess. Additional support levels are 2020, 1990, 1975 and then back to the August lows at 1867. I am not predicting any specific level but once below 2,040 the market sentiment could change dramatically.

The S&P closed under the 50-day average (2,054) on Friday for the first time since February 26th. The 200-day average at 2,012 could also be support but the S&P has not been reactive to that average since last August.


The Dow closed at an 8-week low at 17,535 and just over critical support at 17,500. A breakdown there would test light support at 17,500 and then decent support at 17,135. The Dow sprinted higher so fast in March there are few support levels that could slow any decline.

The decline on Friday saw nearly half the Dow components lose more than $1 and only three closed positive. Apple was the biggest gainer at +19 cents after dragging the index lower in prior sessions.

I am hoping we avoid a decline like the one we saw in January once support at 17,135 broke. The final resistance failure at 17,750 created two weeks of cascade selling that knocked 2,300 points off the Dow in only 13 sessions. The current resistance failure at 17,925 looks ominous since we have lost about 400 points in just three days. A break below 17,500 could see that selling accelerate.



The Nasdaq was buoyed again by the biotech sector. The $BTK gained +1% on Friday despite a sharp drop in the big cap indexes. The Nasdaq decline was limited to -19 points. Note the majority of the stock on the gainers list are biotechs.

The Nasdaq has been leaving tracks all over support at 4,750 but it does not seem to stick. The Friday close at 4,717 was not yet a lower low like the one we saw on the Dow. We would need to see a break under 4,685 for that to happen. However, that resistance failure at 4,800 was a lower high.

While the Nasdaq lagged in relative performance to the upside over the last couple of months, it is also lagging to the downside. The Dow is now the market leader in this decline.

Support on the Nasdaq is 4,600 then 4,500 and then a long drop to 4,200. Resistance remains 4,800.



The biotech index appears destined to retest that 2,750 support level. This sector is either feast or famine with alternating days of big declines and gains. It should remain under pressure as long as the presidential candidates continue to pick on the drug sector.


The Russell 2000 closed right on support at 1,100 and should easily test 1,090 on the next decline. The Russell was also helped by the biotechs and gave back only 6 points on Friday. Any continued decline should test strong support at 1,065.


I said last week, "In theory, this is a negative week on the market calendar as the sell in May followers accelerate their exits."

It was the third consecutive week of declines and this streak could easily turn into 4 or 5 weeks unless we get another monster short squeeze that is not erased because of a lack of market participants. Traders will be cleaning up their positions ahead of option expiration next Friday and probably not adding too many new positions ahead of the Memorial Day weekend the following week. After Friday's expiration, the volume is going to decline even further as summer begins with the holiday weekend.

Watch S&P 2,040 for market direction.


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Random Thoughts


Donald Trump is declaring war on Jeff Bezos and Amazon. Trump said Amazon had a huge antitrust problem because they control so many markets and are running small entrepreneurs out of business. While Amazon is big and does have its fingers in a lot of pies, the real problem is political.

Jeff Bezos owns the Washington Post personally. Trump called the Post, "Jeff Bezos toy." He said Bezos is using the Post for power over Washington so politicians will not tax Amazon the way it should be taxed and break up the monopoly portions.

While that may sound presidential in some circles, that is still not the problem. The problem is that the Post has put 20 reporters on researching Trump and calling him out on a large number of his past sins and outrageous statements.

Trump is hitting back at Bezos by threatening antitrust actions because of the negative articles written by the Post. Analysts claim Bezos should not take Trump's threats lightly because he has been known to carry grudges for a long time and could actually cause Amazon a lot of trouble if he was actually elected.


The U.S. is moving to activate a ballistic missile defense shield in Europe to defend against missiles from Iran. The former Soviet-era base in Romania is the first point in the shield that will eventually stretch from Greenland to the Azores.

Russia's President Putin came close to declaring war in comments he made after the announcement from the U.S. and NATO. He said Russia will act to neutralize the U.S. missile shield threat. He said the missile defense base activated in Europe was the first step in a new arms race and he vowed to adjust budget spending to neutralize it.

Putin claims the missile system was aimed at blunting Russia's nuclear arsenal. "This is not a defense system. This is part of the U.S. nuclear strategic potential brought onto a periphery. In this case Eastern Europe is such periphery. We are now forced to think how to neutralize emerging threats to the Russian Federation." This is "yet another step to rock international security and start a new arms race."

Of course, it is Russia that violates other countries airspace with fighters and bombers on a weekly basis and runs mock attack drills against American ships in the Black Sea.


Venezuela is moving closer to total collapse. The last beer producer went out of business two weeks ago because they could no longer buy supplies without dollars and the government has run out of money. They have actually run out of money needed to print more money. Last week mobs of more than 5,000 ransacked food stores and warehouses looking for something to eat. Children are dying for lack of medicine and food. Mobs are roaming the streets looking for anything they can steal and trade for food and supplies.

Government food dispensaries were overrun and looted by the mobs while government troops stood by and watch because they were so outnumbered. One reporter said there were 250 rioters for every policeman.

The stores were already empty with people waiting in lines for hours just to get a loaf of bread or a can of food. Now they are really empty with nothing left and no chance of being restocked with the government out of money. In March, food prices rose 582.9% and that was if you could actually find something to buy.


People have resorted to hunting pigeons, cats and dogs for food to feed their families. Livestock like horses, cows, goats, pigs and chickens have long since been stolen from farmers and killed for food. Citizens are now trying to flee to neighboring countries in hopes of finding food and shelter. With millions walking to the borders, this will cause the same type of rioting in neighboring countries when they cannot feed the masses.

There are rumors of an impending coup against President Maduro. The state security personnel have been disarmed to prevent them from turning on the government. The National Guard is said to be waiting for the entire situation to reach a boiling point and the population marches on the government before joining them to overthrow Maduro and his socialist policies.


Goldman Sachs strategist David Kostin warned last week of a coming crash. He said 35 out of 53 tech stocks saw their profit margins decline while valuations were near record highs. "It is time to play defense in a tough market." He currently has a yearend target of 2,100 on the S&P but he said "with 80% of fund managers underperforming their benchmark, the probability of irrational capital allocations increases, and as a result there is a reasonably high probability of a large drop in the S&P-500 this summer."

Also, "unbalanced distribution of upside/downside risks suggests 'sell in May' or buy protection. A shift in investor perception of various risks could easily trigger a sell off."

Officially, Goldman's risks include "elevated valuation, investor positioning, money flow trends, uncertain interest rate policy, weak economic growth, and election year politics. A 5%-10% drawdown in S&P 500 during the next few months implies an index level of 1850 to 1950 and a forward P/E of 15x-16x based on bottom-up consensus EPS." Full article


Dirty bombs? The State of Texas has begun issuing its game wardens radiation detectors. Since game wardens travel in remote areas and encounter many strange situations, they are potentially likely to come into contact with people that are intent on sowing destruction in America. There have been many stories about the potential for ISIS or Al-Qaeda to smuggle in radioactive material over the Mexican border for use in a dirty bomb in some densely populated city.

The devices issued to the game wardens are about the size of a cell phone and will be worn on their duty belts and will emit sounds if the warden approaches something that is radioactive. Multiple thefts of radioactive substances have been reported in Mexico in recent years. Why transport it from overseas if you can steal it in Mexico? We should be worried, very worried.

The Texas Parks & Wildlife division now has its own SWAT teams complete with camo painted assault rifles and night vision goggles.


Wendy's has announced they are going to install self-service kiosks at 6,000 locations because of the hikes in the minimum wage. McDonalds is expected to follow suit but at a slightly slower pace. All 258 Wendy's stores in California, where the wage is rising to $15 an hour will be installing the kiosks. Carls Jr is also installing the self-service kiosks because "the government is making it difficult to afford employees." Does it help to boost workers wages to $15 an hour if it costs them their jobs?

The Eatsa fast food chain now has a zero human interaction ordering process. The customer orders on an iPad and when the food is ready it is placed into a cubicle that looks like a microwave and the customer's name pops up on the screen associated with the order. Customers never see a human employee. It is considered the first fully automated restaurant. Full Story


 

Enter passively and exit aggressively!

Jim Brown

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"The short memories of the American voters is what keeps our politicians in office."

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