Investors may be looking at the election next Tuesday as an adult version of Trick or Treat.

Market Statistics

As the election polls tighten and the rhetoric increases to a fever pitch, the market is reacting more forcefully to the trend over the last couple weeks. The trend has been lower as the polls tightened but this morning an ABC national poll showed Trump in the lead by 1 point. While that could change at any moment, he was down -12 points just two weeks ago. The momentum is definitely in his favor and the market reacted negatively.

The market had priced in a Clinton win and the republicans maintaining control of the House effectively insuring gridlock and the status quo for another two years. Suddenly, that scenario has run off the rails with the steady drip, drip of the WikiLeaks documents and the return of the email scandal in a big way.

Now that fund managers are in a new fiscal year they are free to dump stocks and raise cash so they have some dry powder to use after the election. Certain sectors will do either better or worse depending on who wins. Managers are now free to raise cash to make those bets once the winner is declared.

The market performance today was entirely different that what the futures were showing last night. The S&P futures were up +8.75 late Monday night. The reason for the overnight bounce was Asian economics. China's government PMI index for October jumped to 51.2 compared to estimates for 50.4, which had been the actual reading the prior two months. Meanwhile the Caixin manufacturing PMI also rose to 51.2 in October and the fastest pace of improvement since March 2011. A rebound in new orders and stronger demand were the main drivers. The Caixin report focuses on mid-sized companies not in the government survey.

China's services PMI for October rose from 53.7 to 54.0 and the second monthly gain. The combination of the three reports suggests China's economy is starting to improve. The GDP held steady at 6.7% for Q2 and Q3. Also, September producer prices rose for the first time in almost five years.

The Bank of Japan kept policy unchanged and rates at -0.1%. Bond purchases will remain at the same rate at an annual pace of 80 trillion yen. Several economic reports weakened but the overall outlook remained positive so the BoJ did not feel the need to change policy.

The combination of those Asian economic reports above lifted the U.S. futures and it looked like we were in for a strong open in the USA. By the time morning rolled around the indexes were in decline mode and the Dow hit -201 at the lows of the day. If you do not like the market action just go to coffee. When you get back, it will have changed.


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The U.S. economics were mixed and did not give the Fed any support for a potential rate hike in the near future. Construction Spending for September fell -0.4% after a -0.7% decline in August. Consensus estimates were for a +0.5% gain. Public construction fell -0.9%. Private construction fell -0.2%. Nonresidential construction fell -0.9%. Overall spending is now down -0.2% from the same period in 2015.

The ISM Manufacturing Index for October rose slightly from 51.5 to 51.9. The internal components were mixed and suggested weakness ahead. New orders declined from 55.1 to 52.1 and order backlogs fell from 49.5 to 45.5. The inventory component fell from 49.5 to 47.5 making it the 15th consecutive month in contraction. The highlight was the employment component with a rise from 49.7 to 52.9 and the first time over 50 since June and the highest reading since June 2015. The rising dollar is causing a problem for the manufacturing sector and it is not likely to end soon.


Vehicle sales rose from 17.76 million to 18.29 million on an annualized basis in October. This was the second month the actual numbers beat expectations, which were 17.4 million for October. This pace of manufacturing is not sustainable. Once the pent up demand has been satisfied we could see a significant reduction. However, the average age of a vehicle in the U.S. today is 11 years. That means a lot of cars are going to need replacement in the near future.

Auto sales rose from 7.24 million to 7.27 million. Light truck and SUV sales rose sharply from 10.51 million to 11.02 million. You can thank the low gasoline prices for that surge. Imported vehicle sales rose from 3.61 million to 3.72 million for 20.3% of total vehicle sales. The average incentive per vehicle declined from September's record $3,921 to $3,726.

Moody's Chart

The outlook survey for the Texas Service Sector declined from 13.0 to 9.9 with the survey components weakening. Revenue fell from 13.0 to 9.9, employment from 4.4 to 2.7, hours worked down from 3.1 to -1.4, wages and benefits down from 15.4 to 12.8 and selling prices down from 3.9 to 3.7. The retail sales component fell from 2.0 to -6.6 and a major drag on the headline number. The Texas service sector is starting to benefit from the rebound in the energy sector but the uptick will be slow compared to the activity level in early 2015. The number of active rigs in Texas remains near a 20-year low.

Tomorrow's calendar has the ADP Employment and the estimate has risen from 160,000 to 165,000 since last week. The Nonfarm Payroll consensus has also risen by 5,000 to 175,000.

The FOMC announcement will likely be ignored because there is almost no chance of a rate hike ahead of the election in a weak economy. They will however, point to December as a potential rate event.


Valeant Pharmaceuticals (VRX) hogged the news headlines in the morning and the evening. This morning shares were down -12% after news broke that former CEO Michael Pearson and CFO Howard Schiller are the subject of a U.S. criminal probe in the Philador scam. This is where Valeant sold large volumes of drugs to Philador and to other phony pharmacy companies Philador had set up. This enabled Valeant to maintain its revenue levels according to the current theory. At one point Valeant had an option in place to buy 100% of Philador as this scam was in progress. It is unknown if the company is also likely to be charged.

Late in the day, news broke that Valeant was close to a deal to sell its Salix component for $10 billion to Takeda. Shares immediately spiked more than 30% as all the morning's shorts were crushed. The deal is expected to produce $8.5 billion in cash plus future royalty payments. After the bell, Valeant said it was an open bid process for multiple divestitures and there were additional interested parties.

Valeant has a market cap of only $8 billion after losing -$70 billion in capitalization when the stock crashed. They have $32 billion in long-term debt plus another $8 billion in committed payments for royalties, options, pensions, etc. They need to generate a lot of cash quickly and $10 billion is a good start.


Pfizer (PFE) reported earnings that fell -38% to 21 cents. Adjusted earnings of 61 cents missed estimates by a penny. Revenue rose 8% to $13.045 billion and missed estimates for $13.055 billion. They guided for full year revenue of $52.0-$53.0 billion, up from $51-$53 billion. They guided for earnings of $2.38-$2.45, which was less than the prior $2.38-$2.48. Analysts were looking for $2.46 and $53.1 billion. Shares declined slightly on the news.


Yum Brands (YUM) closed Monday at $86.28 and opened this morning at $62.21. It was not an earnings drop. The spinoff of Yum China (YUMC) occurred and the YUMC shares began trading post spin at $24.50. The Yum China company is going to be the growth company while Yum Brands will be a slow growth high cash flow entity focused on the U.S. market. I am betting Yum US is also going to see its stock decline.


Anadarko Petroleum (APC) reported a loss of 89 cents that was bigger than the analyst estimates for a loss of 57 cents. Revenue rose 12.1% to $1.89 billion and missed estimates for $2.19 billion. The company raised its monetization target again from $3.5 billion to $4.0 billion in 2016. Shares rose on the earnings news despite another drop in oil prices.


Johnson Controls (JCI) was added to the Goldman Sachs Conviction Buy list now that the spin-off of its Adient unit is complete. Adient produces automobile seating components. JCI began trading post spin on Monday at $39.


Tenet Healthcare (THC) reported earnings of 16 cents that missed estimates for 19 cents. The worst news was the guidance. The company guided for Q4 earnings of 17-22 cents and analysts were expecting 54 cents. Shares fell only -3%, which I thought was very surprising. I would have expected -30%.


After the bell, Square (SQ) reported a loss of 9 cents and analysts were expecting a loss of 11 cents. Revenues of $439 million beat estimates for $431 million. The company raised its full year revenue guidance from $1.63-$1.67 billion to $1.695-$1.70 billion. Analysts were expecting $1.68 billion. The company said the total value of payments processed rose 39% to $13.2 billion. Analysts were expecting $12.47 billion. Shares gained 50 cents in afterhours.


Gilead Sciences (GILD) reported earnings of $2.75 compared to estimates for $2.86 per share. Revenues of $7.50 billion did beat estimates for $7.45 billion. Hep-C drug sales of $3.33 billion missed estimates for $3.7 billion. Harvoni had revenues of $1.9 billion that were lighter than expected because of falling demand now that there are multiple Hep-C drugs on the market. Expectations for Q4 are only $1.1 billion in the U.S. and $776 million overseas. Gilead shares were volatile after the close, trading between $71 and $75 but ending down only -90 cents at $73.22. Analysts have been expecting Gilead to announce some big acquisition with their huge cash hoard of $30 billion but nothing was announced. They did announce a dividend of 47 cents payable December 29th to holders on December 15th.


Electronic Arts (EA) reported earnings of 56 cents compared to expectations for 43 cents. Revenue of $1.1 billion beat estimates for $1.09 billion. They guided for the current quarter to revenue of $1.13 billion and that was well below estimates for $2.07 billion. Full year earnings guidance was $2.69 on revenue of $4.78 billion. Shares spiked $5 to $82.40 on the news.


Tableau Software (DATA) reported earnings of 16 cents that easily beat estimates for 7 cents. Revenue of $206.1 million missed estimates for $213.4 million. License revenue rose 7% to $116.7 million and they added 3,600 new customer accounts. Shares collapsed from $49.51 to $40 on the news but battled back to close at $45 in afterhours.


There was not a lot of earnings excitement today but on Wednesday, we will get Facebook, Alibaba and Qualcomm. That could provide a boost to the tech sector but Alibaba is the only one of the three reporting before the open. Facebook and Qualcomm are after the close.

The earnings excitement is fading fast as investors develop a defensive posture ahead of the election.


Apple (AAPL) shares declined to nearly $110 intraday on rumors iPhone sales in China were slowing. Strategy Analytics said Apple only managed to grab 6% of market share in China in Q3 compared to the 10% share it had in Q3-2015. The overall market rose in the number of units sold but Apple's share declined. To put it another way the difference was a 40% drop in market share. The problem Apple has in Asia is the one model per year program. With a dozen vendors each putting out 2-3 models a year, the market is swamped with Apple competitors and continuous offerings of new models.

There was another rumor making the rounds that the Apple Macbook was also losing market share to Windows Surface. The new Surface product has gotten a lot of good reviews and it is cheaper.

Apple Air Buds are also rumored to be delayed until Q1-2017.

The Apple decline was a drag on both the Dow and the Nasdaq indexes.


Brocade (BRCD) continued to rally on expectations for an acquisition by Broadcom (AVGO). Reportedly, Brocade is in advanced talks to sell itself with multiple potential buyers in the discussions but Broadcom is said to be leading.


Crude prices continue to decline after a $2 drop on Monday. The much-hyped OPEC production cut is disappearing faster than M&Ms in a kindergarten class snack break. Nobody wants to cut and now it appears nobody will even agree to a freeze. The next meeting is Nov 30th and prices could decline further if the agreement evaporates.


Markets

The S&P has posted losses for the last six consecutive days. That is the longest streak in 2016. All the major indexes lost ground in October and this week is not looking good. The Russell 2000 is now down -7% from its 1,263 high in September and it has broken below critical support at 1,200. The small caps normally lead the market in both directions and they are leading us down at a high rate of speed. The Russell is unsupported at its current level and portfolio managers are likely moving out of the low liquidity small caps just in case there is a big market drop in the near future. When in doubt, follow the small caps.


The S&P lost -14 points and traded not only below critical support at 2,120 but also under 2,100 intraday. This is a major support break and everyone pointing at critical levels like 2,145, 2,130, 2,119 and 2,114 as critical technical support on the way down, have now run out of levels on which to place their hopes.

Jeffrey Gundlach said this afternoon that he believes the S&P could fall another 5% to 10% over the coming weeks. He is a big dog in the market and while his opinion is just another opinion, his seems to count. His key level was 2,130. He said two closes under 2,130 was the technical kiss of death.


The Dow traded well below 18,000 intraday but recovered to close just above that critical support level. I have no hope that it will continue to recover. I believe the lack of any Dow earnings this week and the post earnings depression cycle from the 26 companies that have already reported will continue to drag the Dow lower.

Add in the weakness in Apple and the election uncertainty and we could easily see significantly lower levels. However, the Dow has been resilient and while trading sideways it has refused to move lower. We may be reaching that point where the next headline will be the one that forces a breakdown below support.

The Dow traded in a very narrow 60-point range on Monday. That was a draw between the buyers and sellers and remarkable considering the volume was nearly 7 billion shares and 1 billion more than any day the prior week. This was a textbook pattern of distribution.



The Nasdaq Composite finally broke below support at 5,200 and nearly touched 5,100. Apple was a big drag but the index got some help from the biotech sector. Strangely, the biotech index was up more than 1% despite a tweet storm by Bernie Sanders attacking Lilly, Sanofi and Novo Ordisk for drug pricing. The biotech sector has been so depressed it must have looked like a safe port in the storm.

Now that 5,200 has broken, I expect the Nasdaq to continue lower and produce a test of 5,100 and a break there will not be pretty.




The VIX spiked through 20 intraday but declined -2 points into the close. However, I believe we will see higher highs, possible in the 25 range by next week. There are a lot of traders that have not converted to the possibility of an unexpected winner in the election.


I believe our election uncertainty will continue to rise and with 6 days left, that is a lifetime in the election cycle. That is six days where the lead could reverse literally every day. This could create some serious market volatility ahead of the election and possibly more volatility after the event.

I would continue to be cautious about being overly long and I would refresh your shopping list for stocks to buy on a dip.


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Enter passively, exit aggressively!

Jim Brown

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