Quadruple witching Friday was quiet but ships can still sink in a calm sea.

Weekly Statistics

Friday Statistics

The markets gapped lower at the open and the Dow declined -140 at the lows. However, once those morning lows were reached, the markets moved quietly sideways the rest of the day. The last hour saw a sharp increase in volume as option positions were settled, the S&P rebalanced and a new S&P sector created for REITs. These events caused volume to spike from 6.7 billion shares on Thursday to 9.6 billion shares on Friday. Internals were 3:1 decliners over advancers but the indexes other than the Dow, remained relatively flat.

The Biotech Index was the exception with a -2.3% decline when the rest of the indexes were only down an average -0.35%. Pushing the sector lower was disappointing news from Novavax (NVAX) on a phase 3 trial. The company said the 3 Resolve trial on an experimental RSV F vaccine "did not demonstrate vaccine efficacy" in the prevention of a lower respiratory tract disease. The trial covered 11,850 patients. In the earlier trials, the RSV vaccine had shown a significant decrease in respiratory illness. In the 3 Resolve trial, the patients receiving the vaccine instead of a placebo actually had a higher incidence of infection.

Shares of NVAX crashed -85% because the drug was expected to generate $6 to $8 billion. Now those hopes have been crushed.


On the economic front, the Consumer Price Index (CPI) rose +0.2% in August and that lifted the chance of a Fed rate hike next week from 12% to 15%. Rising inflation towards the Fed's target of 2.0% is a key metric. The consensus was for a gain of +0.1% after a zero gain in July. The core CPI, excluding food and energy, rose +0.3%.

The headline CPI is now up +1.1% year over year and the core CPI is now up +2.3% and the Fed will be taking notice. This will be a heavily discussed topic at next week's Fed meeting.

Helping to push the headline CPI higher was a +2.9% rise in utility bills. Food prices were unchanged overall but food prices at home declined. Meats, poultry and eggs fell -0.4%, nonalcoholic beverages declined -0.1% and "other" food fell -0.2%. Food away from home rose +0.2%.

One major problem area was medical costs. Medical care costs rose +1.0% and the largest monthly gain since 1982. Medical care services rose +0.9% after a +0.5% rise in July. Hospital services rose +1.7% after a +0.4% increase in July. Physician services rose +0.7% for the second consecutive month and medical care commodity prices rose +1.1% after a +0.4% rise in July. The Affordable Care Act has proven not to be affordable.


The futures probability for a rate hike next week rose from 12% on Thursday back to 15% on Friday. That means there is an 85% chance they will not hike rates. If they did hike with probability that high, the market would decline significantly. The market has almost completely priced out the potential for a rate hike. Meanwhile the odds of a December rate hike have risen to 56.5%



Consumer sentiment for September was unchanged at 89.8 and only -0.2 below the July reading. That means sentiment has been practically unchanged for three months after a high of 94.7 in May. However, the internal components shifted dramatically. The present conditions component declined from 107.0 to 103.5 and the lowest level since October while the expectations component rose from 78.7 to 81.1. Fewer people said it was a good time to buy a car or other major household item.

I believe this is the impact of the political contest. With the mudslinging in high gear and the candidates talking about how bad things are, the consumer is starting to believe them.


The calendar for next week is of course headlined by the Fed announcement and the Yellen press conference. While the Fed is not expected to raise rates, Yellen may point directly at the December meeting as a likely target. If she begins preparing the markets this far in advance, the impact should be minimal.

Of almost equal importance this week is the Japanese monetary policy update at 1:AM on Wednesday. The BoJ is expected to take some kind of policy action. Analysts speculate they will cut interest rates again and push rates farther into negative territory. They are also expected to adjust the asset purchase program, possibly adding more stock and ETF purchases. They are also likely to change their bond purchases by adjusting the duration of securities it will purchase. Some analysts believe they will stop buying long dated bonds, therefore allowing long rates to rise while short-term rates continue to be negative.

The BoJ promised a major report on the direction of monetary policy at this meeting and analysts have been speculating for weeks what that could reveal. Like the ECB the BoJ is running out of bonds to buy. They have already acquired the majority of securities in the market.

The ECB said it was going to maintain the status quo and not increase its QE program. If the BoJ announces the same watch and wait strategy, it will enforce the idea that central banks have run out of ammunition and ideas and it could be market negative.

If the overseas central banks have reached the end of their policy cycle while the Fed is prepared to begin hiking rates, it could upset the risk parity trade, where investors have allocated so much money for equities and so much for bonds with the idea they will balance each other out. If bonds begin selling off in volume, it could upset those ratios and upset the equity market.


The following week we will get the last revision to the Q2 GDP, which was at +1.1% growth in the August revision. The Q2 number is not expected to post a material change. However, the Q3 GDP estimates are suddenly falling sharply after a couple weeks of negative economic data.

In early August, the Atlanta Fed real time GDPNow was predicting +3.8% growth for Q3. That has fallen to +3.0% but the rate of decline is accelerating. This is another reason the Fed would have trouble hiking rates in September. They need to see if this trend is going to continue. The Fed has never hiked rates, until last December, with the GDP below 3.5% growth. With our current growth at +1.1% the data demands no rate hike or the Fed would lose what little credibility it currently has.


UnitedHealth (UNH) shares spiked nearly $3 after the Obama administration told insurers they would not be reimbursed for the billions in 2015 losses. This was expected. However, the Dept of Health and Human Services (HHS) invited insurers to join in lawsuits against the government in order to win future financial settlements over the failure to pay. That is the first time I can remember that one department of government recommended suing another in hopes of financial gain.

The HHS memo confirmed that any funds collected by the government would first be used to shrink the $2.5 billion insurance shortfall from 2014 and no funds would be available for repayment of 2015 losses. The "risk corridor" program was designed to transfer funds from insurers that made money from Obamacare to insurers that lost money under the program. Any "excess profits" of more than 3% of premiums paid were to be paid in to the government to be distributed to other insurers with "excessive losses" of more than 3%. This is the third and final year of the risk corridor program and that is why the majority of insurers have dropped out of the Obamacare program.

The insurance program is a failure because the younger, healthier consumers failed to sign up, and older, sicker consumers signed up but could not pay and the insurers ended up with much higher costs. For 2014, the excess profits paid into the government were just $362 million while the excess losses were more than $2.9 billion. It is widely known that losses were even higher in 2015 but the government has not released the numbers because it would be a further admittance the program was failing. The 2016 calendar year is expected to be even worse. With no excess profits to compensate for excess losses, the insurers are fleeing the program like rats from a sinking ship.

The suggestion by DHS that insurers sue the government for their losses caused stocks in the sector to spike on Friday.

This is the text of that specific section of the memo from HHS.

We know that a number of issuers have sued in federal court seeking to obtain the risk corridors amounts that have not been paid to date. As in any lawsuit, the Department of Justice is vigorously defending those claims on behalf of the United States. However, as in all cases where there is litigation risk, we are open to discussing resolution of those claims. We are willing to begin such discussions at any time." In other words, sue us, then we will settle with you out of a different bank account called the Government Judgment Fund. And, "HHS recognizes that the Affordable Care Act requires the Secretary to make full payments to issuers. HHS will record risk corridors payments due as an obligation of the United States Government for which full payment is required." The key here is that Congress must authorize the funding and it has been specifically cut off since it was a side deal the president made with insurers after Obamacare was passed and signed into law.


Twitter (TWTR) shares rallied 4.4% after their first NFL live-stream broadcast on Thursday night. There was an average of 243,000 Twitter viewers throughout the broadcast and that was only a fraction of the 15.7 million people that watched on TV. Some 2.3 million Twitter viewers clicked in for a few seconds, probably to see what the fuss was about, but many left almost immediately. The average Twitter viewing time was 22 minutes.

The actual reviews were actually good but most said it was unlikely they would ever watch more than a few minutes on Twitter because of the screen size on the mobile phone and the lag time, which some said was 30 seconds or more. There were many complaints about the pause to "buffer" before the transmission could continue. These are all growing pains for the Twitter effort to become more relevant.

The problem for Twitter is that the 2.3 million unique viewers is now a benchmark that future NFL streams will be weighed against. If over the next several weeks that number declines on a weekly basis, the positive hype surrounding the effort will quickly turn into a death knell as analysts predict the end of streaming.


Deutsche Bank (DB) was hammered after the U.S. Justice Dept asked the bank to pay $14 billion in fines over the subprime mortgage disaster in 2008. The bank was expecting a fine of $2.0 to $3.0 billion. The bank already paid $1.9 billion in 2013 to settle similar claims. They said they "have no intent to settle these potential civil claims anywhere near the number cited." DB said the negotiations have just begun and they are sure the eventual settlement will be more in the range of settlements with other banks.

Unfortunately, for DB there have been some whopper settlements. With the EU taxing authority asking for $14 billion in back taxes from Apple, there may have been a little payback in the number requested from DB.

Aug 2014, $16.6 billion, Bank of America
Nov 2013, $13.0 billion, JP Morgan
Jul 2014, $7.0 billion, Citigroup
Apr 2016, $5.1 billion, Goldman Sachs
Feb 2016, $2.6 billion, Morgan Stanley
Feb 2016, $1.2 billion, Wells Fargo


Dow component Intel (INTC) raised its Q3 revenue guidance to $15.6 billion give or take $300 million. That compares to the prior guidance of $14.9 billion give or take $500 million. The company said they underestimated PC demand. Gross margin is expected to be 62%, up 2% from the prior estimate. R&D is expected to rise $100 million to $5.2 billion and the Q3 tax rate at 22%. They made the announcement on Friday because their quiet period before Q3 earnings on Oct 18th began at the close on Friday. Shares spiked 3% on the news.


Citigroup (C) shares were down slightly after Goldman Sachs cut the bank from buy to neutral and removed it from the focus list. Goldman said Citi's earnings failed to materialize and the 7.7% return on equity was well below management's 10% target. "We do not see a path to meaningful inflection without an improvement in the macro environment." Goldman said Citi's capital returns may be prohibited under the 2017 stress test rules.


The market would be in a different place this weekend were it not for Apple (AAPL). Monday's low was $102.53 and shares hit $116.13 on Thursday. That was worth approximately +108 Dow points and it is the largest weighting in the Nasdaq 100 at 14.6% and responsible for 41 points of the +172 point rebound from Monday's lows.

Not only did Apple rock the indexes but the stocks in the Apple food chain were also up strongly. AVGO, SWKS, QRVO, NXPI, QCOM and CRUS were all up on expectations for higher sales. That powered a strong rebound in the Semiconductor Index to a new high at Friday's open.

Without the gains from Apple and its suppliers, the markets would probably have closed significantly lower for the week. Instead the Dow closed with a minor +0.2% gain for the week while the Nasdaq 100 gained a whopping +2.9% along with a +2.3% gain in the Nasdaq Composite.


Amazon (AMZN) garnered some upgrades on Friday. Evercore raised their price target to $1,015 and the highest on the street but RBC Capital Markets was right behind them at $1,000. RBC said an independent survey found that Amazon likely had 60 million Prime accounts. They also said Amazon had sold more than 7 million Echo devices powered by their Alexa Voice Service. In their survey, many homes with an Echo had more than one. Even with that market penetration, they have only scratched the surface. Recently in a discussion with hedge fund managers, the common assumption was a double in Amazon's share price over the next three years.

Another new product Amazon is pushing is the "Dash Button." This is a WiFi enabled button you can get for almost any product you can buy at Amazon. In the example graphic below, there is a Dash button for Tide laundry detergent. You place the button on or around the washing machine using the self-adhesive backing. When you are about to run out of Tide you push the button. The button communicates with Amazon over WiFi and two days later Tide arrives on your doorstep courtesy of Amazon Prime free shipping. The button is programmed when you receive it through an Android or Apple smartphone. You tell it which product/quantity you want whenever the button is pushed and then place it in an appropriate location. I am amazed at the gimmicks Amazon comes up with to further hook you as a permanent Prime customer. The button costs $4.99 to buy but the first time you use it you will receive a $4.99 credit so basically it is free.

This will be so handy that millions of Amazon customers will order buttons for things they would normally buy at the local grocery store. Having a button means no shopping list, fewer bags to carry in from the store and probably fewer trips to the store. Need more coffee, toilet paper, Red Bull, trash bags, kitty litter? Push the button. Amazon Page

I have no doubt Amazon shares will reach $1,000. It is only a matter of time.



Tesla shares may have found a new bottom at $195 after Elon Musk said a new version of the Autopilot will be available next Wednesday. The new software will rely more on radar than on cameras in order to help the software "see" what is going on around the car and better avoid collisions. Radar was added to the cars in 2014 but it was initially supposed to supplement the cameras. There will also be a driver penalty for failing to obey the commands to take control of the wheel. If a driver repeatedly ignores those commands, the car will park itself and the driver will have to restart it in order to engage the "Autosteer" mode again. Musk said, while the update will make the autopilot much safer it does not mean "perfect safety." "Perfect safety is really an impossible goal."


Abbott Labs (ABT) shares rallied 2% after the company said Johnson & Johnson (JNJ) was buying its medical optics unit for $4.325 billion in cash. That unit was responsible for just over 5% of Abbott's revenues in 2015. This will include ophthalmic products in the company's cataract surgery, laser refractive surgery and consumer eye health segments.


Gilead Sciences (GILD) may finally be ready to go on a shopping spree. They are selling $5 billion in debt that will close on the 20th. Jefferies pointed out that unlike prior debt deals the prospectus added the words "future acquisitions" to the phrase regarding the use of the funds. The "general corporate purposes" language was enhanced. In prior debt deals, there was no reference to acquisitions. After the debt sale is concluded next week, the company will have $29.5 billion in cash on hand and its outstanding debt will rise from $22 billion to $27 billion. Analysts are now suggesting Gilead may not do just one acquisition but potentially several acquisitions to really beef up their future drug portfolio. Gilead is scheduled to announce the results from nine clinical trials over the next three months. Companies mentioned as potential Gilead targets include CLVS TSO VRTX and KITE. Clovis would be my bet.


Real estate is now the 11th S&P sector. REITS and real estate companies have been removed from their prior home in the Financial Sector and given a home of their own. For the Global Industry Classification Standard (GICS) this is the biggest event in 15 years. The flurry of new REITS over the last several years has been strong enough to warrant their own classification and it will be a dividend producing beauty. The stocks in the sector will hold trillions of dollars in real estate and their market cap is in excess of $900 billion. The last GICS change in 2001 allowed REITs to be included in the S&P indexes. The S&P indexes now include more than 90 REITs with 26 included in the S&P-500. Analysts believe the sector could see new investments of as much as $30 to $100 billion because of the new focus. A quick review of several REIT charts found that nearly all had been in sharp decline over the last week. I am using Digital Realty (DLR) in the chart below.



Netflix (NFLX) was sued by Twenty-First Century Fox (FOXA) for illegally hiring two of its employees while they were still under contract with Fox. The two employees were a former drama-programming executive and a film promotion executive. A Netflix spokesman released this comment. "We intend to defend this lawsuit vigorously. We do not believe Fox's use of fixed term employment contracts in this manner are enforceable. We believe in employment mobility and will fight for the right to hire great colleagues no matter where they work." Netflix shares were up $2 on Friday but the news did not break until just before the closing bell.


Oil prices declined on Friday as OPEC production increased. Exports from Nigeria and Libya are increasing now that internal problems in those countries are fading. Libya lifted the force majeure from its main port after the military seized the port from rebel control. In Nigeria, Exxon is preparing to export Qua Lboe crude for the first time in months with the first cargo to load next week.

Earlier in the week, the IEA reduced its forecast for demand growth by -100,000 bpd for 2016 and -200,000 bpd in 2017. The agency said a supply glut could continue through the first half of 2017.

The Algerian energy conference will be Mon-Wed starting on the 26th and some OPEC countries have agreed to meet unofficially on the sidelines to discuss a production freeze. The result of this meeting will provide for direction to Russia and Saudi Arabia when they meet at the end of October. The official OPEC production meeting is not until Nov 5th.

Analysts are starting to talk about oil in the $30s again but it is just speculation at this point.


Baker Hughes pointed out that more than 100 active rigs have been reactivated since May. While that is encouraging the total today is only 506. We would have to reactivate more than 1,425 additional rigs to return to the 1,931 peak from August 2014. Everything is relative.


 


 

Markets

The Dow did not make a 1% move on Friday but it came close when it was down -140 points at the lows. The Dow and S&P are exhibiting extreme volatility with the last six days of dramatic movement. The S&P is now stuck under resistance at 2,150, which was support for the prior 8 weeks. The 2,120 level is now support and a breakdown there should find additional support at 2,100.

The Dow and S&P both have lower high patterns but until they make a lower low, it is just consolidation. Typically, the market is positive on the day before a Fed announcement. However, the last two months have been anything but typical. With the chances for a rate hike at only 15% the market "should" ignore the risk and continue the historical trend. However, investors are very nervous about the market. The number of high profile hedge fund managers coming out with market warnings in recent could keep retail investors on the sidelines.

The market is approaching an inflection point. Next week is the fifth week of the most volatile six-week period in the year. If negative volatility does not appear next week, it probably will not appear the week after either.

Fund managers are looking for a serious dip to buy stocks for their October 31st fiscal year end window dressing. They typically do that in the middle of October. If a decline does not appear this week, they may accelerate those buys and the normal end of October rally could start early.

As long as the S&P remains above 2,100 next week, that could be a signal there will be no further selling and the funds could begin buying stocks.


The Dow has a similar level of new support at 18,000. Despite the big gains by Apple last week the Dow only managed to gain 38 points for the week but the highlight is that 18,000 did not break. As long as we can say that same thing next weekend, we should begin to see positive moves.

There is not likely to be any headlines moving Dow stocks next week but anything is always possible. We were not expecting the guidance upgrade from Intel but it appeared.



The Nasdaq 100 big cap index ($NDX) is only 13 points from a new closing high over 4,831 thanks to Apple and the chip stocks. Any continued gains by the Apple gang could push the index to a breakout and that would be positive for market sentiment. At this point, it would be a good bet that any October rally will be led by tech stocks because funds will be adding those stocks that have performed the best in order to dress up their portfolios.


The Nasdaq Composite Index is 39 points below its closing high at 5,283. The composite index is dragging a lot of dead wood along with it but it could still make a new high if the Apple gang continues to post gains.

The biotech sector was a major drag with a -2.3% decline on Friday. However, the sector was up +1.3% for the week in spite of Friday's loss. Biotechs are probably the main reason the composite index did not keep up with the Nasdaq 100.

The Nasdaq has been rising all week so it does not have the clear support line that we see on the Dow and S&P. With the index back over 5,200 it does bring that prior support back into play.



On the Russell 2000, the strong pattern of gains over the last two months finally broke but the support at 1,205 held on the initial dip and the index did not retest the August lows at 1,200. This is strong for sentiment and we need that 1200-1205 range to continue to hold until the broader market turns positive. This may be the only dip fund managers are going to get so any light weakness next week could be bought.


This is important. All the major indexes closed down on Friday with the Dow down -140 at the lows. However, the Volatility Index ($VIX) declined -6% suggesting nobody was worried about a further market drop. The VIX is calculated on the price for puts on the S&P. Put prices rise when there is a lot of demand and decline when demand drops. A declining VIX means limited demand for puts and is bullish for market sentiment.


With time expiring on the worst six week period of the year and the markets failing to extend the losses from the prior Friday, I am borderline bullish for the next two weeks. We still have to cross over the Fed announcement pothole on Wednesday and then hang on for another week or so but the lack of a material decline during this period is market positive.

There is one more hurdle we have to cross and that is the first presidential debate on the following Monday. That is a wildcard for the markets and you never know what will be said and how the market will react. That is especially true this election season.

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Random Thoughts


Bearish sentiment spiked a whopping +7.4% with a lot of neutral investors suddenly turning bearish. The bulls are shrinking as heightened volatility tends to turn people cautious.



At the Delivering Alpha hedge fund conference last week there was an abundance of negativity and most of it revolved around negative rates and the end of the debt cycle. Hedge heads were unanimous that negative rates were a serious danger and without a return to normal soon, there would be a monster bubble that could destroy the global markets.

Former Treasury Secretary Tim Geithner called the market "dangerous" and "scary." "I think the scarier things are really about politics, the scary erosion of the pragmatic center in politics, the diminished capacity to make sensible economic choices, something governments really have to do."

Carl Icahn said, "You look at the environment, and I think it's very dangerous. You're walking on a ledge and you might make it to the end, but you fall of that ledge and you're really going to see trouble."

Ray Dalio said he saw a "dangerous situation" in the debt markets. "There's only so much you can squeeze out of the debt cycle, and we're there globally. You can't lower interest rates more."

Paul Singer said, "I think it's a very dangerous time in the global economy and global financial markets."


Goldman Sachs Peter Oppenheimer warned that staying invested in stocks and bonds is an "unacceptable risk." He recommended selling bonds, the S&P-500 and Europe's Stoxx 600 "due to elevated valuations across assets and the risk of shocks."

"We see strong positioning, headwinds from the resumption of the Fed rate hike cycle and a strong dollar, and increasing political uncertainty into the U.S. elections."

Given the many bad market calls from Goldman Sachs over the last two years, this could be a contrarian indicator leading to a market rise.


Will the last employee out please turn off the lights. On Friday, Sears Holdings, which owns Kmart as well, informed employees in 13 states their stores would be closed in December. They will begin liquidation sales on September 22nd. One newspaper said a total of 60 stores would be closed.

Separately, Seritage Growth Properties, a REIT that owns 235 Sears and Kmart stores, revealed in a SEC filing that Sears had given notice of termination for leases on 17 Kmart stores.

Sears previously announced the decision to close 80 stores starting in July. Kmart operates about 870 stores today, down from 1,300 in 2012.

Moody's warned earlier in the week that Sears and Kmart do not have enough cash to stay in business. Moody's said the company was bleeding cash and would have to continue relying on real estate sales, sales of assets or outside funding to sustain operations. Moody's estimated their cash burn was $1.5 billion a year. In August, Sears reported cash on hand of only $276 million and not near enough to buy inventory for the holiday shopping season.

In Q2, sales fell -8.8% to $5.7 billion. Same store sales for Sears fell -7% and -3.3% for Kmart.

In 2000, Sears had sales of $41 billion a year. That declined to $15 billion in 2015. Over the same period Kmart sales have fallen from $37 billion to $10 billion. Sears has funded debt of $3.5 billion and unfunded pension liabilities of $2.1 billion. The company's minimum pension contributions for 2016-2017 are $596 million and nearly twice the cash on hand.

Shoppers claim when they do go to a Sears store they have to beg them to take their money. Many report wandering around the floor for a long time just trying to find a sales person to handle their sales. Other say they have quit going back because the shelves are bare and the merchandise they do have has been picked over so much there is nothing left but scraps.

Shoppers at Kmarts claim the store has been using sheets and shower curtains to hide empty shelves and closed departments.

Empty Sears store in Richmond Virginia. Center shelves have been removed instead of sitting empty.



A 58-year-old warehouse worker in Scotland took a picture that is believed to be a new photo of the Loch Ness Monster. The Loch has been searched repeatedly using every technology known to man but no signs of a monster creature have ever been found. Still, these pictures continue to surface periodically and at least this one is clear and in focus.



 

Enter passively and exit aggressively!

Jim Brown

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