Today's decline was not caused by a surplus of sellers but more likely a lack of buyers.

Market Statistics

We are entering that period in the summer where the "Why Buy?" question becomes the market driver. We are in the summer doldrums, July earnings are likely to be disappointing, Brexit fallout is continuing and political headlines are ramping up ahead of the conventions. Uncertainty is rampant. Why buy now?

I cannot give you a good answer and that is why the markets are likely to fade away in the days ahead. There is no reason to be a seller either. This is the period when quite a few investors become dormant. They hold on to their favorite positions but they do not add additional positions unless there is a good reason like an unexpected decline that provides a buying opportunity. Otherwise they just wait for the normal Aug/Sep declines that lead into the October rebound and the start of the Q4 rally.

The European markets are still declining from the Brexit vote. Banks were hit hard after the ECB told the oldest bank in the world to cut its bad loans by 2018 or else. Banca Monte dei Paschi di siena (BMPS) was started in 1790, 20 years before Columbus discovered America. The ECB said the time has passed for a government bailout, the provision expired on January 1st, and the bank has to recapitalize or the ECB will act. There are currently about $29 billion in bonds that are owned by mom and pop investors. Under the new ECB rules they can force a "bail in" and force investors to take a haircut on those bonds. The ECB forced this in Greece and can also do it in Italy. They can also force bond holders to swap their debt for equity in the bank. BMPS must cut its nonperforming loans or NPLs by 40% to $16.2 billion from roughly $28 billion. With the ECB forcing the sale of bad loans, the bank could be forced to raise $4 to $6 billion in additional capital. With a share price that has declined 99% over the last year to 27 cents it is unlikely they can do another secondary offering. The Italian government is prohibited by the EU from bailing out its own banks.

If the ECB demands additional bail-ins for European banks it will be another threat to EU cohesion. For most Europeans the ECB is a bunch of unelected bureaucrats and more draconian actions will cause further unrest and votes to leave the EU. The EU is in trouble and these types of headlines are simply additional chapters in the EU decline story. The weight of the ECB on the various banks caused a new round of market declines.


RBS (RBS) shares have fallen from $12.50 in 2015 to $4.25 today. They are down -43.5% in 2016. Barclays (BCS) shares have fallen from $18 to $7 and -27% this year.

Standard Life (SL.L) suspended trading in a UK property fund after heavy outflows after Brexit. Two other lesser-known companies also suspended redemption requests becaus eof outflows.

In the U.S. the Factory Orders for May declined -1.0% after a +1.9% gain in April. That was in line with expectations but still an ugly report. Since last June orders have declined 7 of the 12 months. Durable goods orders declined -2.3% and the biggest decline since the -3.3% drop in February. Capital goods orders fell -4.8%. Orders for defense goods fell -28.1% and the second biggest decline this year. Transportation orders fell -5.7%.

With the pound continuing to decline, U.S. exports are going to slow to a crawl and that will further depress future factory orders. The strong dollar is going to be a stiff headwind.

The ISM-New York rose slightly from 37.2 to 45.4 for June. This is still in contraction territory under 50. Employment crashed from 44.6 to 35.9 and the lowest reading in over a year. Employment has contracted in nine of the last ten months. The Brexit complications will impact the financial services industry in New York City. However, New York could actually see a boost in activity if the EU puts additional restrictions on the UK and London fades as a financial center.

The big report for Wednesday is the FOMC minutes as analysts try to figure out what changed the Feds outlook from strongly hawkish two weeks before the meeting to strongly dovish in the meeting.

The payroll reports will be critical for obvious reasons. If the Nonfarm Payrolls posts another weak month, we could see a negative change in market sentiment. The numbers are not going to be significant to the Fed in their current mindset but they will be important for investors worried about the next recession.


The continued headlines out of Europe are weighing on the equity market but the big hit is to currencies and treasuries. The pound declined another 2% to close well under 130 at 127.38. The dollar strengthened and that is going to be tough on earnings guidance.



Yields on the ten-year treasury closed a historic low of 1.367%. Records date back to the year 1789 so a record low is a real headline. This is due to cash coming from overseas where yields are negative and you have to pay the government to hold your money for you.

The yield on the 30-year treasury fell to a record low at 2.138% and analysts expect it to fall under 2%. It is time to refinance your mortgage again.

The yield on the German 10-yr Bund fell to a new record low at -0.19%. This is a major cause of the flight to the U.S. treasuries for ratings conscious investors.




Tesla (TSLA) shares fell at the open after they reported another miss on deliveries in Q2. They had previously guided to deliveries of 17,000 and only delivered 14,370. For Q1 they estimated deliveries of 16,000 and delivered 14,820. Tesla blamed it on the "extreme production ramp" as they restructure their auto flow and try to get to 2,400 cars a week by year-end. They also blamed the 5,150 cars still in shipment to customers on trucks, trains and ships for missing the target.

For reference this is only the fifth year Tesla has produced cars and they have never hit their delivery targets yet they expect to up to 90,000 vehicles in 2016. Despite the production misses in Q1/Q2 they maintained their 80,000-90,000 target for the year. That means they have to deliver more than 50,000 cars in the next six months compared to the 29,000 cars in the first six months. Tesla ended the quarter with production rates around 2,100 cars per week and expect that to rise to 2,200 in Q3 and 2,400 in Q4.

Tesla plans to produce 500,000 cars per year by 2019. That would require more lithium ion batteries than the world currently produces. The Gigafactory is expected to be fully operational by 2020 and will produce more batteries annually than were produced globally in 2013 and at a 30% reduction in cost. With all the side projects Musk has going plus his plans for Tesla Energy/SolarCity, I could see the need for another gigafactory after 2020.

Historic shipments:

2012  2,650
2013 22,450
2014 31,655
2015 50,580
2016 Q1/Q2 29,190
2016 Q3/Q4 55,000 est
2018 300,000 est
2019 500,000 est


Skyworks Solutions (SWKS) was downgraded from overweight to neutral at Pacific Crest but that was not the damaging part of the broker action. Michael McConnell joined a long list of analysts warning that Apple iPhone 7 sales are going to be disappointing. McConnell said channel checks of Apple suppliers suggested Apple was still lowering production quantities. "Conversations with multiple supply-chain partners indicate Apple is taking an extremely conservative approach toward the iPhone 7 build in 2H16." Pacific Crest is modeling 72-76 million units, which would be a 15% to 20% decline over the 6S in 2H15. The analyst also cut Cirrus Logic (CRUS) but all Apple suppliers saw their shares collapse. These analyst production warnings are becoming a weekly occurrence.


Netflix (NFLX) had a busy day. Needham started off the day cutting Neflix from buy to hold, warning that exposure to Europe should accelerate subscriber churn or slow subscriber growth. They also cited negative currency translation risks and EU legal changes proposed in May that would force Netflix to fund European films at higher costs. Shares dropped at the open on the Needham downgrade.

A couple hours later Guggenheim added Netflix to their "Best Idea List" reiterating a buy rating and $150 price target. Guggenheim said they believe all the negative concerns are already priced into the stock and the catalysts ahead will be positive.

Lastly ReCode reported Comcast and Netflix have buried the hatchet and future Comcast X1 interactive cable boxes will include the Netflix application. This is a big plus for Netflix because it puts their application on every cable box Comcast delivers.


XBiotech (XBIT) shares fell -50% intraday after a late-stage study of its lead drug raised questions about any potential benefits for patients. The study took an abnormal approach to analyzing the results and came up with an unexpected result. The study compared symptom progression during treatment of the colorectal cancer with the drug Xilonix.


Crude oil fell -4.5% after Barclays said "The deterioration in the global economic outlook, financial market uncertainty and ripple effects on key areas of oil demand growth are likely to exacerbate already-lackluster industrial demand growth trends." They were referring to the impact of the Brexit vote and its aftermath. Analysts cautioned that Asia and China were already weak and the impact of Brexit on Europe could lower demand growth globally. A Reuters survey found that 17 of the top 30 U.S. shale producers had significantly increased their hedges last quarter. That suggests they do not expect oil prices to continue higher or they would not have locked in their future sales price. For some of them it was the first increase in hedges in more than 6 months. They are locking in prices in case we retest the lows once the summer demand is over.

There was some new research released on Tuesday showing proved reserves in the U.S. at 264 billion barrels was now above Russia at 256 billion and Saudi Arabia at 212 billion. This is meaningless in the long term because our reserves cost significantly more to extract than Saudi Arabia. Our cost of production is $30 to $85 a barrel compared to $10-$12 for Saudi Arabia. If it comes down to a price war, we lose.


Markets

Why buy? That was how I started this commentary and the premise has not changed. August and September are the weakest months of the year. July is only slightly better. In election years they tend to be weaker because of the uncertainty. This year that uncertainty is at an all time high given the two candidates for president and the diverse economic impact each would bring to the job.

The S&P is locked in below resistance at 2,100. There is no need for me to describe all the various potential moves because they have not changed in the last four months. The major indexes are in a congestion range in a topping pattern. Until that pattern changes with a breakout above resistance, we are just passing time. Unfortunately, we may spend some time at lower levels as we approach the political conventions later this month.


The Dow has the same strong resistance at 18,000 and with financials and energy stocks crashing and the potential for guidance warnings with earnings, it would be a real surprise if we moved over that resistance. The Dow congestion range is 17,400 to18,000 and we could spend the next several weeks chopping around in that range with a bias to the downside.



The Nasdaq has a more pronounced bearish pattern with a series of lower highs over the last month. This is unlike the Dow and Nasdaq with level resistance at 18,000 and 2,100. The Nasdaq has been hit by the biotech sector decline and weakness in semiconductors and Apple component suppliers.

Resistance is 4,900 and support is 4,700 assuming there are no earthshaking headlines.



The Russell 2000 has the same lower high pattern as the Nasdaq and strong resistance at 1,150 and 1,165. Support does appear to be solid at 1,095.


It should be no surprise that my bias is negative for the rest of July. There are too many negative catalysts and very few positive events. I am counting the potential for some positive earnings surprises in those catalysts otherwise there would be almost no potential for positive headlines. The Brexit hangover could last for months and that is going to be damaging to stocks, currencies and the global economic outlook.

I am sure we can pick up some individual stocks when buying opportunities appear but they may be limited for the next three weeks. S&P futures are down -10 points as I type this.

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Jim Brown

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