It may be a sunny holiday this weekend but thunderstorm clouds are forming over the markets.

Weekly Statistics

Friday Statistics

Last week definitely did not turn out as I and other analysts expected. The end of quarter window dressing turned into a strip job instead as portfolio managers took profits in prior high flyers. The charts for the major indexes have turned bearish. Janet Yellen's comments earlier in the week that stocks were "rich" compared to normal valuations may have been the spark that triggered some selling. This is not quite the equivalent of the "irrational exuberance" comment from Greenspan that tanked the market but whenever a Fed head talks about an overvalued market, there is a reaction. You may remember her prior comments about small caps being overvalued.

In her congressional testimony in July 2014, she said valuations on small cap tech companies appear "substantially stretched" and the Russell 2000 fell 30 points in two days with the biotech index falling -114 points. The biotech index bottomed at 2,650 after her remarks and it is 3,859 today. The Russell 2000 was 1,130 and it is 1,415 today. Despite her comments rocking the market in 2014, they recovered to move significantly higher.

The bigger problem is that the Fed head thinks it is necessary to talk down the stock market. That thinking can bleed over into market sentiment and depress the investment outlook. Yellen will get another chance to take a shot at the market on Tuesday July 12th when she gives congressional testimony on the U.S. economy.

Whether it was Yellen taking a shot at valuations or the voices of multiple high profile analysts and investors over the last couple weeks, the damage was done. The Nasdaq has tested support at 6,100 three times and it closed at a five-week low on Friday.


The economic reports on Friday were neutral for the market with the exception of the PCE Deflator. That is the Fed's preferred indicator of inflation. The PCE declined -0.1% in May from a +0.2% rise in April. If you total the last four months you get zero inflation because each minor rise was erased by a similar decline. The Fed wants to see 2% inflation in order to support their rate hike commentary. With inflation either flat or fading that means the Fed "should" not move as fast on their rate hikes.

Food prices rose +0.1% in June but energy goods and services declined 3.0%. Durable goods prices declined -0.2%, non-durable goods -0.8% and gasoline and petroleum prices -5.9%. Housing rose +0.3% and healthcare +0.1%.

On a trailing 12-month basis, the PCE is up 1.4% and the core PCE is also up 1.4%. Those numbers compare to the peak in February at 2.1% and 1.8% respectively. The Fed will continue to say the low inflation is related to transitory issues. Previously they referenced the Phillips Curve and the relationship between high employment and low inflation. Strangely, with inflation fading, the Fed said it was considering raising its inflation target above 2% even though they have not been able to reach that target since the financial crisis.

Personal income rose 0.4% in May and the biggest gain in three months. However, the gain came from intangibles for most people because income from wages and salaries only rose +0.1%. The rest was attributed to "asset growth" and rental income. Exactly how many blue-collar workers are receiving stock appreciation, dividends and rental income?

Personal spending rose only 0.1% for May after a 0.2% hike in April and a whopping +0.6% spike in March. Spending rose 1.3% on durable goods like TVs, 0.2% on nondurable goods, 0.7% on apparel and 1.2% on gasoline. Spending declined -0.8% on motor vehicles and parts, household furnishings -0.1% and recreational goods and vehicles -0.1%. The slowing in spending does not match the rise in personal income. Since Americans always spend more than they make, these numbers are questionable.

The consumer sentiment for June declined from 97.1 to 95.1 and the lowest level since November. The biggest hit came from a drop in expectations from 87.7 to 83.9 and the lowest level since October. The present conditions rose from 111.7 to 112.5. Only 32% of business respondents expect economic conditions to improve over the rest of 2017. That is down from 40% in May.


The calendar for next week is busy despite the holiday. The FOMC minutes will be released on Wednesday afternoon and as always analysts will be looking for clues about future Fed moves. This is the week for the jobs numbers and the ADP Employment has been pushed out a day until Thursday. The expectations are for a gain of 178,000 jobs compared to 253,000 in May. The ADP report has been surprising to the upside recently.

The Nonfarm Payrolls are Friday and expected to show a gain of 180,000 jobs compared to the 138,000 in May. The nonfarm report has been surprising to the downside recently. I tend to believe the ADP numbers because they are taken from real time employer additions to the ADP processing system rather than phone interviews with random people in the nonfarm report.

The auto sales data on Monday could be another piece of the puzzle for economic direction. There is a constant rumor of peaking auto sales and another decline could boost recession worries.

Yellen's testimony to congress on the following Tuesday will be important because it is really a testimony on the state of the economy followed by a couple hours of questions.

The Q2 earnings cycle begins the following week and this week is severely lacking of any reports. The only material earnings are YUM China, Herman Miller and PriceSmart on Wednesday after the close.



ATTENTION: In order to let our staff enjoy the holiday weekend, there will be no Option Investor or Premier Investor newsletter on Monday July 3rd. The market is only open a half day and volume should only be a trickle. We will resume normal publication on Wednesday July 5th. Thank you in advance for your understanding.


The final Q1 GDP report on Thursday rose unexpectedly to 1.42% growth from 1.15% in the earlier revision. The next official GDP will be on July 28th and the first reading for Q2. The Atlanta Fed real time GDPNow forecast for Q2 is now predicting 2.7% growth, down from 4.3% in the first forecast for Q2. I am expecting it to level out around 2.5% over the next month. In Q2-2016 we saw 1.4% growth followed by 3.5% in Q3. If we can avoid breaking under 2% for Q2 that would give us a higher base for Q3 this year.



Mario Draghi said deflation was dead and inflation rising and the ECB could now adjust its policies. Interest rates were immediately adjusted by investors. The ten-year was trading at 2.12% on Tuesday and the rate spiked to 2.3% in the selloff. The dollar crashed to a nine-month low on those same comments and the strength in the European economies.



Last weekend I said I doubted if Nike (NKE) earnings would be enough to move the Dow because they would have to post a 10% gain to really contribute. Well, they reported earnings and a deal with Amazon and shares rallied 11% or $5.83 to add 40 points to the Dow.

The company reported earnings of 60 cents compared to estimates for 50 cents. Revenue of $8.7 billion also beat estimates for $8.6 billion. Much of their earnings beat was due to an unexpectedly low tax rate but nobody seemed to care. However, sales in Western Europe rose 12% to $1.56 billion and sales in China rose 16% to $1.09 billion.

As expected, they announced a pilot program with Amazon to sell a "limited" assortment of shoes and apparel on Amazon. Nike already has a robust online webstore and they have avoided selling on Amazon to avoid competition with their distributors. They also said they had deals in place with Alibaba and European e-commerce site Zalando.


Micron Technology (MU) reported earnings of $1.62 compared to estimates for $1.51. Revenue rose 92% to $5.57 billion. CEO Sanjay Mehrotra said, "Our results reflect solid execution of our cost-reduction plans and ongoing favorable industry supply-and-demand dynamics." They guided for the current quarter for earnings $1.80 on revenue of $5.9 billion at the midpoint. Analysts were expecting $1.57 and $5.62 billion. The company ended the quarter with $4.9 billion in cash.

Micron said DRAM prices rose 14% during the quarter. That is after similar gains in the prior two quarters as well. Memory is in tight supply and prices are rising sharply. Hewlett Packard warned that margins would shrink because of rising memory prices.

After a post earnings spike in afterhours on Thursday the stock fell 5% on Friday. With revenue up 92% and a beat on earnings and guidance you would have expected a blowout gain. However, Micron shares were up 200% since May 2016 so there was a lot of expectation already built in. This is definitely a buy the dip story.


American Outdoor Brands (AOBC), formerly Smith & Wesson, reported earnings of 57 cents compared to estimates for 38 cents. Revenue of $229.2 million beat estimates for $209.5 million. They guided for the current quarter for earnings of 7-12 cents and revenue of $140-$150 million. They guided for the full year for $1.16-$1.36 compared to the $2.25 earned in 2016. Shares were hammered for a 7.5% decline.

The problem for AOBC and Ruger (RGR) and Vista Outdoor (VSTA) is Trump. The current president is very pro gun while President Obama was very antigun. He tried to ban guns and ammo in various ways dozens of times in his 8 years as president. He was the best salesman the firearms sector could have wanted. President Trump is no danger to firearms owners so there is no rush to buy additional guns. Firearms owners have relaxed after 8 years of stress. Federal Premium, a maker of handgun, shotgun and rifle ammo, has been laying off workers since January. They have cut 186 workers in the Minnesota plant to reduce the workforce to 1,246. They said inventory levels have been high since the election and they are waiting on levels to be reduced before resuming full production.

Vista reported a 5% decline in ammo sales this quarter and 11.5% in the prior quarter. As an example, 9mm pistol ammo by various manufacturers can now be bought anywhere online for $160 per case of 20 boxes, compared to $240-$260 a year ago if you could find it. That is a perfect example of supply and demand.


Hain Celestial (HAIN) said activist hedge fund Engaged Capital had accumulated a 9.9% stake and is pushing the company to sell itself. The fund has nominated 7 candidates for the 8 person board. Engaged just won a similar battle with Rent a Center (RCII). Since Hain is still run by its founder, this would be a tough fight. They have already announced a 20% cut in stock keeping units (SKUs) and unveiled the biggest cost savings program of any U.S. food company. Shares spiked 8.5% on the news.


Have you gotten any sweet heart deals lately? If not then your name is probably not Warren Buffett. Back in 2011 when Bank of America stock was trading at just over $5, Buffett bought $5 billion in preferred stock and warrants that allowed him to convert that to common stock if BAC did well in the future. The price of the warrants is $7.14. When BAC announced the dividend increase on Thursday that triggered the option for Buffett to exercise the warrants. He will trade his $5 billion in preferred shares and warrants for 700 million common shares at $7.14 each. Shares are trading for just over $24 today. That gives Buffett an instant paper profit of $12 billion and he will begin collecting $336 million a year in dividends. Buffett will become the banks largest shareholder with a 7% stake.

Buffett also owns 17% of American Express, 9.6% of Wells Fargo, 9.4% of Coke, 26% of Kraft Heinz, 9.3% of United Airlines, 7.5% of Delta and large stakes in 86 other U.S. corporations. It is good to be Buffett.

Bank of America (BAC) said it would raise its quarterly dividend by 60% to 12 cents beginning in Q3 and repurchase $12 billion in stock over the next 12 months. Since BAC has 9.95 billion outstanding shares, the combination of dividend increase and share repurchases will return almost $17 billion to shareholders over the next four quarters.


Tesla's CEO Elon Musk is at it again. He teased on Friday that Tesla would have big news on Sunday. Musk was being heckled by people on Twitter to confirm a production date on the Model 3. Production is supposed to start in July. Musk tweeted back, "News on Sunday" without saying what the news would be. In theory, Tesla is supposed to begin deliveries in July and quickly ramp up production to 5,000 units a month in 2017 and 10,000 a week in 2018. Tesla has more than 400,000 deposits on preorders for the car. About all we know about the Model 3 is that it will start about $35,000 and travel at least 215 miles on a charge. There will be very few options other than battery size. The Model 3 online configurator has not yet been released. Tesla is also expected to give delivery numbers for the Model S and X next week. Total production is expected to be more than 50,000 units for the first six months and put them on track for well over 100,000 units in 2017. They produced about 76,000 cars in 2016. Musk has said the gigafactory is targeting enough batteries for 500,000 vehicles in 2018.

The next six months will be huge for Tesla because the solar shingles will begin delivering in late July and there is a huge backlog for those as well. The battery wall business will also kick into high gear as the gigafactory shifts into high production of those battery units.

Tesla shares have doubled in price since December.


E*Trade (ETFC) may be for sale. The board has given an ultimatum to its CEO. Clearly define the company's future by the end of 2018 or face a possible sale. The board wants the CEO, Karl Roessner, to revitalize E*Trade's core brokerage business and trigger a revival that has eluded the six prior CEOs that failed in the same task. E*Trade is 35 years old and just embarked on a new advertising campaign to appeal to new and old investors alike. E*Trade charged $6.95 commission per trade and Charles Schwab and Fidelity charge $4.95. Interactive Broker's charges $5 or less per 1000 shares. ($0.005 per share with a $1 minimum) E*Trade is restructuring their trading platform for about the 10th time over the last 20 years in an effort to remove the clutter and speed up the process. Time will tell if that will be enough to save Roessner's job. Some analysts think the letter from the board was an actual advertisement to anyone who might be interested in acquiring the company.


Crude prices spiked more than $3 last week in a most unlikely set of circumstances. Crude inventories rose 100,000 barrels in the EIA report on Wednesday and gasoline and distillate inventories barely declined. The lack of demand is very annoying for energy investors. Refinery utilization dropped from 94.0% to 92.5% for the week ahead of the July 4th driving weekend. U.S. production declined 100,000 bpd to 9.25 million bpd. There was an easy answer to this unlikely series of events. Tropical storm Cindy cut production in the Gulf and put all the facilities on storm watch and reduced run rates. Add that to field maintenance in Alaska and you have your production decline.

Since most energy traders do not really understand the mechanics behind the process, they saw the drop in production and thought that was a sign to go long. On Friday, Baker Hughes said active oil rigs actually declined by 2 for the week and ended the record 23 week streak of gains. That caused another spurt of knee jerk buying and crude was up $1.40 on Friday.

Nothing has materially changed over the last week except for the decline in rigs. However, we are entering a holiday period and producers tend not to add rigs ahead of a holiday because workers are gone for the holiday. While the streak ended, the 2 rig decline is not material and a new streak should begin over the next two weeks.





 

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Markets

The markets have had a good year already. The Dow has risen 8.0%, Nasdaq 14.1% and S&P-500 8.2%. The Russell 2000 is up 4.3% but it was up 21% right after the election, so the sideways motion in 2017 has been just holding those gains. Typically, when the year starts strong, especially for tech stocks, it finishes strong. That does not mean there will not be a summer correction first. August and September are the two worst months of the year for the markets.

The equity markets have suddenly caught a bad case of the volatility virus. After four weeks of relatively calm market gains to close at a new high on June 19th, the indexes have found themselves in a stormy sea. Triple digit advances and declines have cleared stop losses in both directions and volume has been very high. Thursday's volume was over 7.86 billion shares and well over the 5.0 billion expected. Friday saw 6.5 billion and this was a holiday Friday before a long weekend. This was amazing volume in what should have been a dull market.

The big cap tech stocks have lost their momentum and have fallen out of favor with investors. Whether this is related to the Yellen comments or not, is unknown. It may be just the end of the run for the FAANG stocks or just a much needed bout of profit taking. Either way it has had a dramatic impact on the markets. The Nasdaq was down -100 points again on Thursday.



The Nasdaq Composite tacked on another triple digit decline over four days of -216 points from high to low. These are getting to be really annoying. The index closed at a five-week low although there have been multiple intraday dips below our closing level. The support at 6,100 has now become critical and next week could determine our market direction for July. The Nasdaq chart is bearish and a close below 6,100 would be a very bearish signal.


The S&P is right on the edge of disaster if support at 2,420 fails. The intraday dip on Thursday cleared the sell stops but the weak rebound managed to close over support on Friday. That is a critical level. The rally remains intact as long as we rebound from here. A break below 2,420 could move significantly lower.


The Dow traded above and below initial support at 21,400 multiple times last week only to close at 21,439 on Friday. That initial support has failed. The Dow is struggling to regain its highs and there are only a few negative components. There is still hope for a recovery.

If the Dow continues lower the critical levels are 21,125 followed by 20,900. The initial level was the breakout from the prior high on June 1st. The second level was support for most of May.



The Russell outperformed for the week. Support at 1,400 held and the index almost made a new high on Wednesday. This gives me a little hope that the market may not decline further next week. The Russell is being held up by the financials, which are 17% of the index weighting. Now that the dividend and buyback news is past tense, it will be interesting to see if that sector can maintain any forward momentum.


In theory, the end of quarter portfolio restructuring is over and next week will see inflows of new cash. Unfortunately, theory and historical trends did not work too well last week. We could blast off on Monday and return to test the highs but I am not counting on it. Sentiment has been damaged, money lost and investors will be more cautious before jumping back into damaged stocks. We need to see how the market performs on Monday and Wednesday before making any new assumptions.

One factor I have not discussed is the failure of the healthcare vote in the Senate. While they may come back from the holiday and pass something before the August recess, I am not holding my breath. Even if that occurs, the potential for getting a bill through the conference committee that can pass both the House and Senate is nearly impossible. Without healthcare reform, there is no tax reform and that is what is weighing on the market.


Random Thoughts


Everyone is jumping back on the fence with both bullish and bearish investors moving to neutral. Just over 70% of investors still do not believe the market is going higher. On a contrarian basis that is good because those unbelievers will be chasing prices if we do move to new highs.



Bank of America said clients were net sellers of individual stocks for the third consecutive week. Institutional clients were also net sellers over the last two weeks. Hedge funds were net buyers over the last two weeks. Clients bought mid caps for the third consecutive week and sold both large and small caps. Pension funds were net buyers of US equities for the fourth consecutive week.

The bank said cumulative flows were heavily weighted into cyclical and defensive sectors and bond proxy sectors. Funds continued to flow into ETFs with $247 billion inflows year to date.

The bank said the flows into defensive sectors suggested the market would be lower for longer. Michael Hartnett penned a piece called "Bubble, bubble, oil and trouble" warning of structural deflation with the Fed tightening into declining inflation. He warned the Fed could be forced to ease again in 2018. Source -- Source

Chart is for the prior week:


Calling all scrabble players. The market is in need of a new acronym for the big cap tech stocks. First it was FANG for Facebook, Amazon, Netflix and Google. Then FAANG appeared with the addition of Apple. Recently FAAMG has been making the rounds with Microsoft replacing Netflix. Several traders have been referencing FANG MAN with Netflix, Nvidia and Microsoft. I am issuing a challenge to our scrabble playing readers. See if you can come up with a one-word acronym for as many of the following stocks as possible. The first 5 would be required but the rest are optional. You can use an A or G for Alphabet. If I missed a fast moving tech big cap stock you can use it as well.

Required: Facebook, Apple, Amazon, Alphabet, Microsoft.

Optional: Netflix, Nvidia, Adobe, Tesla, Priceline

Send me your answers and you could get credit for a new buzzword in the market.


The Iranian city of Ahvaz with a population of 1.1 million tied the hottest reliably recorded temperature on Earth at 129.2 degrees on Thursday. That has been recorded twice before, once in Mitribah Kuwait on July 21st, 2016 and Death Valley California on June 30th, 2013. It is hard to have a reliable recording of temperatures that hot because most thermometers do not go that high. In Ahvaz the humidity was 70% making the heat index over 140 degrees. There was a higher temperature recorded in Death Valley on July 1st, 1913 but most historians believe the measurement was technically inaccurate.




 

Enter passively and exit aggressively!

Jim Brown

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