The Russell 2000 surged +9 points to a new 52-week high and provided a sentiment boost for the market.

Market Statistics

The small cap Russell 2000 continued its steady climb and posted a new 52-week high at 1,248 and well over the prior high at 1,241. The semiconductors, biotechs and the energy sector provided support for the Russell and none of those appear to be weakening.

The surge in the Russell suggests fund managers are already starting to nibble at stocks for their yearend portfolio restructuring push. The fiscal year end for most funds is October 31st and that makes the next 60 days critical for fund performance. Typically, they dump stocks in September and then buy stocks on the October lows. So far this season the market is not showing any weakness and managers appear to be putting some of their cash hoard to work in the small cap stocks where they can get the most bang for their bucks. This suggests there could be a healthy rally at some point in the future if managers are not worried about the most volatile six weeks of the year that started on Monday. Based on the chart below there is plenty of room for backing and filling to 1,238 or even 1,225 and still maintaining the uptrend bias.


The New Home Sales for July were off the charts with a 12.4% surge to 654,000. That was up from 582,000 in June, which was a 1.7% rise. Compared to July 2015, sales have risen 31.3% and still climbing. The months of inventory on the market fell to 4.3 compared to the 5.5 month high in March. There were 233,000 homes for sale at the end of July. There is some seasonality in those numbers since builders try to have a large supply of completed homes in the late spring months so shoppers have an assortment to choose from when the buying season begins. Now that summer is over we should see the pace of sales slow in coming months but the very low interest rates will still be a sales driver.

Sales were strongest in the South and Northeast. Sales in the Northeast rose 40% and +18.1% in the South. The Midwest increased only 1.2% and the West was flat. The median price for a new home was $355,800 and a +4.1% increase from July 2015.


Before investors could become too excited about the home sales, the Richmond Fed surveys knocked all the wind out of the market. The headline number on the manufacturing survey declined from +10 to -11, and the lowest reading since -13 in January 2013 and the second lowest reading since the financial crisis.

The internal components imploded with the gap between inventories and orders falling to -44, order backlogs -21 and new orders falling -35 to -20. This was a very ugly report. With the inv/ord gap at -44, this suggests the next couple months could also be very negative. The 35-point drop in new orders means manufacturers will have nothing to build and employment could decline as layoffs increase.

The headline number on the separate services survey fell from +8 to zero. The internal components were equally negative. Sales of big ticket items fell to -10, shopper traffic went negative at -4 and sales revenues fell deeper into negative territory at -26.



The SEMI Book-to-Bill ratio for North American manufacturers rose slightly from 1.00 to 1.05 for July. That means they received $1.05 in orders for every $1 they billed. Shipments declined from $1.715 billion to $1.705 billion. Bookings rose from $1.714 billion to $1.794 billon.

On Wednesday, we get the existing home sales for July and those numbers should be high as well although several analysts are looking for a decline from the 5.7 million pace from last month.

The big events for the week remain the GDP and Yellen speech on Friday. Both could be market movers but the Yellen speech is the real danger. She could either build a fire under the market with some dovish remarks or smother the smoldering rally with a bucket full of rate hike reality. It is widely believed she will try to maintain a cautious tone but suggest the Fed is ready to hike rates at any time if conditions warrant. A strong employment report in early September could be the trigger point but regional reports like the Richmond surveys could be the anchor that keeps them on the sidelines until 2017.


There were still a few companies reporting earnings and Best Buy knocked the ball out of the park. They reported earnings of 57 cents compared to estimates for 43 cents. That was a 16% increase over the same quarter in 2015. Revenue of $8.53 billion also beat estimates for $8.4 billion. Same store sales rose +0.8% compared to estimates for a -0.6% decline. The CFO said they expect same store sales to rise +1% in Q3.

Best Buy said higher demand for wearable technology, appliances, computers and home theater systems offset declines in mobile phones and video games. The big gains came from a 24% boost in online sales. This was an amazing report from a company that was left for dead back in late 2012 when it was trading for $11 and analysts were saying Amazon should buy them as a way to showroom products in brick and mortar locations. Since they compete head to head with Amazon, the spike in online sales is remarkable.


JM Smucker (SJM) reported earnings of $1.86 compared to estimates for $1.74. Revenue of $1.8 billion missed estimates of $1.9 billion and was well below the $1.95 billion from the year ago quarter. Revenue declined -7% on increased competition on sales of pet food and falling coffee prices. Smuckers is the largest coffee roaster with the Folgers and Dunkin Donuts brands in its portfolio. The company was forced to cut prices on coffee by 6% after bulk coffee prices fell. That was the second decline in 2016. Overall, the drop in coffee sales accounted for 4% of the 7% decline in revenue. Coffee revenue alone was down -9%.

The company guided for the full year to earnings of $7.60-$7.75 and below estimates for $7.70. They also guided for sales to be flat to down by -1% or more compared to prior forecasts for a 1% gain. Shares fell -8% on the earnings.


Homebuilder Toll Brothers (TOL) reported earnings of 61 cents that matched estimates. They sold 1,507 homes in Q2 and a nine-year high. The average selling price declined slightly from $834,000 to $831,000. Order backlogs rose 19%. Shares had been locked in a range in 2016 but the earnings were enough to power a 9% gain.


Shares of La-Z-Boy (LZB) crashed -15% in afterhours after reporting earnings of 28 cents that missed estimates for 29 cents. Revenue of $340.1 million also missed estimates for $359 million. The company blamed the flat sales on "weaker demand" and "inconsistent" foot traffic. Same store sales fell -1.9% compared to a rise of +5.5% in the year ago quarter.


Zoes Kitchen (ZOES) shares fell -17% after reporting earnings of 6 cents that matched estimates. Revenue rose +27% to $66.3 million but missed estimates for $67.3 million. Same store sales rose +4% but that was driven by a 3.1% price increase. This compares to a sales rise of 8.1% in the first quarter. This caused a lot of analyst grief because adjusted sales had fallen off a cliff. For the full year, the company guided to $277-$280 million and only $1 million below prior guidance. Analysts were expecting $280 million. They guided to same store sales growth between 4-5%. Based on the guidance and the minor miss on revenue I did not think it was that bad of a report to cause a 17% drop in the stock. Buy the dip?


Lannett (LCI) reported earnings of 73 cents that easily beat estimates for 60 cents. Revenue of $168.9 million also beat estimates for $161.8 million. That was a 70% increase in revenue and a sales record. Lannett is a generic drug manufacturer.


The big dog on the calendar for Wednesday is Hewlett Packard. The headliner on Thursday is Sears along with Gamestop and Ulta Salon. It will be hard for these companies to provide any market lift.


Elon Musk tweeted this morning that Tesla would make a new product announcement in the afternoon. Shares of Tesla immediately rallied from $222 to $228 as shorts ran for cover. Musk is a twitterholic and his tweets do move the stock price. When the announcement was finally made it was a larger 100 kWh battery pack for the Model S and the Model X. Musk said it would make the Model S the fastest production car in the world with a 0-60 time of 2.5 seconds in Ludicrous mode. The Model X would not be a slouch at 2.9 seconds. The new battery would provide a 315-mile range for the Model S and 285 miles for the Model X, assuming you are not racing off every stoplight.

The new high performance version will be called the P100D and will cost $134,500 with the SUV starting at $135,500. A normal Model S starts at $75,000 and can go roughly 200 miles on a charge. Musk said there have been faster production cars from Porsche and Ferrari but they are no longer produced and they cost $1 million each. Musk said demand is expected to be strong but they can only make 200 of the P100D battery packs a week due to production constraints. Shares gave back about half of the gains by the close.


Delphi (DLPH) and MobilEye (MBLY) announced a partnership to develop an autonomous driving technology package for automakers. They plan to develop the market's first turnkey Level 4/5 automated driving solution, which carmakers could begin integrating into vehicles by 2019. Level 5 is totally self-driving while Level 4 is close to complete autonomy.

Nearly all the automakers are working to develop the technology. GM is already testing self-driving cars and Ford plans to have a fully autonomous car in five years. Google has already made giant inroads into the process with more than one million miles of actual driving already completed. Google and Fiat are jointly producing a fleet of 100 self-driving minivans to further test the technology. With Delphi and MobilEye partnering to make an off the shelf package it could free up the various automakers to simply produce the cars and not spend billions developing their own technology. MobilEye was instrumental in Tesla's initial self-driving efforts.


Crude prices came back from an opening dip to trade at $48 intraday after Iran signaled a willingness to participate in a potential production freeze discussion at the end of September. Iran is OPEC's third largest producer. While the comments came from the Venezuelan oil minister after his visits to the Middle Eastern OPEC members, Iran did confirm it was going to participate in the late September talks in Algeria. The Venezuelan minister said "Iran is reaching its pre-sanctions production level soon and after that it can cooperate with others." Iran did not participate in the prior talks. Oil prices rallied from an early morning drop on the Iran news to close at $48.

Unfortunately, after the close the weekly API oil inventory report showed a 4.5 million barrel build in oil inventories. Expectations were for a decline of 500,000 barrels. Crude prices fell back to $47.68 on the news.

Goldman Sachs warned this morning the current rally in crude prices would fail. They said the rally was built on talk from nations known for saying anything to boost prices. There was no fundamental basis for the rally and Goldman was seeing increasing bearishness in the actual fundamentals. They retained their yearend price range of $45-$50 but warned there could be volatility ahead.




Markets

While the Nasdaq was breaking out to a new high this morning, Bank of America was warning of an impending correction back to 2,000 on the S&P. Dan Suzuki, senior investment strategist, said there were multiple factors that could cause the correction. He said short interest had moved from near record levels to the lowest point in 2016. Stocks were now expensive given the five quarters of earnings recession. He said if you adjust for currency impact and energy, the S&P revenue growth was the lowest in three years.

He warned the market was likely to suffer from stimulus disappointment as central banks pulled back from the brink. The Fed is on the verge of changing policy again and the ECB is no longer expected to cut rates at the next meeting. The European PMI out this morning was an 8-month high. He also warned the leverage in the market was very high and current earnings estimates for 2017 were unsustainable and would have to be revised lower soon. Goldman Sachs has a 2,100 year end target, JP Morgan 2,000 and HSBC 1,960.

Suzuki said we were experiencing the calm before the storm with the calm in the markets at 20-year lows. He was referring to the very tight ranges and extremely low volatility.

The S&P spiked to 2,193 at the open and came to a dead stop. That was also the high from the big short squeeze on August 15th. Note the nearly identical candles from those two days. We had a big gap open followed by an immediate decline. The S&P closed at the low for the day.

In theory, this is a bearish pattern and suggests strong resistance and the potential for a drop back to 2,175 ahead of the Yellen speech on Friday. Theory has not worked well lately so anything is possible. The problem is the lack of a catalyst to break through that resistance. There is nothing on the horizon that could produce a move strong enough until the Yellen speech. If she is strongly dovish, that could be the catalyst. If she is turning hawkish that could be a downside catalyst.



The Dow chart has a similar pattern with an opening gap higher to the resistance from the July 20th and August 11th tops. The August 15th short squeeze did trade higher but the index immediately fell back into the consolidation channel. The opening spike today was immediately sold and the Dow closed nearly -100 points off its high and at the low for the day. There are no leaders in the Dow components. There is a new set of winners/losers every day and none are consistently higher but some are consistently lower like MCD, WMT, TRV, etc. The path of least resistance for the Dow is bearish.




The Nasdaq did not close at a new high despite trading at one intraday. The close at 5,260 was -2 points below the August 15th high. The Nasdaq is benefitting from the semiconductors, biotechs and energy stocks. Any of those could retreat at any time. With the furor over high priced drugs seeming to grow stronger each week, we could see a crack in the biotech armor at any time.

Current support is 5,225 and resistance 5,270.



The Russell 2000 has the most bullish chart but it is not without challenges. The top of the short-term resistance of 1,250 and the longer-term channel is about 1,255. The Russell is trading at the top of the channel and could easily see some backing and filling and decline to the bottom of the channel without harming the overall trend. That would be around 1,225.



The market has survived for several years with a steady morphine like drip of global economic stimulus. The punchbowl of stimulus has been continuously refilled. Eventually that will stop. As I mentioned earlier the Fed, the ECB and even the BoJ are starting to make noises that could be interpreted as a prelude to turning off the stimulus spigot. It is not going to happen all at once. The ECB is committed to QE through March. The Fed will continue buying replacement securities for those that mature so interest rates are not going up in the near future. While they will probably hike by 25 basis points over the next five months, there is always the danger they could become more hawkish. Yellen's speech on Friday could be a turning point in Fed policy, or not. She may retain her dovish bias and the uncertainty will continue for another two months.

The market is not declining. That means it is not letting buyers into new positions. If this continues past Labor Day, the portfolio managers will be forced to chase prices higher. If we could choose market direction over the next 8 sessions, I would like to see a 3-5% decline. That would open the door to a major rally as the fund managers all tried to squeeze through the door at once in September. A decline of that magnitude would be painful because everyone is long. However, it would be a vaccination against a bigger decline later.

Wednesday is the anniversary of the mini Flash Crash from last August. The Chinese markets suddenly began to implode and that carried over into the U.S. markets with the Dow losing more than 2,000 points in only five days. Could Yellen cause another August implosion? Absolutely, but I seriously doubt it. The wealth effect from the market is a major plank in the Fed's economic support although they will not admit it.

The key point here is that a catalyst can come from anywhere. Nobody expected that Chinese implosion and its impact on the U.S. markets. We need to remain long but keep our stop losses in place as we enter the six most volatile weeks of the year, which started on Monday. The market never needs a reason to correct but it tends to move faster when an unexpected event appears in a normally volatile period.

Enter passively, exit aggressively!

Jim Brown

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