Market Wrap

Happy New Year

by Jim Brown

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Regardless of what January brings, I expect 2017 to be a very good year!

Weekly Statistics

Friday Statistics

Dow 20,000 was not to be in 2016 but you can rest assured we will see it in 2017 and probably 21,000 and 22,000 as well. That would only take just over a 10% move from Friday's close.

The dreaded pension fund rebalance that was supposed to see selling of more than $38 billion in equities as December came to a close, turned out to be a dud. There was selling over the last three days but it was muted. Volume rose from 4.1 billion on Tuesday to 5.7 billion on Friday as a result of the rebalance and year-end adjustments.

The Dow was down -110 at its lows and just after 3:PM it looked like there would be $2 billion or more left to sell at the close. That paired off early and dropped to $1.2 billion at the close according to Art Cashin. The combination of short covering and end of quarter buying saw the Dow rebound to close only 57 points lower. The Nasdaq did see some heavy selling in the big caps and closed with a loss of 49 points with the Nasdaq 100 losing 55 points.

The S&P-500 gained 9.5% in 2016. More than 7.4% of that gain came post election. There were 265 stocks that gained 10% or more and 68 that lost 10% or more.

There was no economic news and almost zero stock news. There would have been nobody around to react to it since almost everyone had already left for the weekend.

Next week has a heavy calendar economically with the ISM, jobs and the FOMC minutes. None of it should matter because it will not change Fed direction and the market has already priced in at least two rate hikes for 2017.

What will matter is the market direction. This is going to be a critical week and it will be interesting to see if the expected January decline is a nonevent like the pension fund rebalance.


Apple shares lost $1 after news broke that it has asked component suppliers to reduce production by 10% in Q1. The Nikkei Asian Review cited calculations based on data from suppliers. Apple cut production by 30% in Q1-2016. The problem seems to be a lack of new features that create a buying urge by existing users. There are also the rampant rumors about the iPhone 8 that will be announced in September.

There continues to be leaks about various features and sizes and rumors of new technical breakthroughs. DigiTimes reported on Friday of another leak from suppliers confirming the available sizes will be 4.7, 5.5 and 5.8 inch screens. The two smaller models will use TFT-LCD panels and the 5.8 inch will use an AMOLED screen, with rounded edges. According to DigiTimes, Samsung will be the sole supplier of those AMOLED screens and they are predicting sales of 70-80 million. Reportedly, Samsung had to guarantee production rates of up to 20 million a month to get the order. If the big phone sold 70 million and the smaller phones had similar numbers to prior versions, this would be a record-breaking model. Since it is coming on the 10th anniversary of the phone's introduction, it is expected to be packed full of new features.

There was also news that Apple is going to start manufacturing iPhones in India. Foxconn was rumored to be exploring plans to build a plant in India but news broke that Taiwanese manufacturer Wistron Corp had won the bid and was opening a factory in Peenya, the industrial hub of Bengaluru. Wistron previously manufactured the 5C phone. Apple will have to buy at least 30% of its raw materials from Indian vendors as part of a new foreign direct investment program initiated in June. Rumors claim Wistron could begin iPhone production as early as April. Manufacturing labor costs in India run about 92 cents an hour compared to $3.52 in China. Manufacturing in India would also avoid the heavy import tariffs now in existence.

India's smart phone market will be larger than the U.S. market by 2018 and second only to China. IDC said Indian smartphone subscribers have surged to about one billion. Reliance Jio Infocomm, an Indian based mobile network operator, said last month they are rolling out 4G coverage in 18,000 cities and 200,000 villages. Drexel Hamilton said India's growth story for Apple is reminiscent of China's back in 2010. Apple exploded on that surge in growth. However, in 2016 Apple's share in China fell -30% as other suppliers multiplied.

I believe Apple is on the cusp of a new growth surge despite the cutback in production for Q1. If they are truly, "breaking into India" sales are going to surge as well as expected strong demand for the iPhone 8. Apple's services businesses are on track to hit 25% of revenue in 2017 and continue growing from there. CEO Tim Cook said they have features in the planning stages that users will wonder how they ever lived without them. Apple accounted for 44% of all phones and tablets activated during the holiday season according to Flurry's Analytics Blog. That compares to 21% for Samsung.


Tesla (TSLA) was named best pick for 2017 by Baird's Ben Kallo with a target price of $338. The analyst said the battery business was going to surge as the Gigafactory nears completion and full production. The combination with Solar City will increase battery demand along with the initial production of the Model 3. Kallo said the storage battery business of already accelerating and all the other factors will just add to that acceleration. Tesla is going to offer an analyst tour of the Gigafactory on January 4th and that should be a positive catalyst for the stock.


The Dow gained 13.4% in 2016 or 2,337 points to end at 19,762.60. The biggest Dow gainer for the year was Goldman Sachs with a 32.9% gain and accounting for 392 Dow points. In the table below, I calculated the gain/loss for the year for each Dow component and the amount of Dow points they contributed to the Dow for the year.

Visa, Coke, Disney, Pfizer and Nike were the laggards with Nike subtracting 77 Dow points. I do not follow year to date gains and losses on a regular basis and I was surprised to see Home Depot near the bottom with only a 1.4% gain. I went back and looked at the HD chart and the company had plenty of volatility that kept erasing their gains.

UnitedHealth was a big gainer and is expected to be a big gainer in 2017. They have dropped the Obamacare exchanges and that was a big loser over the last two years. They are expanding services in multiple areas and should do significantly better in 2017 without the hundreds of millions of dollars of Obamacare losses dragging earnings down.

JP Morgan is the financial in the Dow that is expected to outperform in 2017. Interest rates are rising, regulation should be declining and the majority of the legal issues plaguing the big banks are now in the rear view mirror.

It is clear by looking at the list that the Dow was lifted higher by only about a third of its components. Stocks making a $3-$6 gain for an entire year should be kicked to the curb. Their day in the spotlight may eventually come but they are dead money until that day comes.

Stocks like Microsoft have a great business and they make a lot of money but with 8 billion shares outstanding, they just cannot move the needle on the share price. GE is actually getting their act together and should grow earnings this year but with 9 billion shares outstanding, they just cannot grow earnings per share by more than a couple pennies in each report.

I would not be surprised to see the Dow managers replace a couple stocks in 2017. Coke, DuPont and Cisco would be my targets to be replaced.


The FANG stocks were responsible for much of the market weakness over the last several weeks. While industrials and financials were leading, the big caps techs were stuck in a two steps forward, one step backwards pattern.

Google (GOOGL), yes I know they changed their name to Alphabet but they will always be Google to me, lost almost 50 points over the last three weeks. They have massive earnings power but their high stock price makes them a cash register for companies rotating out of tech stocks and into industrials. They will recover but it may take a quarter to get out of the rut. They need to get rid of the two stock symbols. Having GOOG and GOOGL is confusing to traders. Why are both in the S&P and Nasdaq? Google could easily come up with a plan to eliminate the GOOG symbol. The GOOG shares are the voting shares but they have no real impact since the B shares, which are not publicly traded, have ten times the voting power and are held by the insiders. The GOOGL shares are non-voting. Google is not issuing any new GOOG shares but they are issuing GOOGL shares to employees and for use in acquisitions.


Amazon shares have lost nearly $100 since their October high of $847 and they closed at a three-week low on Friday. Amazon had a 37% market share of online shopping in the six weeks before Christmas and Best Buy was number two at 3%. I get it! They control the online environment and I use them at least once a week. However, their PE of 168 is very high. If you buy their shares it is because you think they have something else up their sleeve to revolutionize the world rather than as a fundamental investment. Amazon now has a fleet of 40 cargo jets and "thousands" of 18 wheeler trucks and trailers. They claim they are not going into competition with UPS and FedEx but their fleets just keep growing. They have the largest cloud service in the world and nobody else is even close.

Amazon even has a patent for a floating "airborne fulfillment center" or AFC that could float over large cities and allow delivery of products by drones in a matter of minutes. The AFC would be held aloft by a dirigible or similar airship. The drones would drop from the AFC to deliver their packages and then congregate at a local pickup center where they would be loaded into shuttles making routine flights back to the AFC with more inventory, fuel and the accumulated drones to be reused again. The patent also says the airship could be used for advertising, think Goodyear Blimp, and as a floating Internet access point like Facebook is working on for Africa. While this is "wishful thinking", it is this kind of thinking that has put Amazon light years ahead of its competitors. As long as Jeff Bezos can continue to produce groundbreaking new ideas, the stock will trade at a ridiculous PE.

Amazon shares typically decline after the selling season so the drop from their $850 high was not unexpected. Bezos needs to be thinking stock split to get new investors interested in his shares. Shares are likely to decline to $685 in any Q1 weakness.


Facebook has been struggling since they warned in November that earnings would slow because of increased spending. Shares are close to breaking below support at $115 and that could trigger a new leg lower. Facebook has a lot of positive factors in their favor but the stock has lost its excitement. It is nearing two billion users but that user interaction has started to fade. The average user is not spending as much time on the site as before but the decline is minimal. Facebook already has more advertisers than it has ad spaces available for rent. The big expectation for 2017 is that Facebook will find a way to monetize Instagram and WhatsApp. The WhatsApp messaging service now has over one billion users. Instagram has more than 600 million users. Also, Oculus VR is expected to become commercial by the end of 2017. The next big thing in VR will be a courtside seat at a sports game or concert simply by putting on a HD headset in the comfort of your home. In a severe or prolonged market downtrend FB shares could retest $100. That would be a buying opportunity. The average analyst target price is $155.


Netflix (NFLX) is the only FANG stock still in rally mode. Shares are fighting resistance at $130, which is the high from 2015. In January 2016, the company added 130 countries to its service with multiple language offerings. The first couple of quarters the subscriber growth was slow but last quarter it finally exploded as the advertising took hold and word of mouth began to spread. The Q4 numbers should be huge. Netflix has been instrumental in accelerating the demise of the video rental business in the U.S. and now it is doing the same thing in 130 more countries. Remember Blockbuster Video? Netflix has a lot more competitors today but none of them can scale like Netflix. They may capture viewers in a geographic area like a cable company but Netflix has got them beat with the 1,000 hours of original programming due out in 2017. They recently announced an upgrade where you can download content to your devices and then watch it anywhere even if there is no internet or WiFi connection. They currently have 86 million subscribers in 190 countries. They will be printing money for the next decade and could be a takeover target by Apple, Disney or even Amazon. The average analyst price target is $150.


Nvidia (NVDA) was the biggest gainer on the Nasdaq in 2016 with a +224% gain. The last week has been rocky after a noted short seller said the stock had risen too far, too fast. He was looking for a drop back to $90. The next day Goldman Sachs said Nvidia was a "unique growth story in semis, levered to positive secular trends in gaming, VR, AI, ML and automotive." Goldman said buy calls ahead of CES, which begins on January 5th and runs for four days. The CEO of Nvidia will be giving the keynote address and the company will be unveiling new products in AI, self-driving cars and gaming. Goldman said this will be a high profile event and Nvidia normally gains 4-5% during CES.

I wish that short seller was right and we could see $90 again but I seriously doubt it. That would be a definite buying opportunity. Nvidia is the Intel for the next decade.


It is all in how you phrase it. I reported last weekend that Lipper said investors pulled $21.6 billion out of equity mutual funds over the prior week. This was the 41st consecutive week of fund outflows from stock mutual funds.

This week ETF Trends reported that 2016 saw record inflows of $283 billion into ETFs. The top three ETFs were the SPY at $24.4 billion, iShares IVV Core S&P at $13.5 billion and Vanguards VOO S&P-500 ETF at $11.4 billion.

There are currently 1,960 U.S. listed ETFs with $2.55 trillion in assets. In 2016, there were 237 new ETFs and roughly 150 were closed.

Investors are pulling money out of equity funds and buying ETFs instead. There has been a lot written recently about the growing danger of ETFs to the market. Because of the way ETFs operate, the large inflow of cash is setting the market up for an eventual crash. If the same money was in equity mutual funds, there is a manager that operates as a check valve when investors begin to get nervous and want to exit the market. There is a little interaction and a little more thought when an investor exits a fund. When the same money is in an ETF, the exit is instantaneous. Stop losses are common and that can lead to a loss of market liquidity when a bunch of stops are all hit at the same time.

Remember, the flash crash? ETFs lost liquidity for several minutes and sold at ridiculous prices, when they sold at all. I like ETFs but I understand the threat of a surge in selling. If an investor actually held individually the 50 stocks in a given ETF, the odds are good he would not sell all 50 at exactly the same time. There would be some thought given to the merits of each stock before the sell decision is made. Weak stocks would be sold first and stronger stocks held in hopes of a recovery. That would help slow any market decline. With ETFs there is only one decision and it impacts every stock in the ETF.

Crude prices held at $53 all week as traders wait for the production cuts to begin. Clearview Energy Partners said it is inevitable, "somebody is going to cheat." Kevin Book said there is little chance members of OPEC will stick to their production targets. "You get until January 21st to believe in your hoped-for outcome and then you converge with reality. Historically OPEC always blows past its targets." The 21st is the date the OPEC monitoring committee will meet. The agreement is for OPEC to reduce production by 1.2 million bpd and non-OPEC producers to cut another 558,000 bpd. Kevin also said the notion of "ROPEC," coordinated action by Russia and OPEC, is a myth. This has been attempted for decades and has never been successful before. Russia's energy minister Novak said recently, "We will look at the cuts within our technical parameters." That is hardly a convincing promise to cut.

Stephen Schork, editor of The Schork Report, said on Wednesday that oil prices have likely topped out at $53-$55 because or additional supply coming back onto the market from the U.S., Libya and Nigeria. Schork expects only a 60% to 70% compliance with the production cuts.

Tom Kloza, global head of energy analysis at Oil Price Information Service, predicted only a 70% compliance at most that would only equate to 700,000 to one million barrels per day. That is because OPEC plays games with the production numbers. Kloza said current prices are fully valued for the next 12-24 months.


The active rig count rose by only 5 rigs over the holiday week. That was 2 oil rigs and 3 gas rigs. Once the holidays are over, we should see the pace increase to about 10 per week as long as prices remain over $50.



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Markets

There is not a lot to say about the markets this week that has not been said over the last three weeks. The S&P made a new intraday high on December 13th at 2,277.63 and the selling was immediate. Resistance at 2,275 was tested on five days over the next two weeks and never broken again for more than a few minutes. The big decline began on Wednesday and Friday's close was a three week low.

The pension fund rebalance could have been responsible for those three days of declines but I am sure it was also a result of investors shutting down for the year ahead of the holiday.

The market has declined in January for the last three years and 2016 was the worst January in nearly two decades. None of those last three Januarys had a 9% rally in the prior six weeks. Also, none had the terror risk of a presidential inauguration to deal with. In theory, this makes January 2017 a potentially volatile month. Whether that volatility begins on Tuesday or at some later point in the days to come is of course unknown. About the only guarantee is that we will see some volatility. Even in normal election years, the market tends to decline around the inauguration event.

The first material support level is the 2185-2190 resistance range from August. That would be my first target if a market decline appears as expected. In the Index Wrap last weekend, I laid out the various support levels for January for all the major indexes.


A long time reader emailed me last week asking if I had my Dow 19,000 hat yet. It took me a few seconds to understand what he meant. The odds of us retracing to 19,000 before 20,000 are very good. The initial support for the Dow is about 19,250 but is very light. The most likely target would be 18,850 and the stutter step from mid November after the initial post election bounce.

Because the Dow is being powered by only 10 of the 30 stocks and most of those are very over extended, we could see a significant decline. There was a very active rotation cycle out of tech stocks and into those Dow stocks that led the charge. There is a lot of profit that needs to be captured as the Trump honeymoon rally meets the reality of governing.



The Nasdaq Composite Index broke through two levels of support with a 49-point decline on Friday. The weakness in the big cap techs is dragging both indexes lower. You may remember earlier in the year when the big cap techs were outperforming and leading the indexes higher. That has now reversed and the decline could continue now that we are into a new tax year.

The Composite index could easily retest the early December level at 5,240 and the Nasdaq 100 could retest support at 4,650.




The Russell 2000 small caps led the post election rebound with a gain of 20.1% at the highs. While the index has been volatile the last two weeks it has not yet broken below support. What goes up fast normally comes down fast but that has not yet happened. With many small cap stocks up 30% to 50% since the election there will be profit taking once 2017 opens for trading. The Russell will again be out market sentiment indicator and once it breaks lower, the big cap indexes are sure to follow. Initial support is 1,310 and 1,300.


Just because the pension fund rebalance did not tank the markets, we cannot assume that January will not begin 2017 the same way we began 2016. There is no guarantee there will be selling just like there is no guarantee we will spring past 20,000 at Tuesday's open.

We simply take into account all the reasons why the market may go up or down at any time and there is an abundance of bearish reasons today and zero bullish reasons. However, the market tends to act in the opposite direction people expect in order to make fools out of the most traders possible.

With everyone leaning bearish for January, it might not take much to create a monster short squeeze. While I do not expect it, that possibility always exists.

I strongly suggest that readers not initiate new long positions for the first couple days and let the market pick a direction for us to follow. The New Year has 52 weeks in which to trade. We do not have to jump in on the first couple of days without any clue as to market direction.

 



 

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Random Thoughts


There was an interesting switch last week. When investors should have been turning more bearish they actually turned less bearish. In typical contrarian fashion investors tend to be the most bullish at market tops. This survey ended on Wednesday.

Last week results


The home market received a once in a generation gift in 2015. The yield on the 30-year treasury fell to 2.1% in July and mortgage rates were at lifetime lows. Despite that volatility, the 30-year yield closed up only 5 basis points for the year. The 2015 closing yield was 3.01% and the 2016 close was 3.06%. Most analysts believe the post election yield bounce will fade and homebuyers will get one more chance at low rates in 2017. The expected low yield is in the 2.75% to 2.80% range. If you have not yet refinanced this would be the time to do it.



The year 2016 saw us lose a large number of entertainers. Every year takes its toll but it seems like 2016 was especially harsh.

Carrie Fisher
Debbie Reynolds
George Michael
Prince
David Bowie
Glenn Frey
Maurice White
Leon Russell
Leonard Cohen
Merle Haggard
Doris Roberts
Garry Shandling
Patty Duke
Alan Thicke
Anton Yelchin
China
Gene Wilder
Florence Henderson
Garry Marshall
Morley Safer
Nancy Reagan
Harper Lee
Zsa Zsa Gabor
Muhammad Ali
Alan Rickman
John Glenn
Abe Vigoda
Arnold Palmer

As we get older, we need to take special care of our health. Our families depend on us and with a little extra diet and exercise, we can extend our lifespan by several years. That could mean meeting an extra grandkid or two, being less of a burden to our children or even staying out of a retirement home.

Instead of wishing you a simply Happy New Year, I would like to extend that to a long string of Happy New YEARS!


 

Enter passively and exit aggressively!

Jim Brown

Send Jim an email

 

"The time of maximum pessimism is the best time to buy and the time of maximum optimism is the best time to sell."

John Templeton