The major indexes excluding the Nasdaq all posted single digit gains on Friday. The Nasdaq surged to another new high.

Weekly Statistics

Friday Statistics

The Nasdaq Composite dipped back to 5,800 on Thursday but surged on Friday to close at 5,838 and a new high. The Nasdaq 100 ($NDX) dipped to 5,290 on Thursday but rebounded to close at 5,324 on Friday. Both indexes closed over new round numbers of 5,800 and 5,300 and show no signs of weakness despite being severely overbought.

The Nasdaq 100 ($NDX) Relative Strength Index (RSI) reading rose to 83.09 when 70 is considered overbought. Friday was the highest reading since January 3rd, 2000 when it hit 84.15 after 2.5 months of nearly consecutive daily gains. Overbought oscillators can always become even more overbought but this is at a seriously extreme level.

In 2000, the index declined more than 500 points over the next three days but once the overbought conditions were equalized, the index went on to gain 1,400 points over the next two months before the bottom fell out in March. We need a few days of equalization so the rally can continue.


Friday did not have any market moving economic reports. The E-Commerce Sales for Q4 only rose +1.9% from Q3 despite being the holiday shopping season. Sales were $102.7 billion compared to $101.3 billion in Q3. However, compared to the $89.8 billion in Q4-2015, sales rose 14.3% to a new record. Q4 sales in 2015 rose 3.9% from Q3. This is one more piece of evidence that the holiday shopping was lackluster at best. E-Commerce accounted to 8.3% of total sales in Q4.

Moody's Chart

Next week has a limited calendar of events with home sales the top two reports. Winter month home sales reports are seldom exciting but with the warmer than normal winter there may have been more shoppers out and about.

The FOMC minutes will be the midweek hurdle. With Yellen's testimony slightly more hawkish in some areas and dovish in others, the minutes will have a little more importance. The chance of a rate hike in March declined slightly from 25% to 17.7% after her comments.



The Dow struggled on Friday to overcome a big decline in UnitedHealth (UNH) of -$6 that knocked more than 41 points off the index. However, that was the only Dow stock that lost more than $1.

UnitedHealth was sued by the Justice Dept claiming the insurer had overcharged Medicare hundreds of millions of dollars. The period in question was five years ago and the company said they would contest the charges vigorously. Supposedly, the insurer claimed their members were sicker than they actually were and billed for procedures that were more expensive than those actually performed. The original suit was brought by a whistleblower and the Justice Dept joined that suit. The allegations were against Texas-based WellMed, which UnitedHealth acquired in 2011.


Several days after Aetna (AET) cancelled its plans to buy Humana (HUM) for $34 billion, the company announced a $4 billion stock repurchase program and doubled its quarterly dividend to 50 cents a share. Shares spiked $7 to $129 after the Tuesday announcement of the deal cancellation. They gave back $4 on Friday despite the sudden burst of good news for shareholders. Analysts believe the cash dispersal plans suggests Aetna is not going to move forward with another acquisition of a smaller company and that is why the shares fell.


Kraft Heinz (KHC) reported it had made a $143 billion offer for Unilever (UL) in what would be the largest takeover ever in the food and beverage industry. A successful acquisition would create a company valued at $300 billion or more. Unilever said it had rejected the $50 a share proposal. Shares were trading at $43 when the announcement was made. Unilever said the offer dramatically undervalued the company and the company saw no further basis for further discussions. Kraft Heinz said it would seek to gain agreement on the terms of a transaction. Under European laws, KHC now has 30 days to make a firm bid or it would have to walk away for a six month cooling off period.

KHC was formed two years ago when Warren Buffet and 3G Capital teamed up to buy H.J. Heinz. Analysts had speculated the two deep pocket investors would attempt another acquisition to add to KHC. Kellog (K), Mondelez Intl (MELI), Campbell's Soup (CPB) and General Mills (GIS) had been speculative targets.

Everyone knows you do not lead with your best offer despite it being an 18% premium to the pre announcement price. That would equate to 3x sales and a PE of 21. A combined company would have annual sales of $85 billion. 3G Capital is known for aggressive cost cutting and developing synergies to increase value. Unilever shares posted the worst performance in 2016 since the financial crisis.

Analysts believe the real target is the Unilever food business. Kraft is probably looking to acquire the food business and spin off the household and consumer goods company. They may also be able to offer enough to induce Unilever to just sell them the food business outright. It would be worth a fortune to Kraft as a market expansion opportunity.



T-Mobile (TMUS) shares rose after multiple reports that Softbank was preparing to approach T-Mobile about selling them Sprint (S), which is majority owned by Softbank. The company is waiting until the end of the FCC spectrum auction, which restricts carriers from talking to each other. The auction ends in April. Goldman Sachs (GS) believes a deal is unlikely because the FCC wants to keep four major players in the U.S. market to increase competition. We are seeing the result of that competition with Verizon going back on its prior marketing plan and offering a new unlimited data plan. On Friday, AT&T (T) also relented and expanded their unlimited plans. Sprint and T-Mobile both need each other. They are so far down the competitive landscape they have no hope of regaining any significant market share on their own. Together they would be a strong third place and could give the big boys some competition. Now the focus will shift to how a Trump led FCC would react to a potential deal.




Investors are voting on the outcome of the Bass Pro Shops merger with Cabelas (CAB) and they are running for the sidelines. Cabelas reported earnings of $1.05 that missed estimates for $1.22. Revenue of $1.34 billion missed estimates for $1.45 billion. That was not the biggest problem for the stock. The fate of the proposed merger is in serious doubt. Cabelas was supposed to sell its credit card division to Capital One (COF) in order to reduce the amount of cash needed for the acquisition. When COF reported earnings last week they said the deal was all but dead. They expected to either withdraw the application or have the acquisition denied by the Comptroller of the Currency.

Another challenge is that the third largest retailer in the sector, Gander Mountain is preparing to file bankruptcy. That means letting the two largest merge could be a challenge for the FTC. Bass Pro Shops offered $65.50 per share for Cabela's. Shares have fallen from $63 to $45 suggesting investors think there is little chance of a successful conclusion. If a deal did get done in the coming months the price could be dramatically lower than $65. This may be a buying opportunity for Cabelas shares if the deal is called off. The selling is way overdone.


St. Louis based LMI Aerospace (LMIA) agreed to be acquired by Sonaca Group for $14 a share. That was a 52% premium over Thursday's closing price. The company will remain in St Louis but will operate as a member of the Sonaca Group. Sonaca is a global company based in Belgium that manufactures and assembles advanced structures for civil, military and aerospace markets.


GSI Technology (GSIT) announced a breakthrough technology called an Associative Processing Unit (APU) that results in an "orders of magnitude" performance ratio improvement compared to conventional CPU, DRAM methods. In the computers we use now, the data has to be moved from memory to the CPU for processing and then moved back into memory for every operation/calculation. This creates a bottleneck moving data into and out of the CPU for processing. The patented APU no longer needs to move the data and can process it at its current location in memory. This greatly speeds up the computing process and could be a game changer in future computing systems. They are going to present at the ECI Workshop on Feb-23rd. Shares exploded higher on the news.


TrueCar (TRUE) reported a smaller than expected loss of 9 cents compared to 33 cents in the year ago quarter. The adjusted loss was one cent compared to estimates for 5 cents. Revenue of $74.1 million beat estimates for $71.1 million. The number of vehicles purchased rose from 183,157 to 218,807 or +19%. The number of franchise dealers rose from 9,094 to 11,151 or +23%. The company said a recent JD Power survey showed that 60% of the buyers that use the internet to search for a car visit the TrueCar website.

They guided for Q1 for 205,000 to 210,000 vehicles, up from 174,982. Revenue of $71 to $73 million, up from $61.9 million. Adjusted EBITDA between $4 and $5 million, up from $1.1 million. For all of 2017 they guided to 920,000-930,000 vehicles compared to 806,953 in 2016. Revenue of $315-$320 million, up from $277 million. Adjusted EBITDA $20-$24 million, up from $15 million. This was a very strong report.


Broadcom (AVGO) saw a bounce on Friday after JP Morgan said adding wireless charging to the iPhone 10 or iPhone X, which is their term for the iPhone 8, would add $500 to $600 million annually to Broadcom revenues. Working with Apple, Broadcom has developed a chip solution to power the wireless charging functionality on the iPhone.


Skyworks Solutions (SWKS) shares rallied 4% after beating on earnings and raising guidance. The company also announced its SkyOne chip system for the high growth China LTE wireless market. Skyworks reported earnings of $1.60 compared to estimates for $1.58. Revenue of $914 million beat estimates for $903 million. They guided for the current quarter for a 12% rise in earnings to $1.40 and 8% rise in revenue to $840 million. Analysts were expecting $1.39 and $818 million.


The Q4 earnings cycle is coming to a close. The last two Dow components report on Tuesday followed by the Hewlett Packard twins HPE/HPQ. The retail sector also wraps up with GPS, JWN, KSS, LB, WMT, W and JCP. Tesla is the highest profile reporter for the week on Wednesday after the close. Another 50 S&P companies report this week to bring the total reported to 92% of the S&P-500.


More than 82% of the S&P 500 has reported earnings for Q4 and 66% have beaten estimates with 53% beating revenue estimates. The blended earnings growth for Q4 is now 4.6% and the forward PE of 17.6 on the S&P is the highest since June 23rd, 2004. The 10-year average PE is 14.4. The blended revenue growth is now 5.0%. Some 61 companies have given negative guidance and 29 have issued positive guidance.

Expectations for Q1 earnings growth is now 9.6% with revenue growth of 7.4%. Q2 expectations are for 9.0% earnings growth and 5.5% revenue growth.

Crude oil prices remain locked in their recent range between $50.75 and $54.25. The OPEC production cut news has failed to provide any additional gains. However, last week OPEC, led by Saudi Arabia, said they might extend their six-month cuts for another six-months because they are working so well. I do not know what metric they are using to measure that performance since oil has flat lined. We can expect several more months of posturing and "suggesting" there will be an extension in order to keep prices at this level.

Crude prices typically decline in late February and early March as inventories build while refiners are offline for maintenance. In late March, prices typically rise into August as demand season kicks into high gear.


The active rig count has continued to rise with another ten rigs added last week. That brings the total of new rigs to 92 over the last five weeks. This is going to pressure crude prices 3-6 months from now.


Energy equities have been declining since early December. That is when oil topped out at $54 and everyone began taking profits on the post election rally. It will take higher crude prices or a couple quarters of rising earnings to lift equities from here.


 


 

Markets

The Investment Company Institute (ICI) reported that equity outflows from January through October 2016 were $117 billion and the highest since the financial crisis. Since the election, more than $67 billion has flowed into equity funds. They credit the election results and the Dow crossing over 20,000 for the surge in fund flows.

Morningstar reported funds leaving actively managed equity funds and more than $500 billion flowing into passive equity funds over the last 12 months. In January, $13.8 billion flowed out of actively managed funds with passive equity funds seeing inflows of $20.8 billion. U.S. equity index funds saw inflows of $30.6 billion in January. Currently, actively managed equity funds are holding $3.6 trillion in assets. Passively managed equity funds are holding $3.1 trillion in assets. All classes of actively managed funds have seen outflows of $325.6 billion over the last 12 months while passively managed funds have seen inflows of $563 billion. Vanguard saw inflows into its passive funds of $43.7 billion. Blackrock saw inflows of $14 billion.

Strangely, taxable bond funds saw inflows of $32.2 billion with municipal bonds seeing inflows of $4.3 billion. The "great rotation" has failed to appear and yields on the ten-year are holding at the 2.4% range despite the equity rally. There is no material selling in bonds. There was a surge just after the election but that faded quickly and yields have been in this range since December 1st.


The equity markets continue to move higher although the gains are taking a little more effort each day. The morning dips are being bought and we are still closing at the highs. The S&P has been fighting resistance at 2,350 for the last three days. Support is now well back at that prior resistance at 2,300.


The Dow has pulled to within 375 points of Dow 21,000. The 20,600 level has been resistance for the last three days but the Dow has managed to string together seven consecutive days of gains. The index is very overbought but as long as the majority of the individual components continue posting minor daily gains the index will continue higher. More than 50% of the Dow components are at or near their recent highs.

The drop by UnitedHealth knocked 41 points off the Dow and caused an 86-point drop in the index at the open. Late day buying lifted the index back into positive territory right at the close. You can credit Trump's appearance and speech at the Boeing plant for the 13 Dow point bump. Home Depot also gained ahead of their earnings on Tuesday.

Seeing the Dow rebound to close positive ahead of a three-day weekend is either a very positive signal that buyers believe we will go higher next week or it was shorts covering ahead of the weekend event risk. I believe it was the shorts covering. Very few investors will put new money to work at a market top ahead of three-day weekend event risk. Anything can happen overseas when their markets are open and ours are closed.



The Nasdaq indexes continue to lead the market higher and investors should be looking at these charts and developing a healthy skepticism about their chances to move higher. They are very overbought and "should" be due for a 3-5 day decline to equalize these pressures.

However, markets can remain irrational far longer than we can remain liquid if we are betting against them. Once everyone capitulates and the shorts disappear, the markets will correct.




The small cap Russell 2000 closed at a new high on Wednesday then weakened the next two days. The Russell is struggling to move higher despite being over prior resistance. If the small cap stocks ever catch fire we could have an explosive market. However, should they begin to weaken again it could poison the big cap advance.

The S&P-600 closed at a new high by a few cents on Wednesday but also declined the last two days. It was the only major index in the red on Friday. This is confirmation the Russell weakness is not just related to the Russell.



We are due for a bout of profit taking but as long as the dip buyers persist in snapping up every little intraday decline, the bigger dip is not going to happen. Eventually we are going to get a headline that catches the market off guard and the low volume dip buyers are going to be overrun in the higher volume collapse. Whether that is this week or next month, nobody actually knows.

What we do know is that trees do not grow to the sky and markets do not rally indefinitely. We do have streaks where the markets can continue in a specific direction for a couple months without any material pause but eventually there will be a pause and the longer we go without it the worse it will be.

They say the trend is your friend until it ends. Right now the trend favors anyone willing to hold their nose and buy stocks that have been up for 7-10 days straight. The winners continue to be winners but when that headline appears, it could produce a significant air pocket. Keep your seatbelts fastened and stop losses in place.



Random Thoughts


The markets closed at new highs but nearly 5% of the voters in this week's poll fled back to bearish territory. Previously bullish and neutral responders decided the market was leaning out too far over its skis and retreated to the sidelines to wait for the crash. The survey ends on Wednesday and that was before the late week softness. The markets ended on the highs on Wednesday. Is this too much of a good thing?

Last week results


The headline that matters could be only a few days away. The border adjustment tax is on life support according to Greg Valliere, chief global strategist with Horizon Investment. In theory, the border adjustment tax would tax imports but exports would be untaxed. The concept was to raise a lot of money from the import tax to be able to cut corporate taxes significantly. The expectations for a corporate tax cut is one of the main reasons the market is in rally mode. President Trump was lukewarm on the idea before he was elected. His idea was to tax certain imports as punishment for American companies producing products in other countries and importing them back into the U.S. for sale.

The border adjustment tax concept was seized by the republicans in the House as a way to offset the corporate tax cuts. When Trump met with retailers last week they expressed their extreme displeasure at the idea and his resolve appeared to weaken somewhat. The president indicated his lack of support saying the plan was "too complicated."

Trumps own advisors are mixed on the topic. Steve Bannon is for it and Gary Cohn is against it. Clearly, Cohn would be a far stronger voice on the subject coming out of Goldman Sachs while Bannon came from a news website. Peter Boockvar, chief market analyst with the Lindsey Group, believes the administration is trying to come up with another plan but not having much luck. They have to raise $1 trillion over 10 years to offset the potential losses from a corporate tax cut to 15% or a little less if the cut is to 20%. Short of a miracle solution, the only way to do that is with the border tax. Boockvar said "without a satisfactory Plan B the market will collapse." That suggests the announcement about the new tax plan may delayed for weeks and it may be a lot weaker than previously promised. That realization could easily tank the market, which expects a major tax cut. Since almost every retailer in the country sells imported goods, a border tax could spike the cost of those goods by 15% to 20% and potentially create a recession as purchases screech to a halt.

The democrats have already started their "tax cuts benefit fat cats and big corporations" defense and getting any cut through congress that is not revenue neutral would be nearly impossible. Goldman Sachs said late last week the potential for a border tax is 20% or less. If that is the case, the potential for a meaningful tax cut is 20% or less. The market has not yet come to that realization. Goldman said a tax cut without a border tax would likely be minimal to a lower rate of 25%. Goldman said a border tax could be challenged by other countries in the WTO.

John Stoltzfus, chief investment strategist at Oppenheimer Asset Management, said the market could decline 3-4% once that realization became apparent.

Trump's "phenomenal tax plan" had better be phenomenal or there will be a major hiccup in the markets.


The Philly Fed Manufacturing Survey on Wednesday shot up from 23.6 to 43.3 and the highest level since the 43.4 reading in March 2011. Some economic sites are claiming it is the highest since 1984 and since we are only talking about one tenth of a point I am not going to argue. This was a very strong report and has been increasing steadily since the 8.7 in November. That was followed by 19.7, 23.6 and now 43.3. The pace of the manufacturing economy is definitely accelerating.

Two other reports out last week included the Producer Price Index at +0.6% and the Consumer Price Index at +0.6%. The PPI was the highest since September 2012 and the CPI the highest since February 2013. Those are inflation indexes and inflation is suddenly rising twice as fast we analysts expected. Consensus estimates for the CPI and PPI were for a +0.3% gain. That is eventually going to wake up the Fed and the results will not be market friendly.



 

Enter passively and exit aggressively!

Jim Brown

Send Jim an email

 

"I contend that for a nation to try to tax itself into prosperity is like a man standing in a bucket and trying to lift himself up by the handle."

Winston Churchill


 

If you like the market commentary you have been receiving and you are on a free trial then now is the time to subscribe. Don't wait until you miss a newsletter to decide you want to take the plunge.

subscribe now