I constantly warn that it is the headlines you do not expect that cause the most damage.

Market Statistics

The morning began with European markets negative on comments from Mario Draghi that "deflationary forces" were dead and he was seeing "reflationary forces" in the European economy. European markets declined sharply on the expectations for normalization of rates at a faster than expected pace. He said, "The central bank can accompany the recovery by adjusting the parameters of its policy instruments, not in order to tighten the policy stance but to keep it broadly unchanged." Traders did not understand how the ECB would "adjust" the parameters but "keep policy unchanged." Confusion reigned and bonds were sold off all over Europe and in the USA.

These comments brought up fears of a new "taper tantrum" which crashed the markets several years ago when the Fed began tapering its QE purchases. Since the ECB is still buying bonds under its QE program, there were all sorts of concerns about policy changes and how that would impact rates.

The confusing headlines out of Europe pushed our futures negative and the markets opened lower. There was a rally attempt ahead of Janet Yellen's speech but once she said asset valuations (stocks) are somewhat "rich" today by standard metrics, a new move lower quickly appeared.

Lastly, the late afternoon news that the Senate had cancelled the vote on healthcare until after the July 4th recess, weighed even more on the market. The multiple republican groups are a long way from securing an agreement that would allow the bill to pass into the next phase of consideration. Putting it off until after the holiday probably means it will not get a vote until just before the August recess and there are no guarantees it will pass. As of today, it appears dead in the water. If you change some provisions to please some holdouts then other factions will leave the consensus.

The problem is not so much the healthcare bill but the tax ramifications. A tax reform bill has no chance of passing until after a healthcare law has been completed. There is roughly $1 trillion in taxes embedded in Obamacare that need to be handled in a reform package but they cannot be handled until Obamacare is repealed and replaced. No healthcare, no tax reform and that is the big carrot for investors. The Trump agenda is slipping farther into the future every day and the delay on the vote probably means tax reform and infrastructure spending will not happen until 2018. That is a major disappointment for investors and the market decline reflected that disappointment.

On the economic front, the Richmond Fed Manufacturing Survey for June rose from 1 to 7 on the headline number. As you can tell by the chart, there is a lot of noise in this number as it tends to be volatile. On the positive side shipments rebounded from -2 to +11. However, the order backlog improved slightly but not enough to lift it back into expansion territory. The inventory/order gap improved only fractionally from -15 to -14. New orders were up slightly but well under the numbers from early this year.

The separate Richmond Services Survey declined sharply from 34.0 to 19.0 and analysts blamed it on the very rainy spring depressing outdoor events.


There were expectations for the headline number to continue lower into contraction territory so even though the rebound from 1 to 7 was minor, it did avoid going negative.


The Consumer Confidence for June rose 1.3 points from 117.6 to 118.9 to end the two-month slide. The present conditions component rose from 140.6 to 146.3 but the expectations component declined from 102.3 to 100.6. That is the lowest level since January. Relatively speaking confidence is still strong, now up 21.5 points over June 2016. The optimism peaked in March at 124.9 but the decline has been shallow. There is still plenty of post election optimism.

The respondents who think jobs are plentiful rose from 30.0% to 32.8%. Those expecting an increase in income rose from 19.1% to 22.2%. Those planning on buying a car slipped slightly from 12.5% to 12.2%. Homebuyers declined from 6.1% to 5.9% but appliance/TV buyers rose from 48.5% to 50.5%.


The rest of the week is lacking any material reports and even if there were headliners, there will be nobody around to read them. The volume is already declining and it will only slow from here.

Unless there is a significant miss of expectations, the remaining reports will not move the market.


The earnings calendar is just as lackluster with the exception of Dow component Nike on Thursday along with Micron Technology and American Outdoor Brands, formerly known as Smith & Wesson.


In stock news, Google (GOOGL) was hit with a $2.7 billion fine from European regulators over its shopping comparison feature. Google was accused of favoring its own products over those being sold by other retailers. The company has 90 days to shut down the comparison shopping feature or face additional fines. Google said it respectively disagrees with the ruling and plans to appeal. Under the existing feature retailers can pay Google to highlight their products rather than hoping they will appear in the listing organically. This was the largest single fine to date. Intel was fined $1.2 billion in 2009. Apple is fighting an attempt to collect $14.7 billion in back taxes the EU says it owes but its domicile country, Ireland, says it does not. Ireland cut a sweetheart tax deal with Apple to get the company to put its operations in that country. The EU says that is illegal and is trying to force collection.

Google shares fell from Monday's $990 to $948 on Tuesday and erased $19.7 billion from its market cap. Google shares are approaching critical support at $942. Today's share decline was a major impact to the Nasdaq.


Darden Restaurants (DRI) reported earnings of $1.18 that beat estimates for $1.15. Revenue of $1.93 billion also beat estimates for $1.87 billion. The big news came from same store sales. The overall company rose 3.3% with Olive Garden up 4.4%, Longhorn Steakhouse +3.5% and Eddie V's +3.3%. Yard House was flat and Seasons 52 fell -1.3%. The company guided for 1.0% to 2.0% for the full year. They are expecting full year earnings of $4.38-$4.50 and analysts were projecting $4.41. Shares rallied $2.61 in a very bad market. The CEO was asked how the sudden expansion of delivery services at competing restaurants was affecting his business. He pointed to the sales and said millennials still enjoy a quiet meal in a restaurant setting.


Homebuilder KB Homes (KBH) reported earnings of 33 cents compared to estimates for 26 cents. Revenue of $1.0 billion beat estimates for $922.1 million. The builder said its net order value increased 15% to $1.4 billion and its order backlogs rose 19% to 2.2 billion. Deliveries rose 11% to 2,580 homes. Shares rose initially in afterhours but then faded back to breakeven.


T-Mobile (TMUS) shares fell sharply after the talks with Sprint (S) over a possible merger were put on hold while Sprint negotiates with Comcast and Charter Communications over a potential wireless deal. Sprint majority owner, Softbank, put the discussions on hold until the end of July. Comcast and Charter entered into a wireless partnership in May in hopes of doing a deal with some wireless carriers to deliver broadband to customers over wireless networks. If they could include Sprint in the partnership, it would be beneficial for all parties. T-Mobile's CEO John Legere said if Sprint did a deal with a cable company, he would push for T-Mobile to team up with Dish.


Energy company Chicago Bridge and Iron (CBI) won a decision in the Delaware Supreme Court reversing a lower court ruling on a dispute with Westinghouse. In 2015, Westinghouse bought the nuclear power business from CBI. Westinghouse is owned by Toshiba and the deal was a nightmare and has caused major problems for Toshiba and forcing the sale of their memory business to raise cash. In today's ruling, the court reversed a $2 billion verdict from a lower court. Westinghouse had sued CBI for $2 billion claiming the purchase price of two unfinished nuclear power plants was supposed to be adjusted after the closing. CBI sold the plants and its nuclear business to Westinghouse for zero. They just wanted to be free of the anchor around their neck. Once Westinghouse realized it was a bad deal, they tried to reverse it. The court said no deal and the claim was without merit. Shares of CBI rallied 39% on the news.


While on the topic of Toshiba, the company has agreed to talk to Western Digital about the sale of their jointly owned chip business. Toshiba had rejected WDC's bid and awarded the deal to a consortium of investors including Hynix and Bain Capital. WDC sent the consortium a cease and desist letter warning them Toshiba did not have the right to sell the asset because it was jointly owned with Western Digital. WDC threatened them with legal action if they tried to close the transaction. The consortium told Toshiba the company would have to settle the dispute with WDC before they would proceed with any transaction. Toshiba needs the $19 billion in cash today to avoid bankruptcy from the Westinghouse nuclear problem. WDC has filed an arbitration claim that could take up to a year to be heard and they have asked for a court injunction to prevent a sale until then. Basically, WDC has the leverage.

With Toshiba agreeing to talk to WDC about a resolution it appears WDC could end up with the unit. WDC and KKR submitted a new bid, even though bidding is closed. The new bid is expected to appease Toshiba and could break the deadlock. Toshiba was trying to sign a deal before their shareholder meeting on Wednesday but that does not look like it is going to happen.


Nvidia (NVDA) is nearing another buying opportunity. Shares fell -$5.57 today despite news they had partnered with Volvo and Swedish auto supplier Autoliv to jointly develop self-driving vehicle technology. They have already partnered with Tesla, Toyota and others. They are going to be a major force in the self-driving car market in years to come.


Crude prices were ticking slowly higher over the last three days but that ended after the bell tonight. The weekly API inventory report showed an unexpected build in crude of 851,000 barrels. Analysts were expecting a -3.25 million barrel decline. Gasoline inventories rose 1.351 million barrels compared to estimates for a 900,000 barrel decline. Distillate inventories also rose 678,000 barrels. This is not a good sign for oil prices. Libya said production rose from 885,000 to 935,000 bpd over just the last week. Global inventories are no longer declining.



 

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Markets

The end of quarter window dressing took a wrong turn on the way to month end. If you want to break a historical trend, all you have to do is bet on it. The setup was perfect as of Friday's close but the outlook is significantly different today. The only window dressing occurring today was in the form of raising cash. The confluence of unexpected events combined to add to the minor selling pressure we saw on Monday. Now we could be looking at a race to the exits for any traders still in the market.

With the market on shaky ground and a four-day holiday weekend ahead, the event risk may be too much for investors to bear. Futures are down only slightly tonight and Asian markets are poised to move lower. If the market declines make a full circle through Asia and Europe and back to the U.S. on Wednesday, we could be setting up for some support tests.

The majority of selling was in the tech sector and that includes the biotech sector. The biotech index lost -3.2% after making almost a two-year high on Friday. The selling was strong in those stocks with the most gains, as is usually the case.


The Semiconductor Index also joined the party with a -2.71% decline to uptrend support. This should be a buying opportunity there as well but I would want to see it rebound before I added a new position.

The chip stocks normally lead the Nasdaq so a break of support on the $SOX is a bearish signal for the Nasdaq.



The Nasdaq rallied to resistance at 6,300 on Monday and failed. The index dropped back to support at 6,245 at the close. That support failed at the open on Tuesday and the index is now in danger of retesting critical support at 6,100. Rarely, does a third support test hold. Anything is possible but a break below 6,100 should easily test 6,000 and the May lows.



The S&P touched the year-end price target of 2,450 on Monday and was immediately rejected. The close last night just above 2,430 was only light support and that broke at the open today. Critical support from June at 2,420 technically failed at the close at 2,419.38 but that is close enough for me to claim success unless there are further declines. This is a 2,400-point index. I am not going to quibble over 62 hundredths of a point. A breakdown here should target 2,400 but it would be a significant break of sentiment and I would expect a lower low.


The Dow actually held up rather well. Despite breaking critical support at 21,400, there were only a couple of big losers and those losses were not that big. This was more of a lack of bidders than a surplus of sellers. The index is below critical levels and could easily retest the 21,125 breakout point from June 1st.



The small cap Russell was doing ok until the Nasdaq crashed. The lingering rebalance buying was keeping it positive but once the market rolled over this morning, it was a decent drop. Support at 1,400 needs to hold.


I missed the boat on the end of quarter window dressing. That was a historical trend and it failed. That is now past tense. I would recommend remaining in cash until after the holiday. We do not know what direction the market will take in the very low volume we are likely to see over the next five trading days. Don't bet the farm and then find yourself at the beach with the kids, wondering more about what the market is going to do than who is going to eat the most hotdogs.

There will always be another day to trade if you have capital in your account.

Enter passively, exit aggressively!

Jim Brown

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