Has the market volatility run its course or is there more to come?

Weekly Statistics

Friday Statistics

For a holiday week, we saw significant volatility. Other than Monday's 3.8 billion shares, the volume was moderate at 6.0 to 6.7 billion shares for the rest of the week. Alternating triple digit gains and losses and closes under critical support, were just a few of the market events. However, by Friday's close the Dow, Nasdaq and S&P all managed to post minor gains for the week. All are under recent resistance but rebounded to close back over support. The Nasdaq closed at a six-week low on Thursday and below support at 6,100. The S&P closed at 2,409 on Thursday and also under critical support at 2,420.

Both indexes rebounded back above support on Friday's short covering but the charts are still bearish.



The Friday short squeeze was driven by a sharp rebound in the payroll numbers for June. June posted job gains of 222,000 compared to the previously reported 138,000 in May. The May number was revised up to 152,000 and the April number was revised up from 174,000 to 207,000. Including the revisions, that was an addition of 266,000 jobs. Analysts had expected 180,000. The average monthly gain for the quarter was 194,000 jobs.

The initial reaction in the futures market was negative because wage growth rose only 0.153% and May was revised lower from 0.2% to 0.1%but once traders realized that all the other metrics were positive, a positive bias appeared.

The unemployment rate rose from 4.3% to 4.4% because 361,000 people entered the labor force. The labor force participation rate also rose from 62.7% to 62.8%.

The private sector added 187,000 jobs and government added 35,000. Retailers added 8,000 jobs much to everyone's surprise. Healthcare added 37,000 jobs, leisure and hospitality 36,000, construction 16,000, temporary help 13,000, financial services 17,000, mining and energy 8,000, professional and business services 35,000.


The payroll report did not have any material impact on Fed policy. They are on autopilot for a new hike in December. While they have not hit their 2% inflation target, they are now focused on a bubble in bonds, equities and commercial real estate values. This is a Fed that is looking for an excuse to hike rates. The Fed released its Monetary Policy Report (PDF), which forms the basis for Janet Yellen's testimony to the House and Senate next week.

Currently there is an 86.3% chance of the Fed doing nothing in September. The recent economic reports, slowing inflation growth and sharp selloff in Treasuries have moved the expectations out to December for the next hike and even then the chances are barely over 50:50. There are some analysts that believe the Fed will be forced to wait until 2018 and that may be why the Fed sudden interest in asset bubbles as a reason to hike rates.


The Atlanta Fed's real time GDPnow forecast has fallen to 2.7% growth in Q2 but there is still a month of reports to go that cover the June period. I am expecting 2.5% when the initial GDP is released at the end of July.


The calendar for next week is headlined by multiple appearances by Janet Yellen. This is the week for her testimony to the House and Senate and that always provides an opportunity for a foot in mouth event. However, she has been very good in recent interactions and not say anything that will get her in trouble. She has learned her job well and is far more careful now than in her initial months in office.

On Thr/Fri we get the two price indexes, Producer and Consumer, with their update on inflation. Everything else is just filler including the seven Fed speeches. No Fed speaker is going to say anything that will contradict Yellen's testimony this week.


The Q2 earnings cycle kicks into high gear on Friday with Citigroup, JP Morgan Chase, Wells Fargo and PNC Financial. The banks are expected to do well and several are holding near their recent highs. Wells Fargo is the laggard because of their duplicate account scandal that continues to plague them.


Thomson Reuters is predicting 7.9% earnings growth in Q2. So far, 23 S&P companies have reported and 78.3% have beaten earnings expectations compared to the long-term average of 64%. Some 84% of companies have beaten revenue estimates and well above the average of 59%. For Q2 there have been 80 negative preannouncements compared to 43 positive announcements. Only 9 S&P companies will report earnings next week. The only Dow company to report this week is JPM. There will be 9 Dow reporters the following week.

There was very little stock news on Friday but Tesla (TSLA) was at the top. On Wednesday, Goldman Sachs (GS) predicted the stock would be cut in half and reiterated a sell rating. The analyst lowered the price target to $180 but that was only $10 lower than his prior sell target. The analyst said there was potential for downside as the Model 3 launch curve misses the company's production targets. At the same time, he said the demand for the Model S and Model X appeared to be hitting a plateau below an annual run rate of 100,000 units.

On Friday, Tesla saw its national car registrations decline nearly 10% through April, with California, its largest market, falling 24% according to IHS Markit. Since the May/June numbers are not yet available we do not know if April was a fluke or the start of a new trend. Elon Musk blamed a battery shortage for missing the production targets in June with deliveries of 22,000 cars compared to the 25,000 target. Shares have crashed 16% for the week and 19% from their $387 high the prior week.

Production on the Model 3 began on Friday and the first customers will get their cars by the end of the month. Tesla said in its latest earnings release that Model 3 sales could impact demand for the Model S and X. Elon Musk is trying to avoid that by reminding consumers, "Model S will always have more range, more acceleration, more power, more passenger cargo room, more displays (two), and more customization choices."

Long time Apple analyst Gene Munster said the economics of the Model 3 would catapult Tesla's addressable market in the U.S. from 1 million vehicles a year to more than 11 million. However, they will have to double production in 2017, 2018 and again in 2019 to capitalize on that larger market. Musk expects to make 10,000 Model 3s or more per month in 2018.

Tesla also announced on Friday that it won a contract to install the largest grid scale 100-Megawatt battery in South Australia. Tesla must install the battery within 100 days of the contract signing or the batteries are free. Musk said a failure to install on time would cost Tesla $50 million or more. The battery installation is large enough to power 30,000 homes if the main power were to fail. Prior to this installation the largest battery backup in the world was an 80-Megawatt installation in California, also powered by Tesla batteries. South Australia made a commitment to shut down its coal fired generation stations and rely on wind, solar and gas. This makes the grid unstable since the sun only shines half a day and the wind is unreliable. The battery backup system is supposed to fix that problem. In September, 1.7 million residents were without power, some for up to two-weeks because the renewable systems could not keep up with demand and collapsed.


Sears Holdings (SHLD) CEO Eddie Lampert is on his way to being the worst retail CEO ever. He announced on Friday they were closing another 43 stores, 8 Sears stores and 35 Kmarts. That is in addition to the 265 store closings already announced in 2017. Shares recovered some of their intraday losses on the announcement.

Well after the close on Friday, the company announced a new "Line of Credit Facility" for $500 million with a maturity of not more than 179 days. The facility will be secured by a second lien on inventory, receivables and related assets. The announcement of the loan facility said Lampert's ESL Investments was considering participating in the loan but was under no obligation to do so. This is known as a tease to incentivize lenders.

The company also said it sold and closed on more than $200 million in real estate transactions and reduced the balance of the April 2016 $500 million real estate loan to $347 million. The announcements were made at 5:30 after the extended hours session ended so there was no stock movement.


Snack maker Mondelez (MDLZ) said second quarter revenue growth would be reduced by 3% as a result of the recent wave of cyber attacks. The company said locations in different regions were experiencing technical problems as a result of the attacks. In some markets, revenue was permanently lost due to timing of holiday sales but some revenue will be recovered in Q3 when delayed shipments eventually arrive. Mondelez said shipping and invoicing was delayed during the last four days of the month. Those systems are now up and running again. They also expect to incur incremental one-time costs in both Q2 and Q3 as a result of the attacks. Shares declined on the news but recovered by the close.


Canaccord Genuity analyst Mike Walkley reiterated a buy rating on Apple with a target of $180 saying iPhone sales are doing just fine. He said a recent survey showed sales were tracking for 42 million in Q2 and 47 million in Q3.

In addition, a Raymond James survey showed that 14% of iPhone owners plan on buying Apple's Home Pod when it goes on sale in December. Another 12% are planning on buying the Apple Watch and that is the highest of any prior survey. There was also strong buying interest in Apple speakers and Beats headphones.

On Thursday, Qualcomm increased its legal attack against Apple and is trying to block importation of some iPhone models into the US. Analysts believe this is just another round of legal sparring and there is no danger to Apple. This is a negotiating tactic just like Apple's suit against Qualcomm and refusal to pay $1 billion in license fees. If Qualcomm were to get close to an import block sometime in 2018, Apple would pay the fees. Most analysts believe the companies will reach a settlement in mid 2018 and all the legal battles will end.

Apple is suing Qualcomm for unfair licensing practices. Qualcomm supplies one component to the iPhone but demands a percentage of the phone's total selling price rather than a fee on just the one component. Apple says this is taxing Apple's innovation rather than just the one component. Apple says they should not have to pay Qualcomm for technology breakthroughs that do not relate to the Qualcomm component. Qualcomm contends that without their component there would be no iPhone.


McDonald's (MCD) shares rose 2% after Cleveland Research said U.S. same store sales were stronger than expected and earnings are poised to beat estimates over the next 6-12 months with Q2 comps looking "solid." The analyst was bullish on the company's execution, new products, messaging, mobile expansion and product conviction.

Stores in my neighborhood have more activity and longer lines than I remember seeing in a long time. 12-18 months ago, they were empty more than busy and it was a quiet place to take the grandkids for an ice cream and 30 min of play time. Now the place is a zoo with lines and the play land is packed out. My wife said everyone she knows is going there for the $1 drinks when everyone else averages $2.50. That loss leader for McDonalds is scoring them a lot of food orders to go with the cheap drinks. Shares spiked to a new high on the analyst comments.


Blue Apron (APRN) has already fallen 22% from its IPO price and it has only been trading for six days. This is everyone's IPO nightmare. Initially they wanted to price it in the $15-$17 range. They eventually conceded and priced it at $10 and that is exactly where it closed on the first day of trading after an intraday high at $11. Some analysts blame the poor performance on the Amazon/Whole Foods announcement just prior to the IPO. There are worries Amazon's ability to deliver products fast and Whole Foods reputation for fresh produce and meat, could allow the combination to duplicate the Blue Apron business model very quickly.

Another challenge is the lack of customer retention by Blue Apron. With more than 20 prepackaged foods companies in their market, they have only been able to retain 23% of prior customers. About 72% of customers cancel the service within the first six months. I believe this is a fad business. It looks like a good idea in the advertisements but you still have to retrieve it from the porch and cook the food. Consumers today are very active and the type of consumer this appeals to is probably the most active. About the only hope Apron has today is a mass merger with multiple other companies to reduce the competition.


The silver market declined sharply on Friday after a flash crash in the commodity at 7:PM on Thursday evening. Silver is a commodity so the futures are open at all hours. At 7:PM volume is normally somewhere between 25-50 contracts in a five-minute period. On Thursday, somebody dropped a 6,000 contract sell order on the market and prices declined 11% in just a few seconds from $16 to $14.34. Those 6,000 contracts represented about $500 million in silver. The CME reviewed the action and adjusted the sales prices of everything below $15.45 to that price. That saved many traders a lot of money as stop losses were hit during that air pocket.

There was no shortage of conspiracy theorists. Why would anyone drop a 6,000 contract sell on the market at the most illiquid time of the day? Analysts determined it was not a fat finger trade because there was no corresponding buy orders to recover from their error. Several analysts pointed to some volatility in the Japanese bond market at exactly the same time. With the Bank of Japan buying all the bonds available at the exact same time there could have been some complicated relationship of bonds, yen and silver in some account that triggered the massive sale.

Regardless of the reason, the trade killed the sentiment for silver and the commodity lost -2.6% on Friday to close almost exactly on that CME price adjustment.


Oil prices had an eventful week. Prices rallied to just over $47 on Monday and then crashed back to $45 on Wednesday. Both the API and EIA reported large declines in inventories of -5.76 MB and -6.3 MB respectively. Cushing inventories fell to a multi-month low and product demand rose to a record 22.23 million barrels thanks to July 4th holiday driving. Prices should have risen. However, US production rose 88,000 bpd and the biggest weekly increase this year.

OPEC said it was mulling production caps on Libya and Nigeria. Prices rallied. Russia and Kazakhstan said they would reject future production cuts proposed by OPEC. Kazakhstan just started the 370,000 bpd Kashagan field that will add to the glut. Russia is starving for cash so their compliance with the 300,000 bpd cut they initially agreed to is very low at this point and will probably be nonexistent in the near future. Prices declined.

Once the summer demand cycle is over and that is about six-weeks from now, the outlook for oil prices will fade. Once a few countries begin dropping compliance with the OPEC cuts, there could be a rush to market by everyone else.

In the Non-OPEC cuts, Russia and Mexico were the only main players. If Russia drops compliance completely, you can bet the rest will be heading to the exits.

Bloomberg Chart


Now that the holiday is over the activation of rigs resumed with 7 new oil rigs and 5 new gas rigs. The one-week decline was holiday related as I wrote last week.



 

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Markets

Dip buyers have had a tough year because there have not been any material dips. According to JP Morgan, the 3% intra-year decline has been the smallest since 1980 and in a tie with 1995. The long-term average is a 14.1% decline every year. While we have seen some increased volatility in recent weeks, it pales in relation to "normal" volatility. This makes the markets hard to predict because there are no normal peaks and valleys. Every 5-10 day move higher is met with expectations for a decent correction but instead the indexes move sideways with maybe a day or two of declines then additional sideways consolidation. Eventually, there will be a real correction and it will be very painful. In the Random Thoughts below, I have comments from Bank of America on the coming "Humpty-Dumpty" crash. This is just their opinion, not a guarantee of a future event.

The S&P closed well under critical support at 2,420 on Thursday but the minor bout of short covering on Friday lifted it back over that level. The pattern is still bearish with multiple resistance levels that need to be broken before it will turn bullish again.


The Dow continues to chop around just below its recent highs and prior support at 21,414. The intraday dip to 21,200 was brief as was the spike to 21,562. There is tremendous indecision and the Dow has been posting alternating gains and losses for a couple weeks now. The Dow chart has retained its bullish bias but it is looking "toppy" because of all the volatility. That is a symptom of tops and bottoms. Only one Dow component reporting this week and that is JPM on Friday.



Supporting the Dow is the Dow Transports. The index closed at a new high on Friday and the Dow Industrials are not likely to decline as long as the transports are positive. The breakout is being powered by the airlines, railroads and low oil prices


The Nasdaq Composite closed under critical support at 6,100 on Thursday but the Friday short squeeze lifted it back into the recent congestion. There are multiple levels of resistance that would have to be broken for the chart to turn bullish again. Despite Friday's rebound, the chart is still bearish until proven otherwise. At Thursday's lows, the index was down -222 points from the 6,303 lower high on June 26th. The pattern of lower highs and lower lows needs to be broken to repair sentiment.



The small caps are outperforming the big caps for a change with the Russell 2000 only about 12 points from a new high. Resistance at 1,427 is strong as is support at 1,400. The strength in the financials is supporting the Russell.


Last week was full of external events to push the markets around. We had the low holiday volume and strong inflows of end of quarter retirement money hitting the market. Funds were repositioning for the coming earnings cycle and the two weakest months of the year in August/September. The earnings cycle begins this week with the big banks reporting on Friday. Funds should be positioned to capture any earnings gains. The holiday volatility should be over but the Yellen speech/testimony is always a hurdle. As long as the Nasdaq is over 6,100 and the S&P over 2,420 I would be in buy the dip mode. If we have new closes under those levels I would move to flat or short.


Random Thoughts


Very little movement in the sentiment survey last week. 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's Michael Hartnett said last week that "central banks have exacerbated inequality via Wall St inflation and Main St deflation" and now they are looking for a way to painlessly undo their error. He said, "There are only two ways to fix inequality. You can make the poor richer or you can make the rich poorer." He believes the "Fed/ECB are now tightening to make Wall St poorer" because it is "no longer politically acceptable to stoke the Wall St bubble."

One year ago, the 30-year Treasury yield hit an all time low o 2.14%. The Swiss government could have issued a 50-year bond at a negative yield. Over the last year, yields have improved slightly but the global equity markets have gained $10 trillion to $76.3 trillion. Global debt has risen $50 trillion to $217 trillion since the financial crisis. Unfortunately, nearly one-third of the global government debt is held by central banks. They need to unwind this massive stimulus but inflation is not cooperating.

They have begun tightening in the case of the Fed and talking about tightening in the case of the ECB but rates are not rising materially. Beware the next taper tantrum. The Fed has already warned they are going to begin tapering their ongoing QE purchases. In the past, the tapering process did not go well. Without rising inflation, it may not go well this time either unless they proceed very slowly.

Hartnett believes the Fed's various operations to hike rates in a zero inflation economy will not go over well in the equity market. He is expecting a "Humpty-Dumpty" fall in the market over the next six months, most likely in September/October. He is expecting a global financial event as a result of the Fed/ECB trying to raise rates using the equity market valuations as an excuse.

Hartnett received a significant amount of criticism for this call but there are other believers in this scenario.

Ray Dalio from Bridgewater, warned the Fed QE party is ending. The days of easy money are over. "Investors should keep on dancing but move closer to the exits."


Here is a reason Sears is having so much trouble maintaining positive retail growth. The malls are dying. There is even a website called DeadMalls.com that has a running commentary on the various dying malls around the country. The malls are turning into ghost towns and you cannot sell any products if there are no customers. This is affecting the real estate value of Sears properties as well.



The Yellowstone super volcano is making noise. Over the last two weeks, there have been over 1,100 earthquakes in and around the Yellowstone caldera. Quakes are spreading out from Yellowstone and there was a 5.8 earthquake in western Montana on Thursday. This was the strongest quake in more than 20 years. Prior to that, the largest was a 7.2 magnitude earthquake in West Yellowstone 58 years ago.

The last time Yellowstone erupted was 640,000 years ago. The caldera is 34 miles long by 45 miles wide and dwarfs any other active volcano on the planet. If Yellowstone actually erupted again, it could kill thousands of people in the USA. Ash depth could be measured in feet hundreds of miles from Yellowstone. Farmland would be buried, transportation halted and civilization as we know it severely disrupted in the 8-10 surrounding states and as far away as Little Rock, Dallas, Chicago and St Louis.

The volcano has erupted at least three times and emitted more than 250 cubic miles of magma. The last time, 640,000 years ago, it was 2,500 times more destructive than the Mt Saint Helens eruption in 1980. Recent technological improvements has allowed researchers to map the current magma pocket. Scientists found that the pocket under the caldera is 2.5 time larger than previously thought and 20 miles by 55 miles wide and 6 miles deep. That is very close to the size of the pocket when the volcano last erupted.

Scientists do not believe the volcano is about to erupt despite the upsurge in earthquakes. They believe they can map the magma flows and predict when an eruption will occur. When the Bardarbunga volcano in Iceland erupted in 2014 they were able to track those flows for weeks in advance and there was plenty of warning before the volcano finally erupted. If they did start to see magma flows rising, there would be widespread alarms and time to prepare. Stay tuned.

Source 1

Source 2

Ash fall projections by USGS


 

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