Positive economics suddenly resurrected the fear of a Fed rate hike at the June meeting.

Market Statistics

The June meeting is a live meeting. Investors have tried to ignore it in hopes it would go away but the sudden rise in inflation has made that impossible. Add to the economics the comments from San Francisco Fed president John Williams that the Fed will rise 2-3 times in 2016 and comments from Robert Kaplan that the Fed will move quickly to normalize rates. Richmond Fed president Jeffrey Lacker said June rate hike should be on the table, "The case for raising rates looks pretty strong in June." Suddenly the June meeting is not just alive but it is expanding in importance.

The report causing trouble this morning was the Consumer Price Index for April. The headline number rose 0.4% and the largest gain since February 2013. The core rate excluding food and energy rose +0.2%. On a trailing 12 month basis the headline CPI is up +1.1% and the core CPI is up +2.1%.

The headline number was lifted by a +1.9% increase in fuel oil and +8.0% rise in gasoline prices. Food prices rose +0.2%.

In theory, the Fed is smart enough to realize that the current inflation is caused by rising oil prices rather than normal inflationary forces. Hiking rates in June will not do anything about the rising inflation caused by higher gasoline prices. If they hike for the wrong reasons, it will be a market disaster. Higher rates will hurt oil producers already suffering from low prices. Rising rates would raise their debt payments and make it harder for them to recover from the oil crash.


Industrial Production for April rose +0.7% and well over estimates for +0.3%. This was the first rise in three months. The March reading was revised down from -0.6% to -0.9%. That was the weakest reading since August 2012.

The April headline number is misleading because utility production rose +5.8% and mining/energy declined -2.3%. Business equipment production rose +2.4%. Those numbers skewed the headline significantly. Production has been handicapped by the strong dollar and weak global economy. This report looks good on the surface but many of the internal components were still weak. I would disregard the April reading since the chart clearly shows a strong decline going into April. Utility production is not really an economic plus.


New residential construction starts rose +6.6% in April from 1.089 million to 1.172 million. That was more than the 1.125 million analysts were expecting but still well under the February rate of 1.213 million. Single family starts rose +3.3% and multifamily starts rose +13.9%. Permits rose +1.5% and multifamily permits rose +8.0%. Completions fell from 1.048 million to 933,000 or an -11% decline.

In the chart, you can see that housing starts have plateaued at 1.2 million and appear to be tapering off. With mortgage rates at near record lows, this is troubling for the sector. Home buying appears to be tapering off and housing is a very large portion of the economy.


Internet E-Commerce sales for Q1 rose from $89.1 billion to $92.8 billion in Q4. Compared to the $80.6 billion in Q1-2015 and $70.1 billion in Q1-2014 this is proof the retail economy is moving to the web. To put that into context Amazon's sales in Q1 were $29.1 billion. That was a $7 billion increase over Q1-2015. Out of the $12 billion increase in all E-Commerce revenue over 2015 levels, $7 billion or 58% of the increase was sold by Amazon. To look at it a different way Amazon's $29.1 billion in Q1 revenue was 42% of all the E-Commerce revenue from all sources. Also, Amazon's revenue for the quarter rose 28.2%. They will be 50% of all E-Commerce revenue soon.


The economic calendar for the rest of the week is headlined by the FOMC minutes and the Philly Fed Manufacturing Survey. The Philly survey is expected to show a strong increase so anything in the opposite direction would be a big disappointment.

The NY Empire State Manufacturing Survey on Monday was expected to show a +6.5 and posted a very disappointing -9.0 instead. If the Philly survey, which is much more important, showed a similar decline, it would be a disaster.

Some analysts believe the FOMC minutes on Wednesday could contain language suggesting a June rate hike even though the official post-meeting announcement gave no indications. Worry over the minutes were part of the market's problem today.

I believe raising rates in June would send the wrong signal that the Fed was in a hurry to hike rates because they are behind the curve. I believe they would be better off to use the June meeting to signal their intention to raise rates at the July meeting. That would show they were being deliberate rather than urgent and it would give the market time to decipher the Fedspeak and adjust accordingly. It will also give oil prices time to level out and reduce their impact on the inflation figures.


After the bell, Japan's GDP for Q1 came in at +0.4% growth compared to expectations for +0.1%. This was a significant improvement from the -0.4% decline in Q4. Analysts were worried that Q1 could come in negative and fit the definition of a technical recession with two consecutive quarters of negative growth. While domestic demand for things like televisions and food rose +0.2% there were still problems. In a separate report capex spending declined -1.5% in Q1 and the fastest pace of decline in a year. S&P futures spiked higher on the GDP and then turned negative on the capex spending.

On the earnings front, Dow component Home Depot (HD) reported earnings of $1.44 that easily beat estimates for $1.33. Earnings rose 24% for the quarter. Revenue rose +9% to $22.76 billion, up from $20.89 billion and higher than the $22.32 billion analysts expected. Same store sales rose 6.5% globally and +7.4% in the USA. The company cited warmer than normal weather and a rebound in the housing sector. April temperatures set record highs and was the 7th consecutive month of record highs.

HD said it expected full year earnings of about $6.27 per share with revenue rising 6.3% and same store sales up 4.9%. They had previously forecasted earnings of $6.12-$6.18 and sales growth of 5.1-6.0%. Despite the big earnings beat and higher guidance, shares dropped -$3.50. Analysts believe investors were expecting an even bigger beat and that is why shares dropped. I believe investors are just afraid of the market and they wanted to take profits quickly before they evaporated.


Red Robin Gourmet Burgers (RRGB) reported earnings of $1.03 that missed estimates for $1.11. Revenue of $402 million rose +1.8% but missed estimates for $415 million. Same store sales declined -2.6%. The company said the number of guests declined -4.1%. Shares fell -19% on the news.


TJ Max (TJX) reported earnings of 75 cents that beat estimates for 70 cents. Earnings rose +7.14%. Revenue rose +10% to $7.5 billion. Same store sales rose +7% and more than the +5% in the comparison quarter. During the quarter, the company spent $375 million to buyback five million shares. TJX even increased its dividend by 24% in Q1 for the 20th consecutive year of dividend increases. They guided for Q2 for earnings in the range of 77-79 cents with same store sales rising 2-3%. Full year guidance rose from $3.29-$3.38 to $3.35 to $3.42. Shares spiked at the open to $78.38 but declined with the market to trade flat again.


Children's Place (PLCE) reported earnings of $1.32 that easily beat estimates for $1.03. Revenue of $419 million also bet forecasts for $413 million. They guided for the current quarter to a loss of 22-30 cents. Full year earnings are expected to be $4.17 to $4.27 per share. The current quarter is typically a weak quarter for the children's retailer. Shares spiked to $74.40 on the news but faded with the market to $71.


Wednesday and Thursday are the last big days for the Q1 earnings cycle. Walmart, Target, Gap, Foot Locker and L Brands finish out the retail earnings. Cisco Systems and Salesforce.com are the biggest tech stocks left to report.


Intel (INTC) was initiated with an underperform rating by CLSA saying the declining growth in the semiconductor industry is going to require more specific focus by companies in the space. The analyst said it raised the rating on Qualcomm (QCOM) with a price target of $65 compared to a close at $52. Broadcom/Avago (AVGO) was started with a buy rating and a $165 price target compared to the prior close at $142.65. The consensus target on AVGO is higher at $178.52. NXP Semiconductor (NXPI) was started with a buy rating and $105 target after a close at $85. Microchip (MCHP) was started as a buy with a $58 target after a close at $48.

Of all those mentioned above I like Qualcomm but the stock has been stuck in a $3 range for three months. That is dead money until it breaks out. Broadcom is threatening to break support at $140 because of the decline in orders from Apple. No excitement there either.



Clorox (CLX) announced a quarterly dividend of 80 cents, up from 77 cents, payable on August 12th to holders on July 27th. That is roughly a 2% yield. Clorox has increased annual dividends every year since 1977. Shares fell 2% on the news.


David scored a direct hit on Goliath today. Coherus (CHRS) reported the U.S. Patent Trial and Appeal Board (PTAB) had agreed to hear a case against AbbVie's (ABBV) $14 billion drug Humira. That one drug represents 60% of AbbVie's revenue. AbbVie has a market cap of $97 billion and Coherus has a market cap of $738 million. Coherus is developing a biosimilar drug to compete with Humira. A successful patent challenge could help get that drug to market sooner. The patent review will take up to a year and could cause AbbVie a significant problem if the specific patent under review is invalidated.

Amgen (AMGN) has already tried to petition the PTAB twice on Humira and were declined on both. This is the first appeal the board has agreed to review on Humira. AbbVie claims Humira is safe and will produce $18 billion a year in sales through 2020. They have 70 patents on the drug that do not begin expiring until 2022. Coherus has requested reviews on two other Humira patents and the PTAB has to decide on reviewing them by June 15th. Obviously, it could take a long time before this appeal has any actual impact on AbbVie, even if the PTAB finds in Coherus favor. The decline in ABBV shares is not warranted today. The bounce in CHRS could last until the June 15th deadline on the other two appeal requests.



Many stocks with recent gains imploded on Tuesday. One example would be Kraft Heinz (KHC) with a -4.3% drop on absolutely no news. This is a sign investors are finally throwing in the towel and heading to the sidelines. Profits are being taken even on the strong stocks.


Twitter (TWTR) may be ending the 140-character limit for tweets. Originally, the 140-character limit was because of the limit on text messaging. With 140 characters, the tweet would fit into a single text message. Since almost nobody uses plain text messaging anymore, it is time for Twitter to upgrade. Twitter users already send more than 140 characters by being creative and sending pictures of text rather than the actual text. That way there is a much larger practical limit. However, the text pictures cannot be searched and indexed. They are just pictures. Dorsey recently described the 140-character limit as a "beautiful constraint" that inspires creativity, brevity and a "sense of speed" and Twitter does not want to lose that feeling.

Bloomberg reported on Monday that Twitter was going to quit counting the characters in links and photos in the 140 character limit. Twitter declined to comment on the report but Bloomberg said they had a good source that said the change could come over the next couple of weeks. Shares were up a nickel on the news.


Dell Inc sold $20 billion in secured bonds on Tuesday and the offering was 300% oversubscribed. They had offers for $85 billion. The investment grade notes were spread across six tranches with maturities ranging from 3 years to 30 years. A $4.5 billion 10-year bond was priced with a yield of 4.25% above comparable treasuries or roughly 6%. They still need to sell $4.0 billion in junk rated, unsecured bonds, to raise enough cash to complete the $63 billion acquisition of EMC. They are still waiting on approval from Chinese regulators and EMC shareholders. When the acquisition is completed, Dell will have $50 billion in debt and has committed to pay that down by $5 billion a year from operating cash.

That $20 billion is the 4th largest bond sale on record. The largest was Verizon in 2013 for $49 billion, Anheuser-Busch InBev in 2016 for $46 billion and Allergan in 2015 for $21 billion. Last week companies including AbbVie and Chevron sold $47 billion in investment grade bonds to bring the year to date total to a record $506 billion.

After the bell, the American Petroleum Institute (API) reported a -1.1 billion decline in U.S. crude inventories. Cushing inventories rose 508,000 to a new record. Gasoline declined -1.9 million barrels and distillates declined -2.0 million barrels. The API inventories rarely agree with the EIA inventories due out Wednesday morning. Crude rose slightly on the API numbers but the real move will come after the EIA reports at 10:30 on Wednesday.

In regular trading crude rose to $48.43 and a new six-month high. With record open interest in long futures contracts and with futures expiring on Friday there is sure to be some volatility the rest of the week. The $50 level is the next target and I would expect a serious sell the news event when that level it reached.


Markets

The three-peat is complete. For three consecutive weeks, the Dow has surged triple digits in a monster short squeeze only to roll over and decline triple digits the next day and completely erase the gains. The Dow closed at a new 8-week low after trading under key support at 17,500 intraday. The S&P came within one point of touching critical support at 2,040.

The market is now poised to break those critical support levels and slide until the end of May. Whatever happens we know it will not be straight down. The last three weeks have proven that much. However, we have seen seemingly bulletproof short squeezes erased in just one day. The sellers are definitely waiting for the rips rather than chasing prices lower but I think the market sentiment is changing. If those support levels break, they may throw caution out the window and hit the sell trigger anyway.

If the 2,040 level breaks on the S&P the next logical resting place is the 1990-2000 level followed by 1,975 and then 1,950. Resistance is now 2,070 and the highs from Thursday and Monday.


The Dow traded down to 17,469 intraday and well under the critical support at 17,500. However, the rebound at the close pulled it back from a -240 loss to only -180 and a close at 17,529. That does not mean that 17,500 support is still intact. The intraday dip damaged it and the next decline will more than likely stick.

The next support level is 17,400 followed by 17,135 and then 16,500.



The Nasdaq lost -60 points for the day and closed just over key support at 4,700. A break there targets 4,600 and then 4400-4200. The Nasdaq traded in correction territory intraday but pulled out to only a 9.9% decline at the close. The odds of a breakdown in this index are nearly 100%. The Nasdaq was supported again by the biotech sector, which declined only 0.6% and the least of all the major indexes. The relative strength in the sector was amazing since it has been up for the prior two days. This is rare. The biotechs have been doing the two-steps down, one-step back for weeks. After two major gains, today should have been a major decline. One analyst pointed to the coming ASCO Oncology conference on June 3-7th as the reason biotechs are rising.




The small cap Russell 2000 was the biggest decliner today with a -1.7% drop. The S&P-600 small cap index matched its move with a -1.67% decline. The Russell closed under key support at 1,100 with a close at 1,097. The 1,090 level is the next support target. The Russell declined -18 points today in what could be considered a rout. If that were to happen again tomorrow, the market sentiment would turn seriously negative and we would move into plunge mode.


The hero for the day was the Dow Transports with a +45 point gain. I know, it is shocking to see the transports up the same time oil is up and the broader market is tanking. It only took multiple upgrades to the airline sector and the railroads but they did rally even if they closed well off their highs.

The 7,500 support level was tested on Friday and followed by two days of gains. The Transport index finished -123 points off its intraday high and probably would have turned negative if time had not expired.


Follow the volume. I have mentioned several times recently the market move with the heaviest volume is the move we should trust. Monday's short squeeze came on 6.4 billion shares and the lowest volume since April 26th. Today's volume was 7.6 billion shares and the highest volume since May 3rd. This suggests the market direction is down even if there are a couple up days in our future. If those critical support levels of 17500, 4700, 2040 break we could see an acceleration of selling. Be prepared.

Enter passively, exit aggressively!

Jim Brown

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