The low volume post holiday trades are over and 2014 begins for real on Monday.

Market Statistics

2014 is off to a rocky start but we really can't project any trend for the month based on the last two days. The volume was mediocre and the markets were volatile and we traded down for the first time since 2009 in the opening days of January.

The selling was light and was most likely due to tax selling of winners now that the calendar has rolled over. Those waiting to take profits until the new tax year were free to exit and put the money to work somewhere else. The majority of the stocks sold on Thursday were the high flyers and momentum stocks. There were a few losers sold as well but it was mostly the winners.

The Nasdaq was the hardest hit since tech stocks were up +38% in 2013. Apple lost $20 over the two days and Priceline -$31 to lead the losers list. The Nasdaq 100 closed at the low of the day at 3,538.

The indexes finished mixed on Friday with time spent in positive and negative territory. The Dow was up +70 at one time and slightly negative in early afternoon before finishing with a +28 point gain after losing -135 on Thursday. The S&P closed right on support at 1,831 from Thursday and showed no signs of dip buyers.

The Russell 2000 did rebound from the -13 point pounding on Thursday to gain +5 today. That is a positive for market sentiment. That suggests fund managers were nibbling at the small caps ahead of the weekend and that could be bullish for next week.

The news was sparse on Friday since the majority of investors were still taking down the holiday ornaments and cashing in their gift cards instead of paying attention to the markets. The economics were mostly ignored.

The ISM New York was positive with gains for the fifth consecutive month. The headline index rose from 608.5 to 615.4. The six month outlook rose from 69.6 to 73.2 and the highest level in a year. Employment rose from 50.8 to 55.1. However, the current conditions component declined from 69.5 to 63.8 but that 69.5 level was a three year high.

This was a decent report but it was not a strong report. The financial sector in New York has yet to recover because of the tens of billions in fines and penalties and the huge amount of new regulations coming out of the recession. Once the mortgage cloud passes we can expect the banks to become more profitable and employment to pick up again. Until then the New York economy will continue to creep higher as long as de Blasio, the new mayor of New York, is ineffective in passing new regulations that limit business expansion and employment. He launched his term on Wednesday with an assault on income inequality and promises to end that trend. Good luck with that since corporations will move if the business environment becomes onerous.

Vehicle sales for December declined sharply to a pace of 15.4 million per year compared to the 16.4 million pace in November. More important was the total sales for the year at 15.6 million units. This was the highest level since 2007.

GM sales declined -6.3% in December, Toyota -1.7%. Ford sales rose +1.8% for the best year since 2006 and Chrysler +5.7%. Analysts were quick to blame the weather in December for the decline in sales but in reality November sales were very strong but Black Friday weekend sales were extremely strong. It is more likely the sales were pulled into November by discounts, rebates and good weather.

Foreign car sales were very strong. VW sales rose +22.7% and Mercedes had record sales in December of 33,007, up +17.3% bringing the full year total of 312,534, up +14%. Jaguar sales rose +20% for the year and +17% in December. BMW had 37,389 sales in December to push full year sales up +8.1% and a record for the company.

The strong December sales by foreign car makers kind of kills the idea that it was weather that slowed sales by GM and Ford.

News from China also put a cloud over the markets with the nonmanufacturing purchasing managers index falling from 56 in November to 54.6 in December. That was the lowest since August. The manufacturing PMI declined from 51.4 to 51.0. The Markit manufacturing index fell from 50.8 to 50.5. The trio of lower than expected economic reports caused the Asian markets to sell off hard and that carried over to the U.S. on Thursday.

Economic intensity will increase next week with the arrival of the various employment reports. The ADP report on Wednesday is expected to show a gain of +200,000 jobs compared to 215,000 in November. The Nonfarm payrolls on Friday are expected to show a gain of 195,000 compared to 203,000 in November. Analysts are expecting the November number to be revised higher. However, the headline number for December could be +/- 100,000 jobs because of the seasonal adjustments and the fluctuations in the holiday labor force.

The Nonfarm number will be the key for the FOMC meeting at the end of January. A sharp increase in jobs could accelerate the taper process and a sharp decline could put the taper on pause so the Friday number will be critical.

The FOMC minutes on Wednesday are also important since they will give analysts some more color on how the taper decision was made at the December meeting. That will help them forecast the future taper decisions.

Philly Fed President, Charles Plosser, a voting member on the FOMC and a hawk, said on Friday the Fed must be ready for a rapid tightening program as the Fed unwinds its $4 trillion balance sheet. He said "We like to believe that everything is going to be gradual, everything is going to be smooth, and everything is going to be hunky-dory. History does suggest that he Fed, as an institution, is oftentimes late when it comes to tightening." He said the Fed has the technical ability to unwind the stimulus quickly but it will need "sufficient willpower" to tackle the task of removing the $4 trillion in stimulus. Plosser's comments weighed on the market Friday morning.

Ben Bernanke gave what could be his last speech as Chairman on Friday afternoon and took questions from the audience. The market rallied slightly ahead of the speech on hopes he would throw the market a parting bouquet. He did not do the market any favors and the indexes sold off into the close. Most of the questions he was asked had to do with the technical reasons for implementing QE during the early stages of the recovery. He reiterated again that deflation was the biggest worry when QE1 was implemented.

He spent some time discussing the "audit the Fed" legislation and why it would not work. He said the GAO has 100% access to everything the Fed does with one exception. In the 1970s Congress exempted the Fed from giving the GAO access to the rate decision process. The idea was to prevent Congress from using the GAO to show up the day after a rate decision and demand all the documents and transcripts of the meeting so they could oversea the decision process and potentially criticize it. That would have prevented the Fed from being an impartial and independent entity and Congress rightly took that action in the 70s. Other than that the GAO has 100% access to all Fed records and there is no need for the audit the Fed legislation.

He said the headwinds holding back the U.S. economy may be abating and leaving the country poised for faster growth. "The combination of financial healing, greater balance in the housing market, less fiscal restraint and continued monetary policy accommodation bodes well for the U.S. in coming quarters. The economy has made considerable progress since the recovery officially began some four and a half years ago. Of course, if the experience of the past few years teaches us anything, it is that we should be cautious in our forecasts."

The Senate is expected to confirm Janet Yellen on Monday as the new Fed Chairman. Bernanke could resign almost immediately to clear the way for Yellen to plan for the late January meeting. Officially she would take over on Feb 1st but a Bernanke resignation could accelerate that event. With Plosser and Richard Fisher both voting members in 2014 and both dissenting hawks that want to tighten stimulus faster, she will have her work laid out for her to develop a consensus that is more in line with her dovish goal of no rush and the gradual removal of stimulus.

In stock news Intel (INTC) is said to be planning an announcement at next week's Consumer Electronics Show in Vegas of a dual OS laptop that can run the Windows or Android operating systems. That would be a huge plus for Intel as the only company with a dual offering. With the Android market growing so quickly but the Windows market still the choice for business this could be a strong announcement. Intel shares were flat on the news but still closed near a 52-week high.

Apple is rumored to be close to announcing a 12 inch iPad with the functionality of the MacBook Air and the same spirit as Microsoft's Surface tablet. It will be aimed at the enterprise buyers.

The Federal Trade Commission handed investors a poison pill on Friday when it announced a press conference for next Tuesday to describe a new attack on deceptive claims made by providers of weight-loss products. The FTC did not name any specific company but shares of Herbalife (HLF -2.74), NuSkin (NUS -5.66) and USANA Health (USNA -1.67) took a tumble. All sell nutritional supplements and weight-loss products. Nutrisystems (NTRI) ended the day flat after early morning gains. Weight Watchers (WTW) also rebounded to end slightly positive.

The FTC may not even be targeting these companies and instead the smaller over the counter products like Hydroxycut, Jenny Craig, Slimgenics, Flat Belly, Medifast, Zone or Dukan Diets. There are literally hundreds of diets, pills, drinks, cleanses, etc that compete for advertising space with pictures of petite women and hunky men and promises of quick results. I suspect the FTC is pointed at the hundreds of those competitors rather than NUS and HLF but we will have to wait until Tuesday to find out.

NuSkin has been on a vertical ascent in 2013 and it needed to see some profit taking so the Friday decline could be a buying opportunity if the FTC news is not directed at them.

Herbalife has seen a lot more volatility thanks to the war between Ackman and Icahn. The decline only knocked it back to support at $77 and no harm done.

Security firm FireEye (FEYE) rallied +35% after announcing it was acquiring computer forensics specialist Mandiant Corp for $1.05 billion. Analysts were very upbeat about the deal and said it would give FireEye a giant leap up in the network security sector. The announcement added $1.7 billion to FireEye's market cap so it was real win for shareholders.

Mandiant specializes in telling companies who broke in to their computers and what information they stole. FireEye systems detect malicious software and alerts administrators of the attacks. The combination of the two companies expands the addressable market for FireEye from $11 billion to $30 billion. Goldman raised their price target on FEYE to $45 but they had already spiked to $55.

Sprint (S) received some hate mail on Friday with Steifel Nicholas and S&P Capital IQ both cutting their ratings from hold to outright sell. Sprint had been up over the last couple months on merger news and the analysts now believe the company is overvalued. Give the +80% gain over the last three months that was probably a good call.

Wells Fargo downgraded Apple (AAPL) from outperform to market perform based on declining margins. The analyst felt all the good news was already priced into the stock and with the entrance into the China Mobile market the margins were going to get squeezed. The most popular smart phones in China sell for about $170 while the Apple phones will be in the $775 range. In order to offset the import duties and competition Apple is going to be forced to lower its prices. The analyst also believes the iPhone 6 to be launched later this year will also carry a lower price tag to compete with Samsung and the dozens of new Android models out every year. The iWatch is reportedly already in production and is experiencing multiple production problems. This will raise costs and shrink margins according to Wells Fargo. The Apple TV is also expected to have low margins in order to compete in a very tough field. Televisions are typically low margin products and they last forever compared to a cell phone. The low turnover is going to be a challenge for Apple.

Carriers are currently moving to shrink or eliminate subsidies for phones. This is another margin crusher since without a carrier subsidy the $775 iPhone is priced out of the market compared to the Androids. That means cheaper models and lower margins. On the flip side the China Mobile deal could add another 40 million units to iPhone sales. That is a definite needle mover even if the margins are slightly lower.

Google's Motorola Mobility unit dropped the price of the Moto X with 16 GB of memory to $399 without a wireless contract, down from $550. That puts it below the top line devices made by Samsung like the Galaxy S4 which costs $600 at Verizon. The iPhone 5s at Verizon is $650. The Moto G starts at $179 with no contract. This is another example of why Apple's prices are eventually going to get cheaper and margins shrink.

Mining equipment maker Joy Global (JOY) was cut from neutral to sell at Goldman on "significant commodity and equipment over-supply." Goldman said the capex cycle for miners was about 10-years and had just run its course with a +500% increase in spending and $200 billion in debt to finance it. Goldman said current levels of supply and deterioration suggested order levels were sustainable but not enough to push earnings higher. They saw an 11% downside risk and recommended an outright sell on Joy. Shares were off -$3 from Tuesday's close.

3D Systems (DDD) rallied to another new high after they said they were acquiring Gentle Giant Studios, the leading provider of 3D modeling for the entertainment and toy industry. Gentle Giant has been in business for 20 years developing state of the art content using 3D scanning and modeling to develop and manufacture licensed 3D printed characters, toys and collectibles. Brands they produced for included Marvel, Disney, The Walking Dead, Avatar, Harry Potter and Star Wars. This gives 3D Systems a strong consumer platform and retail experience to leverage 3D Systems future products. Shares rallied $2 on the news to close at $96. Needham liked the deal and raised their price target to $100. Can you say too little too late?

I wrote Tuesday about an alleged advance by an unknown activist at Hertz (HTZ). Shares were up on a poison pill adopted by the board and news two other hedge funds had acquired a stake. On Friday we learned it was Carl Icahn that had accumulated as many as 40 million shares. The poison pill kicks in at the 10% ownership level and 40 million shares would be about 8% with 449 million shares outstanding. So far Icahn has not disclosed his stake but multiple news sources are naming Icahn as a result of leaks in the market. Reportedly some of his stake has been acquired using swaps and options which don't have to be reported when certain thresholds have been reached as the rules require with stocks.

After the bell Liberty Media (LMCA) offered to buy the 48% of Sirius XM it does not already own. It would be an all stock deal valued at more than $10 billion. During the financial crisis Liberty made a multimillion dollar loan to Sirius in exchange for a large equity stake. Since then Liberty has increased that position to 52%. In 2012 Liberty took control of Sirius and forced Mel Karmazin out. With Liberty's initial $1 billion investment now worth $11.5 billion the proposal to acquire the remaining 48% would make Liberty the sole owner of a $21.5 billion company. The stock swap would give current SIRI shareholders a 39% ownership in the common stock of Liberty Media. An analyst on the conference call asked if they planned to spinoff SIRI in the near future. Liberty's CEO Greg Maffei said, "This was an unusual time to be asking that question, but nothing could be ruled out." Liberty has already spun off Discovery Communications, Starz and Direct TV. As Liberty Media how do you recover the $11.5 billion you have invested in SIRI? Do you buy the other 48% and then do a clean spinoff? Stranger things have happened. Shares of SIRI popped to $3.75 in afterhours. The value of the stock swap is about $3.68. SIRI shares traded as high as $4.18 in October.

The energy sector took a dive in 2014 after the price of oil imploded over the last week. WTI fell from nearly $101 on December 27th to close at $93.96 on Friday. The decline came on the heels of another train wreck carrying oil from the Bakken. The wreck and explosion caused U.S. regulators to warn that oil shipped from the Bakken and other shale production areas could be more flammable than regular oil and more dangerous to ship by rail. Shale oil has a greater gas content making it more flammable.

Just a few years ago only about 60,000 bpd was shipped by rail. With the sudden availability of shale oil in places where there are no pipelines the producers and refiners have increased the rail capacity to the point where about 800,000 bpd is shipped by rail today.

If the government suddenly issued new regulations on shipping oil or mandating the types of cars and various safety components the shale oil business could come to a screeching halt. About 17,000 of the 80,000 existing rail cars are the newer double insulated type with stronger walls and crash panels at the front and back of the car. If the government suddenly mandated that only that type of car was suitable it would be a disaster. It would take years to produce the number of new cars needed and billions of dollars. Refiners on the east and west coasts would be forced to buy Brent crude and costs would rocket higher. They currently buy Bakken crude for as much as $10 less than WTI prices.

The drop in WTI was seen as hurting the earnings of the oil producers and new regulations would slow drilling dramatically. This pushed much of the energy sector lower even though the weekly oil inventory report showed a drop of 7 million barrels for last week. That brought the inventory decline to -30.8 million barrels over the last five weeks.

Cooler heads are sure to prevail and any new regulations are sure to have a long lead in period. Surely lawmakers will understand the potential damage from aggressive regulations.

Every week I read literally hundreds of articles on the economy and the market in my quest to project where the market is going in the coming weeks and months. Some are only several paragraphs and some are lengthy tomes penned by other analysts and companies like Goldman Sachs, Bank of America, JP Morgan. This week JP Morgan produced a Guide to the Markets for Q1 that has every conceivable data point you can imagine in charts and tables. It is well worth reading if you want to know where the market and economy is today compared to prior periods. They left no stone unturned. Guide to the Markets

One chart I am sharing here showed the fund flows into equities since 2009. Note that only the last six months had any material flows into equities. With interest rates rising the money that fled equities for the bond market over the last four years is going to be reversing and returning to the equity markets. Remember, There Is No Alternative or TINA. Where are investors, funds and money managers going to put money to work if the bond market is going to be a bear market over the next several years? Equities or commodities and I would bet the majority of the money goes to equities.

Sam Stovall, chief equity strategist at S&P, had these comments last week. Mid-term election years have higher than normal occurrences of 5%+ declines. The 2nd and 3rd quarters are typically the weakest in mid-term election years and the weakest of the entire 16 quarter election cycle. More than 40% of declines greater than 5% occurred in mid-term years. This year the "sell in May" strategy could return with a vengeance. Tapering will inject uncertainty. It has been 27 months since our last correction and the average span is 18 months.

S&P Capital IQ warned of the potential for a significant pullback in 2014 but remains broadly bullish. They reiterated the history that the year after a great year is normally a good year BUT involves significant retreats along the way. Since 1945 the S&P has posted 21 years of gains of more than 20%. The average gain the next year was 10%, with the index up 78% of the time. However, EVERY one of those "good" years saw drops of at least 6% and up to -19.3%. Four of those years triggered new bear markets.

Pepperdine University just released a study on market reaction during the election cycle. The typical S&P return during mid-term election years has been 5.3% with substantial pullbacks, corrections or outright bear markets not at all uncommon.

Craig Johnson, technical market strategist at Piper Jaffray said since 1930 pullbacks during the mid-term election years have averaged -17%. "However, we believe that this pullback will unfold AFTER the S&P hits our interim target of 2,000 early in 2014 and the market will end higher by year's end. Johnson predicted a 1,850 target for the S&P in 2013 well before the majority of his peers.

Art Cashin at UBS is expecting a drop of 3-5% in mid January and warns that a decline could be a troubling harbinger since January direction typically determines the path for the year.

With geopolitical events heating up around the world there is always the potential for a black swan event where something unexpected causes a volatility event in the markets. The suicide bombings in Russia ahead of the Olympics are a prime example. Even with 40,000 security personnel it is very hard to prevent a determined suicide bomber(s) from causing serious damage. When you get that many people crowded into one location it is a target rich environment.

Al-Qaeda linked militants captured Fallujah over the weekend despite attempts by the Iraqi military to stop them. The military used artillery and aircraft and reportedly killed 55 militants but they have not yet retaken the city. The militants seized military equipment left by the U.S. and used it against the Iraqi military. Militants also captured the al-Mazraa military camp near Fallujah after heavy fighting. More than 40 civilians had died and scored more injured in the fighting. The U.S. pledged to send more helicopters, missiles and surveillance drones.

In Egypt at least 17 people died in fighting between Mursi supporters and the Egyptian military. The Muslim Brotherhood called for protests yesterday and violence flared in Cairo, Alexandria, Fayyoum and other provinces.

The Thai Baht fell for the 11th consecutive day on Friday to hit 32.955 to the dollar and the worst level since March 2010. The SET Index fell -5.2% and the biggest opening day decline since Bloomberg began compiling data. A decline in the Thai Baht led to the collapse in Long Term Capital Management in 1998 and forced the Fed to structure a $3.6 billion bailout to keep the market from collapsing. The Russian debt default also contributed to the disaster. The company had assets of $5 billion and had borrowed $124.5 billion with 25:1 leverage and had accumulated $1.25 trillion in off balance sheet derivatives such as interest rate swaps. The collapse in the Bhat and the Russian debt default caused massive imbalances in those derivatives and LTCM imploded.

No one would have thought that Thailand could cause the collapse of LTCM and nearly crater the U.S. markets. This is an example of unexpected consequences from a world away.

Peace talks broke down in South Sudan as Sudanese troops pushed back an attack by rebels headed towards the capital. In the last two weeks thousands have been killed and hundreds of thousands displaced. The U.S. embassy has recommended that all U.S. nationals leave the country and organized charter flights to take them to a "safe haven" country.

Turkey is on the verge of a civil war with thousands of protestors demanding the resignation of Prime Minister Erdogan. Turkey is a NATO country and key player in the Iraq and Syrian conflicts. The Lira currency hit a record low on Friday with stocks at a 17 month low. The administration has "purged" about 70% of the police force involved in a scandal that has nearly toppled the regime.

Last week interest rates in the interbank market in China surged above 10% for the second time in six months. This is prompting fears of a liquidity crisis that could trigger mass defaults and cripple the world's second largest economy. Add in the declining economic metrics I wrote about earlier and there is something to worry about. The PBOC quickly injected $65 billion into the market to solve the problem temporarily but that is just a band-aid. The investment driven growth model in China is cracking under a mountain of bad debt. Total debt has risen from 125% of GDP in 2008 to 215% of GDP in 2012. Credit has risen from $9 trillion to $24 trillion. The additional $15 trillion is more than the entire U.S. banking system lent out over the last five years. With a large part of their capital tied up in nonperforming loans the only way they can keep the Chinese economy growing is with new debt. In 2013 China's total credit grew by more than 20%. The shadow banking system is reaching critical mass and massive cash injections to keep the interbank system intact will only work so long. There is trouble brewing in China and this could be the liquidity event that eventually crashes the global markets.

Don't forget the current increase in hostilities between China and Japan over the disputed islands and the implementation of a broad ADIZ by China. Each country traded hostile accusations again last week along with pledges to never concede .

Any day an event like one of those above could blossom into a market stopper. While we can't live our lives worried about what the next headline may bring we need to be aware that headlines do arrive. When the market has climbed so far without a major correction that means investors could be operating with a hair trigger in anticipation of a volatility event.

Lastly, Henry Blodgett wrote last week, "Anyone who thinks we need a 'catalyst' for a market crash should brush up on their history. There was no catalyst in 1929, 1966, 1987, 2000 or 2008." Reversions to the mean can and do happen throughout history and wreak havoc on investment plans.

2013 was only the tenth year ever where the S&P was never down for the year for a single day. That has already failed for 2014 with the S&P down .9% for the year.

Next week is going to be critical for market sentiment. If we blast off on Monday as fund managers return to work then tensions will ease and everyone will go back to business as usual and looking for any minor dip to buy. That could last until the Q4 earnings begin to flow and then market direction will depend on those earnings.

If the market drops next week the January barometer will become the centerpiece of attention and everyone will begin to expect the worst. If support breaks at 1,830 on the S&P and the Russell 2000 makes a new low for the year it could be an ugly couple of weeks as profits from 2013 are quickly taken off the table.

In theory year end retirement funds should be flowing into equities next week. Money previously earmarked for the bond market should be flowing towards equities as interest rates creep over 3% on the ten-year treasury.

The S&P has resistance at 1,850 and interim support at 1,830. A break below that uptrend support line could open the way for a significant decline. For now that long term trend line is support and a rebound on Monday would solidify it.

On the Dow the spike through resistance at 16,500 was short lived and that level has reemerged as the level to watch. Support is just slightly below at 16,440 so we are easily within striking range. A break below interim support could easily hit 16,375 and a breakdown there could fall all the way back to 16,000.

The big caps were catching all the fund flows in the week before Christmas as managers parked money for year end. Next week will be the test to see if they leave it parked in those window dressing stocks or retrieve it for use in a late January dip.

The Nasdaq 100 big cap index failed just below 3,600 on two separate days and was followed by a significant decline on Thr/Fri to close at the low of the day. The tech big caps are definitely under pressure. They were the favored vehicles leading up to the holidays and now that money is being withdrawn.

The Nasdaq Composite was slightly stronger than the Nasdaq 100 but has fallen back below the uptrend support. Resistance is 4,175-4,180 and interim support is about 4,075 followed by 4,000. While I don't expect the Nasdaq to drop that low it has shown decent weakness so far in 2014.

The Russell 2000 was hammered on Thursday for a -13 point loss on Thursday but rebounded for +5 on Friday. I view that anemic rebound as slightly bullish. It suggests fund managers were nibbling on small caps on Friday even though volume was light. They saw a dip and bought it even while the Nasdaq indexes were in sharp decline.

On Thursday there was solid support at 1,147 and it was really solid. The initial drop at 11:30 stopped dead on that level and no amount of selling could push it lower. Somebody was defending that level and spent a lot of money to do it. That means 1,147 should be support again next week.

I wish I had a crystal ball for next week. I would love to tell you without a doubt that the market was going higher but unfortunately nobody can do that. Monday will be the determining factor. Everyone will be watching to decide what to do. Whatever happens on Monday will be a strong clue towards the rest of the week. Everyone should be back at work and implementing their plans for January. Let's hope those plans include putting money to work in equities.

Enter passively and exit aggressively!

Jim Brown

Send Jim an email

"While markets often make double bottoms, three pushes to a high is the most common topping pattern."
John Bollinger



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