The markets traded sideways on Friday but that was bullish given the recent gains.

Weekly Statistics

Friday Statistics

The Dow ended a seven-day winning streak and came within 1.7 points of making it eight days. The S&P ended a six-day streak of gains with a 2.7-point loss. The Nasdaq stretched its winning streak to nine days with a 5 point gain. The Russell 2000 only gained five points from Monday's close to Friday's close but that came on top of a 162-point rebound so any gain was unexpected.

There are a lot of events in our future and that could have produced some event risk selling on Friday but it was so light it was not material. A Russian official just back from North Korea said the country was preparing for another missile launch in the days ahead. October 10th is the expected date. President Trump is expected to cancel the Iranian nuclear deal next week and recommend new sanctions. After a meeting with his military advisors on Thursday, Trump asked reporters if they knew what the meeting represented. He then said, "Maybe it is the calm before the storm." When asked about the comment later he winked and said, "You will find out soon." Those comments had people running in circles on Friday. On top of that, it was rumored that Secretary of State Tillerson was going to be replaced as early as this weekend.

Given those worries and the big drop in job numbers, it was bullish to see the Nasdaq extend its streak to nine days and support the market.


The big economic report for Friday was of course the Nonfarm Payrolls. Estimates were in the 75,000-100,000 range with 156,000 added in August. The headline number for September showed a loss of -33,000 jobs because of the impact of the multiple hurricanes. The prior two months were revised lower by a total of -38,000 jobs with July dropping -51,000 while August rose by 13,000.

The biggest hit to September was a decline of 111,000 jobs in the leisure/hospitality sector. Analysts theorize this was due to restaurants/bars being closed in Texas and Florida. Transportation and warehousing saw a gain of 22,000 jobs and government gained 7,000 jobs. Insurance gained 11,000 because of the surge in claims processing.

More than 2.9 million people were working only part time because of the weather while 1.5 million had jobs but were not working because of the weather.

The unemployment rate declined from 4.4% to 4.2% and the labor force increased by 575,000. The labor force participation rate rose from 62.9% to 63.1%. That is the first time over 63% since early 2014. Average hourly earnings rose 0.5% and now up 2.9% for the last 12 months.

Despite the negative headline number, analysts said this report showed the strength in the economy with huge numbers of people entering the job market and the sharp uptick in the wages. They said the Fed is likely to see enough strength here to hike rates in December. The dollar and the yield on the ten-year both shot higher on the news but faded back to flat by the close.


The drop in the payroll numbers caused the expectations for consumer spending to decline from 2.5% growth to 2.2% and changed the Atlanta Fed real time GDPNow forecast for Q3 from 2.8% to 2.5%.


Wholesale inventories for August rose 0.9% and matched analyst estimates. The prior three months all showed a 0.6% gain. Sales of durable goods rose 2% with nondurable goods rising 1.5%. The report was ignored.

The economic calendar for next week will be focused on the PPI and CPI and their impact on inflation. With the Fed unsure about a December rate hike, they will be focused on the price indexes for the next three reports. They would love to see 2% inflation to justify their rate hike.

The FOMC minutes on Wednesday are always important, especially when the various Fed speakers are out spinning different views on the future of rates. On Thursday, Harker was ready to hike under the scenario of hike now to be ahead of inflation growth. On Friday, Kaplan was in favor of holding off on the decision until additional data was available. The minutes are a look into the meeting to see what the group was thinking.


The first signs of Q3 earnings appear later this week with the bank stocks the first to report. JPM will be the first Dow component to report on Thursday but there will be 22 others reporting over the next two weeks.


To date, 23 S&P companies have reported for Q3 and 87% have beaten earnings estimates while 78.3% have beaten on revenue. For the quarter, earnings are expected to rise 4.9% and revenue expectations are for 4.3%. However, over the last four years, Q3 estimates have averaged about 4% below the final number. If the trend holds, that would give us about 8.3% for the quarter. The next three quarters are expected to average about 10% with Q4 at roughly 12% earnings growth. There have been 77 guidance warnings for Q3 with 48 positive guidance revisions. The current forward PE for the S&P is 18.0.

The big earnings disaster for Friday was Costco (COST). The earnings were great but the reaction was terrible. The company reported earnings of $2.08 that rose 17.5% and beat estimates for $2.02. Revenue of $42.3 billion rose 15.8% and beat estimates for $41.74 billion. That compares to $1.77 and $36.56 billion in the year ago quarter. Membership fees rose 13% to $943 million.

Same store sales were up 6.5% in the US and 5.7% globally. Analysts were expecting 5.2%. E-commerce sales rose 21%.

For the 5-week period ending Sept 30th. US same store sales were up 9.0%, Canada 9.4%, international 8.2% and total company 8.9%. E-commerce sales were up 30%. No weakness here!

Analysts and the talking heads on stock TV keep talking about the impact of Amazon dragging down Costco. Show me in the numbers above where Costco sales and earnings are dragging. In a recent survey by BMO Capital, they found that Costco consistently had lower prices and faster shipping than Amazon. They surveyed 16 categories and Costco was an average of 7% cheaper than Amazon. Shipping took an average of 4.5 days from Costco compared to 5.5 days from Amazon. Wal-Mart and Jet.com had prices that were 18% higher than Amazon and average shipping was 9.8 days.

Costco now has free 2 day shipping from 355 of its 741 stores through CostcoGrocery and faster shipping in as little as 2 hours is available with partner Instacart. Costco is not just sitting around waiting for Amazon to catch up. They are actively investing in the e-commerce platform and expanding it to their other stores. With a Costco or two in every major population center, they have an edge on Amazon because the products are already local for most people and that makes shipping faster. Amazon does have a larger number of items but that is not a negative for Costco. They have always had a variety of items based on buying opportunities and they may not have the same exact items on every visit. This allows Costco to buy cheaper and pass the savings on to the customer.

Costco also has its own private label brand in the Kirkland label. Last year Kirkland was the largest selling grocery brand on Amazon. Yes, on Amazon.

Unfortunately, for the stock, perception is reality. If enough talking heads say Amazon is killing Costco then that becomes the perceived reality and shares tank. That is what happened on Friday with COST down $10 after earnings.

Morgan Stanley downgraded from overweight to equal weight and $165 target. Goldman Sachs downgraded from conviction buy to hold. Shares fell to $157 and the $150 level is strong support. I would probably not buy it on Monday because the post earnings drop last time lasted several days. The Goldman downgrade could be persistent. I would be a buyer once a rebound begins. I would rather buy it a couple dollars higher than buy it too soon and be a couple dollars early.


Netflix (NFLX) continued to explode higher after they announced a price hike on Thursday. The middle plan will rise from $9.99 to $10.99, top tier 4K plan will rise from $11.99 to $13.99 and the basic plan remained at $7.99. Most analysts believe Netflix is priced well below the value of its service and these minor increases are not expected to create subscriber flight. RBC Capital said the content, not the subscription price is creating the subscriber churn. Netflix has dropped a lot of the older shows in order to concentrate on new original content. They are planning on spending $6 billion in 2017 and negative cash flow will be $2.0-$2.5 billion.

UBS raised its price target to $225 from $190 saying the company will probably post Q3 subscriber growth numbers that will blow away estimates. The analyst said the Q2 growth number probably persisted or even accelerated as advertising and word of mouth spreads in the 190 countries where they are now streaming. I think the UBS estimates are low. The analyst expects only 100,000 new US subs and 300,000 internationally. Earnings are Oct 16th.


Yum China (YUMC) reported earnings of 52 cents but analysts were expecting 56 cents. However, same store sales rose 6% and double expectations. The company said "food quality investments" led to lower margins and earnings. Bernstein cut estimates for the full year based on the declining margins. Labor inflation is also a factor with wages in China rising sharply over the last two years. The current CEO, Micky Pant said he was being replaced by Joey Wat, the COO since February. The switch will occur in March. Shares rose slightly despite the earnings miss.


Amazon (AMZN) is about to become the biggest drug dealer in the world. The decision could come soon as Jeff Bezos has been in talks with just about everyone involved in the industry. Amazon was an original investor in Drugstore.com with Bezos on the board. Walgreens purchased the site and shut it down in order to attract more people to Walgreens.com. There is almost no chance Amazon will not enter the business simply because of the monster profits, inflated pricing and multiple middlemen. Amazon has the power to go direct and it is going to be painful for companies like CVS (CVS), Rite Aid (RAD) and Walgreens (WBA). All of those stocks crashed on Friday.

Amazon now has 105 fulfillment centers with 35 new ones in the planning stages. Recently, Amazon has been buying up defunct shopping malls. They typically have a lot of acreage, good electric power and utilities and they are in population centers with a large labor pool. This allows faster delivery of merchandise since the malls are in large cities. Amazon increases its merchandise volume by 40% or more every year. That means they have to double their capacity every two years. In 2014, Amazon had over 10,000 operational robots. They are now thought to have more than 80,000 robots in those centers. Since more than 400 malls have shutdown over the last couple of years, there is plenty of opportunity for Amazon's growth.

The company is now developing a new delivery system called Seller Flex. It will allow Amazon to take control of the "last mile" in the delivery chain. That is currently handled by UPS, FedEx and the post office. Amazon already has 40 cargo jets and more than 5,000 semi trailers that deliver packages from fulfillment centers to UPS, FDX and US mail hubs. Instead of those carriers hauling packages all across the country, they only have to carry them from the local hub to the local consumer. Amazon gets a huge discount in rates for this service. It is not clear how Amazon is going to handle the last mile delivery and it will not happen overnight. It could take years, but the company is moving in that direction.


Hurricane Nate made landfall in Louisiana as a category 1 storm with winds of 90 mph. The path took it through a large portion of the oil patch just south of New Orleans. As of Friday evening 71% of oil production had been shutdown. That is roughly 1.25 million bpd. Over 53% of gas production had also been shuttered. Oil companies have been working for four days to shutdown the platforms and evacuate the workers to land. Nate is a fast moving storm and should be well out of the Gulf by early Sunday.

The platforms are built to sustain 90 mph winds but that does not mean there will not be damage. It could take a week or more to repopulate the platforms and additional days to repair any damage. Analysts believe US inventories could decline by 10-15 million barrels or more depending on the damage and the time out of service.


Crude prices fell sharply on Friday with a $1.50 drop. Despite the expected drop in gulf production, there are continued worries over a prolonged global glut. Even with Iran, Turkey and Iraq planning to shutdown production from Kurdistan, the prices are still falling. With Kurdistan planning to seek independence, those three countries are going to try and starve it into submission by cutting off their exports of 600,000 bpd. If they can shut these pipelines that would do wonders for reducing global inventories because it could be a long-term situation.

The US problem is the lack of demand. The driving season is over and the heating oil season has not yet begun. October is typically a low demand period and prices normally decline until around Thanksgiving.


Saudi Arabia's King Salman visited Russia last week. They talked about oil production cuts and a Russian official said the cuts could be extended until the end of 2018. Russia also agreed to sell military equipment to Saudi Arabia. Oil has been kind to the Saudi royal family. King Salman brought an entourage of 1,500 people with him to Moscow. They booked the entire Four Seasons and Ritz Carlton hotels. Even people who live permanently in those facilities were forced to leave for the duration of the King's visit. He brought his own furniture, his own carpets, his own cooks, his own hotel staff and his own food. Each day a Saudi plane arrives with roughly 2,000 pounds of fresh food for the group. The king had his special gold escalator flown to Moscow just so he could exit his personal 747 in style. Unfortunately, it stopped halfway down and the king had to walk the final few steps. He then walked on a painted red path across the tarmac, resembling a red carpet, until he reached his motorcade. Even at $50 oil, Saudi Arabia is still doing well financially.




Markets

The markets are proceeding contrary to the normal trend for this time of year but there are multiple reasons the rally could continue. Positive earnings projections could reach 9% growth for Q3 and average 10% growth for the next three quarters. The Fed is in accommodative mode and even if they did hike in December and the expected three times in 2018 that would only put them at 2.25% at the end of 2018. The winding down of the balance sheet has begun at a snail's pace that will take them years to reduce it significantly. The economy is accelerating except for the hiccup we are going to see for Q3 because of the storms. Manufacturing activity is at a 13-year high. Services activity is at a 12-year high. Intermodal rail traffic is at a record high. Semi truck sales are up 62% over the last 12 months. Air travel is at a record high. Tax reform of some kind will likely be enacted over the next six months. More than likely it will be favorable to corporations and that will increase earnings. For every 1% decrease in corporate taxes, S&P earnings will rise by $2. All of these factors are positive for the market.

While those fundamental factors will be positive for the market long term, there can always be periods of weakness. It has been 461 days since the S&P had a 5% retracement. The average is twice a year. The markets do react to headlines but they do not need an external reason for profit taking.

The recent dips have been shallower and shorter each time. Portfolio managers and investors who were expecting the normal Sep/Oct volatility were left behind and they are eagerly buying every minor decline.

The next potential hurdle could be the budget and debt ceiling deadlines in early December. The reason we did not have volatility in September is because those were pushed out 90 days until December. If the market continues higher until December, we could see some significant profit taking if those events begin to generate ugly headlines. With only a few weeks left in the year, there would be no reason to risk existing profits and the potential for a government shutdown.

All of those events above are long term. For next week, we could see the rally continue even if some profit taking appears. The economic put is in and we need to keep buying the dip until proven wrong.

The AAII sentiment survey showed some neutral investors picking a side. A few turned bullish with the market at new highs BUT more turned bearish, suggesting they do not believe the rally will continue. Just remember, the herd is normally wrong. In this case all three camps are nearly equal so there is little to be learned from the survey this week.


The Volatility Index set a new 24-year low at 9.19 on Thursday. This extended period of low volatility could last if the market continues higher but historically, long periods of low volatility are normally followed by periods of high volatility. This is a trailing indicator rather than a predictor of future market moves. It is a flashing warning sign.


The S&P is in breakout mode and well over uptrend resistance. It is over extended and a drop back to that uptrend line around 2,525 could be expected without damaging the uptrend. A dip to 2,500 would be a little more detrimental but that would only be a 2% decline and represent another buying opportunity. With Q3 earnings kicking off with the banks next Thursday, I do not expect a significant decline to appear.


The Dow almost recovered enough on Friday to close positive and extend its streak for another day but could not push through that final 2 points. Actually, this is a good thing. Without the pressure of a long streak that keeps traders on the sidelines until it breaks, the buyers can now appear.

The Dow components were almost evenly divided between advancers and decliners but the $1.50 drop in crude prices put Chevron and Exxon in the loser column with Chevron erasing 10 Dow points.

The acceleration on the Dow over the last several days has put the index into overbought status and support is well back at about 22,500 or even 22,275. That would be a major blow to short-term market sentiment but not to the long-term rally. It would be another dip to buy. Only one Dow stock reports earnings this week but 20 will report over the next two weeks. That earnings lure should keep investors interested in the Dow stocks.



The Nasdaq has rebounded 237 points since the September 25th low. The index has broken out thanks to a resurgence of the big cap stocks. Once the rotation into small caps faded, the big cap techs began to see investors returning.

The initial resistance of about 6,650 with longer-term resistance around 6,800. The same earnings lure should keep the Nasdaq on an upward path even if there are some pauses along the way. The 6,460 level that was strong resistance for two months, should now be support if a material decline appears.




In the dictionary under the word "overextended" is a picture of the Russell 2000 chart. The index is holding its gains of roughly 162 points since the August 21st low but it is struggling. The last four days have been touch and go but it closed on Friday only 2 points off its record high. Needless to say, there could be some retracement ahead. However, if the Russell were to continue higher there would be additional short covering and it would be good for market sentiment.


I believe the markets will continue to stair step higher. I do not expect uninterrupted streaks to continue because once we do get into earnings there will be disappointments. The key will be to pick your entry points and save some cash back in case a real buying opportunity appears.

Tuesday is rocket man day but unless he actually fires one over Japan and explodes a nuke in the Pacific, I would expect very little market reaction. North Korea is old news now. There is the potential for a single cruise missile to explode on the NK launch pad as a message. This could be the storm President Trump was alluding to last week. The market would react very negatively to an event like that. However, Kim Jong-Un could react unpredictably and that makes a missile strike a very low probability.

Just focus on the market and continue buying the dips.

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Jim Brown

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