Geopolitical worries over what may happen over the long holiday weekend pushed the market to multi-month lows.
The Dow and S&P closed at the lows for the day and at two-month lows. The S&P-600 small cap index closed at four-month lows. The Dow Transports closed at almost a five-month low. The Nasdaq indexes were weak but remained over critical support levels.
The only index that closed with a gain was the Biotech Index, which rallied 1.3% led by Alexion (ALXN), Regeneron (REGN), Kite Pharma (KITE), Incyte (INCY), Ionis (IONS) and Ultragenics (RARE). There was a flurry of drug news that stimulated the biotech rally.
The small cap segment of the market had been riding a wave of consecutive daily gains until Wednesday when the sector imploded. Thursday's added decline saw the S&P-600 close well under critical support at 820 and at a four month low.
Helping to push the VIX higher and the market lower was news North Korea was likely to test a nuclear bomb as early as Saturday. The U.S. warned against it and positioned two Tomahawk carrying destroyers 300 miles off the country's coast. The nonverbal warning was clear to everyone and Little Kim said he was not going to be deterred and would test his weapons whenever he decided the time was right. Whether he is stupid enough to act in the face of extreme danger remains to be seen. It did weigh on the market since he has shown no restraint in any past actions including having family members poisoned, killed by being ripped apart by dogs and shot with anti-aircraft weapons. At this point, I think he is running out of family members to kill.
Also on Friday the U.S. said it dropped a thermobaric Massive Ordnance Air Blast (MOAB) bomb in Afghanistan. The 21,000 pound bomb is nicknamed Mother of All Bombs because of its explosive power. The bomb just above ground level. It contains a highly explosive liquid that is ejected from the bomb just above the ground using a small explosion that atomizes the liquid explosive. The atomized liquid explosive mixes with the oxygen in the air and when the secondary explosion occurs it ignites the "fuel air" mixture in its wake to provide a massive thermal explosion that kills everything within 500 yards in every direction. It kills from massive overpressure from the blast rather than shrapnel or bomb fragments. The blast can be heard up to 100 miles away and can blow out windows over a mile away.
The bomb was used to neutralize an ISIS tunnel complex thought to contain as many as 100 fighters. Because it works on overpressure, they can be well underground and immune to normal bombs but they are not immune to the pressure from the blast. It is actually worse in the caves and tunnels because of the compression effects. MOAB Description Not to be outdone, Russia created the Father of all Bombs on the same principal and said it was four times as powerful as the MOAB. The Russian bomb is said to be the equivalent of 44 tons of TNT.
The U.S. does have an even bigger bomb called the GBU-57 Massive Ordnance Penetrator (MOP) that weighs 37,000 pounds and is designed to burrow deep underground through heavily reinforced concrete bunkers. The bomb reportedly can penetrate more than 60 feet of reinforced concrete before detonating. The Air Force only ordered 20 of them and they cost $314 million each. GBU-57 Description
The press was all excited on Thursday and were spewing the "biggest non nuclear weapon ever used in combat" message and trying to create some news from their different spins on the message. That helped push the market over the cliff on Thursday afternoon.
Adding to the tension in the market was several position changes by the Trump administration. The tax reform effort is back on hold until a health care plan can be completed. That could take months and there is growing doubt that tax reform will occur in 2017. President Trump also flipped his position on NATO, the UN, China as a currency manipulator, the strong dollar, Janet Yellen as Fed Chairman and the Export-Import Bank. It was a very eventful week for the president and Washington is spinning with the multiple abrupt changes in posture despite his campaign rhetoric. The Trump Bump in the market appears to be fading rapidly.
There are growing concerns that we are facing a potential government shutdown on April 29th. When lawmakers come back from recess on April 24th, they only have five days to pass a funding bill and raise the debt ceiling. President Trump campaigned on reducing the $20 trillion in debt and he constantly criticized republicans for being too quick to raise the debt ceiling. Now that he is in charge, some analysts believe it will be too tempting for him not to demand some concessions before agreeing to raise the limit. The democrats have pledged to defeat anything that is not a "clean" limit increase. Republicans are also split on hiking the limit so getting anything passed in the five days after the recess, is going to be a major challenge.
Bond investors are betting on a disaster ahead. The yield on the ten-year treasury fell to 2.23% on Friday and a five-month low. This is not a good sign for the stock market since falling yields normally mean investor flight from equities.
The Volatility Index is at five-month highs going into the weekend on the geopolitical worries and the falling equity market. The VIX rarely stays at elevated levels for more than a few days but it could go significantly higher. We have not had that capitulation event yet. So far, the selling has been relatively slow and steady rather than a panic event.
On the economic front the Producer Price Index (PPI) for March declined -0.1% and the first decline in seven months. However, on a trailing 12-month basis producer prices are up +2.3%. Core PPI rose 1.7% over the last 12 months. Impacting the headline number was a -2.9% decline in energy prices with a -8.3% drop in gasoline prices.
Consumer Sentiment for April rose from 96.9 to 98.0 and a three-month high. The 13-year high was 98.5 in January. The present conditions component rose from 113.2 to 115.2 and are at the highest level since 2000. The expectations component rose from 86.5 to 86.9. Spring weather and an abundance of jobs seem to be the main factors in the strong sentiment. More than 89% of respondents expected their financial situation to improve in 2017. More than 78% of respondents believe business conditions are going to improve.
On Friday the Consumer Price Index (CPI) for March declined -0.3% after a +0.1% rise in February and +0.6% rise in January. The core CPI fell -0.1%. The pace of inflation is slowing thanks to the decline in oil prices, but it should be only temporary.
Retail Sales for March declined -0.2% after a -0.3% decline in February. Excluding autos, it would have been flat and excluding autos and gasoline there would have been a minor +0.1% gain. Motor vehicles and parts declined -1.2%, gasoline -1.0%, building materials -1.5% and sporting goods -0.8%. Electronics was the only material gainer at +2.6%.
Business Inventories for February rose +0.3% and the smallest gain in four months. Wholesale inventories rose +0.4% and retailers rose +0.3%.
The calendar for next week is light with the Philly Fed Survey and two home sales updates the most important reports. The Fed Beige Book on Wednesday will be watched but recent revisions have been neutral with a slightly positive bias so unless something changed, it will be ignored.
The most important event will be the French elections on Sunday the 23rd. The far right candidate, Marine Le Pen and the independent centrist candidate, Emmanuel Macron are currently leading the four-person race with 23-24% of the vote each.
The far left candidate, Jean-Luc Melenchon, surged 7% last week and could upset the status of the leaders. Melenchon has a radical tax and spend platform with a 100% tax rate on people making more than 33,000 euros a month. He is currently 6% behind the leaders.
The two candidates with the most votes will go head to head in a second election. If Melenchon continues to surge and take votes from Macron, there could be a previously unimaginable prospect of a runoff between the far left and far right candidates in a contest that would split the country right down the middle and cause a massive upheaval in French and European politics. Melenchon has seen his approval rating rise 22 points to 68% and he is now the most popular politician in France. Besides the 100% tax rate for the rich he favors cutting the workweek from 35 to 32 hours, lowering the retirement age to 60, raising the minimum wage and social security benefits. He wants to shutdown the nuclear power plants, from which France gets 75% of its power. He wants to withdraw from NATO and forge a warmer relationship with Russia. Conservatives are calling him the French Hugo Chavez, the socialist dictator that bankrupted Venezuela before his recent death.
Le Pen wants to pull out of the EU, so whichever candidate wins, there could be some big changes for France and the EU. Analysts claim a runoff between the two would be a choice of "economic disaster and economic chaos."
Having Le Pen and Melenchon win the four-person race on Sunday would almost be the equivalent of Brexit. Knowing that one of them would be the eventual president would throw the financial system into a panic, tank the EU markets and roil the global markets.
Thursday was bank earnings day. JP Morgan (JPM) reported earnings of $1.65 compared to estimates for $1.51. That compares to the $1.35 earned in the year ago quarter. Revenue of $25.59 billion was powered by $12.39 billion in interest income and beat estimates for $24.88 billion. That compares to $24.08 billion and $11.67 billion in the year ago quarter. Investment banking revenue rose 34% and trading revenue rose 14%. Credit card balances rose from $127.3 billion to $137.2 billion.
Citigroup (C) reported earnings of $1.35 compared to estimates for $1.24. This compares to the $1.10 in earnings in Q1-2016. Revenue of $18.120 billion beat estimates for $17.758 billion. Loans rose 2% to $629 billion and deposits rose 2% to $950 billion. Net interest margin was 2.74%. The bank reported gains in all areas except for Asia, which declined -3%.
Wells Fargo reported earnings of $1.00 compared to estimates for 97 cents. Revenue of $22.0 billion narrowly missed estimates for $22.1 billion. The bank said business was down as a result of the account opening scandal. They also said expenses were up as they employed numerous firms to help them unwind the mess from the scandal and modify policies and procedures to prevent future issues. Wells is also going to reimburse everyone who had accounts opened in their name during the term of the scandal.
PNC Financial (PNC) reported earnings of $1.96 compared to estimates for $1.84. Revenue of $3.88 billion beat estimates for $3.77 billion. Loans rose by $2 billion to $212.8 billion. Consumer loans declined -$700 million due to lower home equity loans, student loans and credit card balances. Shares declined slightly.
Hanes Brands (HBI) preannounced Q1 results of 28-29 cents and slightly above estimates for 27 cents. Estimated revenue of $1.38 billion missed estimates for $1.39 billion. They guided for the full year for earnings of $1.93-$2.03 and revenue of $6.45-$6.55 billion. Analysts were expecting $1.96 and $6.46 billion. Analysts said the results were decent given the weak retail sector and the Easter shift two weeks later than normal.
The earnings parade begins on Monday with Netflix. There are nine Dow components reporting starting on Tuesday. Goldman and IBM on Tuesday have the biggest chance for moving the Dow.
Analysts said 72% or pre-earnings guidance has mentioned the shift in Easter. In 2016 Easter was in March and this year in mid April. This shifts strong buying patterns from Q1 into Q2. All the earnings misses for Q1 will be blamed on the Easter Bunny.
Tesla shares surged again after the company said it was ready to unveil an electric semi-truck in September. Musk tweeted about the upcoming announcement. He had already said he planned to produce a semi and minibus. After several people responded to his tweet on Twitter he also admitted a pickup truck was in the works in 18-24 months as well as a convertible roadster.
An investor group complained that Tesla board members were too connected to Musk and demanded he appoint two independent outside directors. In reply, he said dissatisfied shareholders should buy Ford (F) stock instead. The Ford family controls Ford using two classes of stock and the family has owned the company since the beginning.
Tesla said they would reveal the final Model 3 in July along with all the features and pricing. Morgan Stanley said it could be the safest car on the road. Musk said the initial production models of the Model 3 would have "horribly negative margins" because of all the startup costs to produce the new version. Shares rallied $7 on the news.
News broke on Friday that Apple might be injecting itself into the Toshiba memory auction process. Toshiba is selling its memory business after its Westinghouse subsidiary filed bankruptcy. They have to raise cash and the Toshiba memory division has lots of value. They started with about ten potential bidders but that list had been shaved to only three on Thursday. Those were Broadcom at $23 billion, Hon Hai Precision (Foxconn) at $27 billion and Western Digital at $15-$18 billion. Hynix is reportedly still in the bidding but would be blocked on national security issues. Western has the power to veto any sale because it is a 50% owner in a joint venture with Toshiba. Western warned Toshiba last week that the sale was in violation of their joint venture agreement and demanded exclusive negotiation rights.
Late Thursday news broke that Apple has offered to buy a stake in the business from Toshiba of more than 20%. That would allow Toshiba to retain partial ownership as well as generate some cash. Since Foxconn is Apple's iPhone manufacturer, a joint Foxconn/Apple bid for only a portion of the business could satisfy regulators concerned about national security issues from selling the business to a Chinese company. Japanese broadcaster NHK said Apple wanted Foxconn to own 30%.
This story is bound to have a lot more chapters before we reach a final sale.
Also on Friday, Apple was awarded a permit to begin testing self-driving cars in California. The permit covers three 2015 Lexus RX 450H Hybrid SUVs and six individual drivers. In California all testing must be done with a driver that can take control in the event of a malfunction. Apple is the 30th company to be awarded a permit in California. Those include Ford, GM, BMW, VW, Tesla and Google. The Google subsidiary Waymo has a fleet of cars that have logged more than 2 million miles.
Nintendo confounded everyone on Thursday when they said they were going to discontinue the NES Classic, which just began delivering in Q4. The company has already sold 1.5 million of the games. The list price is $59.99 but the game has been so popular it has been impossible to actually find them in stores. You can buy them from scalpers on Ebay or Amazon for $325-$350. The console contains 32 of Nintendo's most popular games like Super Mario Brothers, Donkey Kong, Pacman, Tetris, etc.
Nintendo said it was discontinuing the Classic because the Switch console had become so popular. Since the beginning of March the switch has sold 906,000 copies in North America alone along with an equal number of copies of the Legend of Zelda, also a classic game.
It appears Nintendo made a mistake in releasing the Classic. Since the games are included and the price is so cheap, they are not making any money on it. With the Switch, the games are extra.
Crude prices declined slightly on Friday after reaching a 4-week high. Energy stocks were down sharply with the market. During the week, Saudi Arabia was rumored to have asked OPEC to extend the production cuts for six more months.
Active rig growth slowed slightly from prior weeks and it was probably due to the approaching Easter holidays. The rig gain for the current week will probably be light as well. Gas rigs are struggling with a loss of 3 while oil rigs rose +11.
I think it is time to start looking for stocks to buy on the dip. As of late Saturday afternoon, there have not been any military events in North Korea. If we can escape the weekend without an event, the market could rally next week. Unfortunately, it might only be a short-term blip since we still have the problem with the government funding and debt ceiling the following week.
The major indexes closed below critical support levels, which would normally suggest we were going lower. When that kind of close comes on a clear geopolitical headline, there is a good chance of recovery when that headline fades. In this case, it was the MOAB in Afghanistan that the news media blew out of proportion and tried to make it a statement over a possible attack on North Korea. That compounded the April 15th Founders Day risk for North Korea and caused the markets to drop.
If we do rebound next week, I would not be too anxious about jumping into a lot of long positions. A government shutdown has historically caused significant market dips. You would think lawmakers would not want to take that risk but the partisan hostility in Washington is at record levels. If one party thought they could successfully blame a shutdown on the other, they may go for it.
In theory, the S&P close at 2,329 and well under strong support at 2,350 and minimal support at 2,340 should suggest a new target of 2,250. Multiple support levels have broken, there is a clear downtrend in place and the index closed at the low for the day at a two-month low. It does not get much more negative than that.
The Dow closed at 20,453 and well under prior support of 20,600. This was a two-month low and the Dow closed on its lows. On a technical basis, the chart is projecting a target of 19,800. Only two Dow components were positive. The energy stocks were big losers despite a lack of geopolitical headlines that would have impacted prices. Goldman closed on support just above $185 and could be poised for a major fall if earnings disappoint on Tuesday.
The Nasdaq indexes remain the strongest segment of the market but even the strong suffered from the recent weakness. The Nasdaq Composite closed just over critical support at 5,805 and avoided a two-month low close by 16 points. A break below that level would target 5,330.
The Nasdaq 100 has been weak for the last seven days as the big cap tech stocks began to see multiple sessions of light profit taking. The index is still well over support and remains the strongest chart.
The small cap indexes imploded over the last two days after positive gains for the prior three days while the large cap indexes were falling. The combination of headlines was too convicting and investors sold everything, especially small caps where the volatility risk is greater.
I would start looking for stocks you want to buy on a dip. Without a negative weekend headline, we could see a relief rally early in the week. Unfortunately, if the government funding and debt ceiling negotiations do not go well the following week, we could see a very volatile market.
If a potential government shutdown appears likely, we could see lower lows. However, these events pass and once the situation is resolved, we could see a decent market rally.
The wild card in all of this forecasting is the "sell in May" cycle, which could be stronger this year given the collapse in the administration's policy agenda. Once we are past the budget impasse, if the tax reform process looks like it will be put off to Q4 or longer, there will be a larger incentive to take profits and come back after the dog days of summer.
The market did not really roll over until Wednesday afternoon and this survey ends on Wednesday. A few bears became less cautious and moved to straddle the fence. The bulls did not really gain any converts and sentiment remained neutral for the week.
Last week results
JC Penny said it was going to postpone the liquidation and closing of 138 stores previously scheduled for April 17th. The company said it was seeing strong sales at the stores listed for closing. This is not uncommon according to JCP. When you announce a closure, local shoppers will appear looking for bargains while others will return to shop because of nostalgia about losing an old friend. They remember shopping there in years past and suddenly want to see what they have been missing. The company said sales had been brisk and it was "prudent to continue selling the spring and summer merchandise at the current promotional levels and begin the actual liquidation a month later than originally planned." The new liquidation will begin on May 22nd and the stores will be closed on July 21st.
This "going out of business" phenomenon has been well known for decades. Back in the 50s and 60s stores would announce going out of business sales at least once a quarter. Once they got you in the store, it was always a particular brand or model year they were closing out. I remember when I lived in Dallas in the 60s they passed a law about how frequently you could "go out of business." I am surprised Sears has not picked up on this and started holding quarterly going out of business sales. Of course, they have been going out of business for so long now, nobody would believe them.
The Canadian government announced on Thursday that it will introduce new legislation to legalize the use of recreational marijuana for adults 18 years and older. The government will introduce a number of bills that will set a "strict framework" around the age, production, distribution and sale. Individual provinces will be able to modify legislation to fit their own localities. Canadians will be able to grow their own but be limited to 4 plants per household. There will be a zero tolerance policy for driving under the influence.
Analysts in the U.S. believe every state could have some kind of permissions by 2021. These are the states that have already passed marijuana access laws.
A student group at Duquesne University in Pennsylvania wants to prohibit a Chick-fil-A from opening on campus because it would cut down on the school's "safe places." Apparently, chicken sold by a company with a Christian founder is discriminatory. I feel sorry for these students when they actually have to make it in the real world where it is survival of the fittest and there are no safe places.
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