A combination of tech valuation downgrades and a short recommendation caused a tech flash crash on Friday.

Weekly Statistics

Friday Statistics

A confluence of unfortunate events triggered a massive sell off in tech stocks, led by the big cap techs that have supported the rally over the last several months. What goes up quickly can also come down quickly.

On Thursday evening, Bank of America Merrill Lynch warned that the tech sector currently "trades at its highest relative multiple since the Tech Bubble." On Friday morning Goldman Sachs warned the top five market cap techs, Facebook, Apple, Amazon, Microsoft and Google, which they named the FAAMG group, "were in a valuation air pocket" and were due for a pause after being inappropriately valued as stable, staple issues, acting as key drivers of the Nasdaq and S&P in 2017.

Lastly, short seller, Citron Research, went all in on an Nvidia short saying the recent price target revisions were "irresponsibly bullish." On Thursday, Citigroup put a $180 price target on Nvidia and laid out a bullish case for it to reach $300. Argus raised their target to $185 and Bank of America $180. The stock rallied $12 on Thursday and declined $10 on Friday so investors are still not running for the sidelines.

The trio of high profile tech downgrades did not stop the Nasdaq from opening at a new high but the hang time was brief. The Nasdaq 100 fell -228 points or -4% intraday before rebounding slightly at the close.



I am pretty sure we can all agree that those three investor notes did not cause a million investors to suddenly race to the exits on a summer Friday. Volume was 8.8 billion shares and well over the 6.4 billion average for the first three days of the week. What we saw on Friday was a case of algos gone wild. Trading computers, which currently account for 40% to 60% of the volume in equities and 60% of the volume in futures, had probably been shifted to a sell bias by their managers after the reports and once they saw the market roll over it was a feeding frenzy. The faster the decline, the faster the computers trade.

The decline hit its peak when there was a mini flash crash in Amazon and shares fell from $980 to $927 in less than one minute at 2:50 with 300,000 shares traded. To put that in perspective there meant $290 million in Amazon shares were traded in less than one minute. I looked at the time and sales and there were $6 to $10 ranges in the trade prices only hundredths of a second apart. There were trades at $927 with trades at $954 a hundredth of a second later and other trades scattered all over between them. To say it was chaotic would be an understatement.


I suspect the velocity of the decline in Amazon acted as a circuit breaker for the trading computers. That was the exact bottom in the charts of all the other big cap tech stocks.

The Nasdaq 100 QQQ ETF normally trades an average of 21.9 million shares a day. On Friday, it traded 109.3 million or five times normal. Note how the volume escalated as the day progressed to culminate at that 2:50 market bottom. The last 12 minutes of the day the volume was positive as traders either covered shorts or bought the dip.


The only economic report for the day was the Wholesale Trade Inventories for April. The headline number was a decline of -0.5% and the largest drop since the same -0.5% drop in February 2016. Durable inventories fell -0.3% and nondurable goods -0.8%. This was a lagging report for April and it was ignored.

The economic accountants did not ignore the inventories. That caused another decline in the Atlanta Fed real time GDPNow forecast to 3.0%.


The calendar for next week is weighted to the middle of the week and the most activity with the Fed rate decision on Wednesday. The Fed is expected to raise rates despite the lackluster jobs numbers. They may actually announce some proposed changes to their $4.5 trillion balance sheet.


Apple had some other problems on Friday than just FAANG valuations. It appears Apple is going to go with a mix of modem manufacturers in the iPhone 8. Apple has been using the modems from Qualcomm. With the patent battle in progress with Qualcomm they are shifting to modems from Intel. They are planning on using Intel in some phones and Qualcomm in others. The problem is that Qualcomm modems can transfer data at 1 gigabit per second and Intel's modems are only rated at 600 megabits per second. To keep from fighting the battle with consumers constantly asking for the phones with the Qualcomm modems, Apple is going to use software to degrade the phones with Qualcomm modems to 600 mb per second to match the Intel speeds. That way all the phones will be the same speed. They also did this in the iPhone 7 but it was unknown at the time. The prospect of Apple offering a premium iPhone for $1,000 or more with communications significantly slower than Samsung, Motorola and Pixel, as well as the much hyped gigabit networks from Verizon and AT&T, weighed on the stock price. The Samsung Galaxy S8 has the Qualcomm X16 LTE modem and the fastest phone modem in mass production.

On Thursday, RBC Capital warned that the iPhone 8 would be delayed by 1-2 months because of problems with the fingerprint sensor and the OLED screens. There have been multiple rumors of this problem over the last couple months from Cowen and Company, KGI and Drexel Hamilton but RBC is the latest to confirm it. RBC still believes Apple will announce the 7S, 7S+ and the iPhone 8 in September but the 8 will not be available until late October or even the late November timeframe.


Sirius XM (SIRI) said it would invest $480 million in Pandora (P). Controlling shareholder in Sirius, John Malone, recently tried to buy Pandora for $8 a share but the company refused his offer. The $480 million will give it 20% of Pandora and 3 board seats. Sirius is prohibited from buying more stock for 18 months and cannot purchase more than 31.5% in total after that period. Activist investor Corvex Management has been trying to get Pandora to sell itself for more than a year. KKR had earlier agreed to make an equity investment and they will get a $22.5 million termination fee to end that agreement.

Pandora also said it would sell ticketing firm Ticketfly to Eventbrite for $200 million and less than half the $450 million it paid just last year. Pandora is a firm in need of a better business plan and new leadership. With the Malone investment, they should eventually be a better run company. This will also give Sirius a potential entry into the music streaming market.


Western Digital (WDC) moved a little closer to acquiring Toshiba's memory assets on Friday. The company said it is raising its bid to 2 trillion yen or $18 billion. The deadline for a decision by Toshiba is Thursday. The acquisition will be in the form of a debt purchase to avoid antitrust concerns over its purchase of the second largest producer of NAND memory chips. A partnership between Broadcom and Silverlake Partners was thought to be the preferred bidder but Broadcom recently said it no longer has sny interest in the business. WDC had been bidding with a consortium led by a Japanese fund but Toshiba said it did not like that group and that led WDC to make a last ditch offer on its own. Foxconn has been rumored to have offered 2.2 trillion yen but the Japanese government will not approve a Chinese buyer.


Citigroup, a previous backer of SnapChat (SNAP) has had a change of heart. Citi downgraded the company from buy to neutral saying they are not sure when SNAP will turn profitable. They downgraded the 2018 earnings estimate from a loss of 42 cents to a loss of 46 cents. Citi said monetization was slower than previously expected because of a slower than expected rollout of new channels and opportunities. "Given issues with Android, summer seasonality, heightened competition and the nature of Snap's social network, we expect user growth to remain modest near term." SNAP missed estimates with their Q1 earnings. Nearly 70% of analysts have something other than a buy rating on SNAP. The company is also facing a large lockup expiration in August. Currently SNAP has 404 million shares available to trade and on July 29th another 663 million Class A shares will be unlocked along with 281.1 million Class B shares and 215.9 million Class C shares. Those convert to Class A shares if the holders decide to sell them. Snap recently tried to get existing insider shareholders to commit to a one-year holding period but were unsuccessful. That suggests many are planning to dump shares when the lockup expires.


Newly IPOed company Cloudera (CLDR) reported a Q1 loss of 27 cents compared to estimates for a loss of 36 cents. Revenue of $79.6 million also beat estimates for $75.8 million. They guided for the full year for a loss of $1.07 to $1.04 on revenue of $345-$350 million. Analysts were expecting $1.07 on revenue of $338.1 million. Shares were knocked for a 15% loss after Raymond James pointed out that billings of $75.2 million missed estimates for $81 million. The average contract length shrank from 20 months to 18 months. Raymond James cut its price target from $24 to $20 saying the newly public company would remain in the penalty box for some time until they established a positive track record.


In the first move of its kind, the FDA asked Endo International (ENDP) to halt sales of its opioid drug Opana ER. The FDA said this is the first time they have asked to remove an opioid drug from the market because of abuse. In 2012, the drug was reformulated to prevent abuse through snorting or injecting but after the reformulation the abuse from injecting rose even higher. The reason the FDA wants to remove the drug from the market makes no sense to me. They warned that continued availability of the drug could lead to a serious outbreak of HIV and Hepatitus C or a serious blood disorder from the injections and needle sharing.

That is like saying you are going to ban hammers because a lot of people could break things and smash their thumbs. The drug as prescribed does what it is supposed to do. The problem comes from the drug addicts crushing it up so they can inject it and reusing syringes. This is not the fault of Endo or the drug. There is such a thing as too much government protection. Shares of ENDP fell -17% on the news.


Zynga (ZNGA) was upgraded from equal weight to overweight by Morgan Stanley citing optimism over their "live services" business, which included poker. The analyst said it was increasing engagement and monetization. Poker makes up 19% of Zynga's revenue. They are expected to roll out a new suite of offerings in the coming months. Shares rose to a new 52-week high.


Alibaba (BABA) held its 2-day investor event and used the opportunity to raise guidance. They expect full year revenue growth of 45% to 49% and more than $34 billion in revenue. The CEO said gross merchandise volume would double over the next three years from $547 billion in 2017 to more than $1 trillion by 2020. Analysts are tripping all over themselves to upgrade their estimates. It remains to be seen how much of that increased revenue will turn into profits. Shares exploded higher on Thursday and declined only slightly on Friday.


It was a crazy week for oil prices after Tuesday's API report showed a decline of -4.62 million barrels and then the EIA report on Wednesday morning showed an unexpected rise of 3.3 million barrels. Prices collapsed from $48.25 to $45.25. Crude closed the week at $45.83 and right near the critical psychological level of $45. A trade under that level should target longer-term support at $43.

Analysts are very confused about the outlook for oil. The next OPEC meeting is in November and despite the Saudi Arabia "whatever it takes" comments on cutting production to control oil prices, the outlook is mixed. If prices were rising it would be easier to get compliance for the cuts because countries would be receiving more money. With prices hovering near six month lows there is rising worry that compliance will deteriorate and production rise. Add in the rising production from Libya, Nigeria, Iran and U.S. shale and the current level of cuts may not be enough to lift prices even when summer driving demand increases.

Refineries in the U.S. processed a record amount of oil the prior week but as expected, the post Memorial Day demand declined slightly. The next demand bump will be July 4th.


Producers added another 11 rigs with 8 of them oil rigs and 3 gas rigs. Active rigs are up more than 100% since the 404 low in May of 2016.

Production actually declined 24,000 bpd to 9.318 million bpd. This is just a blip somewhere in the production stream and definitely not a trend.


 

Markets

Stuff happens. I write constantly that the events that impact the market the most are the ones we are not expecting. We worry over the Fed, UK elections, North Korea, Comey testimony, etc, but the market ignored them because they were known events and the outcome was not disastrous. Theresa May lost seats, Comey called the president a liar, North Korea launched another round of missiles and the Fed is going to hike rates. It was just a normal week in the new normal we are living in the market today.

Analysts blamed the Friday crash on the Goldman and Bank of America warnings and the Citron short on Nvidia. Were they really to blame? I think the Nasdaq chart pattern for the first four days of the week was just as important as the Friday pattern. Nothing bullish happened. The index tested support at 5,850 three consecutive days and barely rebounded each day. More than likely this setup suggested that a topping pattern was forming and then the three events on Friday morning just pushed the Nasdaq over the cliff. The negativity was already there despite the late Thursday, early Friday uptick.


The S&P traded in a 31-point range from a new intraday high at 2,446 to an intraday low of 2,415 and closed right in the middle at 2,431 and a loss of only 2 points. Think about that. The Nasdaq 100 lost -228 points intraday and -143 at the close but the S&P closed flat and the Dow gained 90 points. Friday was bizarre in every way.

The lack of a decline in the S&P and Dow suggests the damage was limited to the big cap tech stocks that led the rally over the last several months. As long as the other indexes do not catch the same valuation flu on Monday, we should be in good shape.

Support at 2,420 is still intact and the S&P closed only 8 points from a new high.


The Dow was a strong performer on Friday with only three components deep in negative territory. Apple and Microsoft we understand but why was Visa tanking? It had to be because of the recent gains. The stock was making new highs and crashed with the techs. I did see some other big gainer stocks that were not techs that also declined. When you need to cover losses sometimes you have to sell other stocks and use those profits to cover the unexpected declines.

The Dow is in breakout territory and assuming the banks continue rising ahead of the Fed, they should support the index over the next couple of days. Support is well back at 21,130.



The Nasdaq sinners list has a lot of double digit decliners and big losers in general. The Composite Index broke below support at 6,200 intraday but rebounded to close fractionally above that level at 6,207. This erased 7 days of gains but the rally is still intact. A real problem would appear if the index moved below 6,200 and developed a downward trajectory.

You can see on the chart there were two other big declines on March 21st and May 17th. The May 17th drop was -173 points, high to low, over two days. The March drop was 143 points, high to low, over two days. Both saw immediate rebounds the second day after an early morning bout of follow on selling. We cannot just assume this rebound will happen again on Monday but there is nothing preventing it.



The Russell 2000 had a great morning with an 18-point gain to a new high. At noon, when the worst of the Nasdaq selling was accelerating, the Russell rolled over and gave back more than half its gains. The index still closed at a new high. Since financials make up 27% of its components, the rally in financials helped to power the Russell.

The first Russell rebalance deletion list was released after the close on Friday. (List Here) These stocks will be sold at the open on Monday and will weigh on the Russell 1000 and Russell 2000. Whether they will be enough to offset other market factors is unknown.


The market does not need a reason to decline. Whenever enough people and computer programs make a directional decision on one day, the rest of the market will follow. Sell stops are hit, causing further declines, triggering additional sell stops. It is not magic. In this day of algorithmic computer trading and heavy reliance on ETFs, we have now seen multiple flash crashes where computer sellers ran out of computer buyers and an air pocket appeared.

Every time this happens, the programmers will go back to work to try and improve their trading programs. Actual investors will buy the dips and be thankful for the opportunities. Tom Lee at Fundstrat said the selloff provided an excellent buying opportunity for the big cap tech stocks.

In theory, there should be some margin selling at the open on Monday but the basic paradigm has not changed. Earnings are good and rising, investors and consumers are optimistic, interest rates are low and there is nothing on the horizon that should tank the markets. Let's hope some common sense reappears on Monday.


 

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Random Thoughts


Bullish sentiment spiked +8.5% to 35.4% but this survey ended on Wednesday and before the Nasdaq crash. If we rebound on Monday I suspect next Wednesday's results will not even show the impact of the crash. Investors with a neutral bias were the biggest change agent with them moving back into the bullish column. The bearish investors do not seem to change much from week to week. Their minds are made up until the market deviates from the current trend.



In the early 1990s if you worked for Apple, there were perks other than a nice paycheck. These sneakers were created specifically for Apple employees. This particular pair is being auctioned off by Heritage Auctions with a starting price of $15,000 and are expected to go for as much as $30,000. They are men's size 9.5. In 2007 a size 8.5 pair sold for $79 on Ebay. Times have definitely changed.



Former FBI Director James Comey has won the Washington Lottery. It turns out fame sometimes does produce fortune. Little did he know when President Trump cornered him in the White House that the event would change his life forever.

Several media outlets are reporting that Comey has been offered a $10 million book deal to give his version of the details surrounding the Clinton email controversy and the events that led to him being fired by President Trump. In addition, Hollywood producers are reportedly lining up for the movie rights to those same events. One producer is reportedly already trying to cast a tall leading man for the role. Comey is 6 feet 8 inches tall. I would be smiling too if I was Comey. This is a significant change from his life back before the election when he was being pounded daily for his stance on the Clinton emails.



This is 1970 and this kid will grow up to be the richest man in the world. This is Bill Gates out for a cruise on his custom bicycle. If you could find that bike today it would be worth a million dollars because of its heritage.



 

Enter passively and exit aggressively!

Jim Brown

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"When I was 5 years old, my mother always told me that happiness was the key to life. When I went to school, they asked me what I wanted to be when I grew up. I wrote down 'happy'. They told me I didn't understand the assignment, and I told them they didn't understand life."

John Lennon