Thank the biotechs for Tuesday's rally as acquisition fever takes hold.

Market Statistics

The surprise announcement of multiple acquisitions and potential acquisitions sent the pharmaceutical sector soaring on expectations for more in the future.

Allergan (AGN) spiked $22 after Valeant Pharmaceuticals (VRX) and Bill Ackman's Pershing Square Management teamed up to make a hostile offer for AGN. Valeant previously offered $40 billion and was turned down. Today Valeant is offering $48.30 in cash and 0.83 VRX shares for every share of Allergan. That values AGN at $153 or $46 billion at the close on Monday. AGN closed at $141 on Monday. However, shares spiked to $164 today after VRX rallied +$9 on the announcement so that suggests VRX may have to sweeten the offer. Investors are bullish on the deal since both companies rallied strongly. Ackman owns 9.7% of Allergan.

Looking at the chart it would appear somebody knew about the pending offer a couple days before the announcement. Shares rallied from $116 to $140 over the last week. Call volume for AGN was eight times normal on Monday. You can be sure the SEC will be looking into that.

Valeant acquired more than 25 companies in 2013 and the CEO said today they expect to acquire more than 25 in 2014. This means almost every biotech/pharma company saw a bounce in their shares as the speculation surged on who would be the next target.

Also making headlines in the sector was a three way deal between GlaxcoSmithKline (GSK), Eli Lilly (LLY) and Novartis (NVS). Novartis agreed to buy GSK's cancer-drug business for $14.5 billion plus up to $1.5 billion more if certain milestones are met. Novartis agreed to sell its vaccine business to GSK for $7.1 billion plus royalties. The two companies also agreed to team up on a consumer health business where Novartis would own 36.5% of the joint venture with an expected $10 billion a year in revenue.

Novartis was not yet done. The company agreed to sell its animal health division to Eli Lilly for about $5.4 billion. Lilly has been hard hit by patent expirations and has been spending a lot of money developing new animal health drugs so the deal was a positive for Lilly in reducing competition and giving them a larger menu of offerings.

Shares of Lilly declined -$1, Novartis gained $1 and GSK rallied $2.

The musical chairs in the drug sector started the market off to the upside and we had a pretty good short squeeze rally going until late afternoon. The closing sell off knocked -50 points off the Dow to leave it with a 65 point gain. The Nasdaq benefitted from the pharma buzz and closed only -10 points off its high with a +40 point gain.

The economics continued to improve with the Richmond Fed Manufacturing Survey for April rising from -7 to +7 to put it back into expansion territory after two months in contraction. New orders were bullish with a jump to +10 after two months in contraction territory at -9. Backorders were not so bullish. Backorders rose slightly from -13 to -9 but they have been in contraction territory since last August. The employment component rose from two months at zero to +4. Expected new orders declined -9 points to 22 but still decent. Spring weather appears to have produced a strong improvement in the Richmond district. However, the Richmond Services Survey declined from +5 to +1. The prior three months of Dec-Feb averaged -1 so it was still a minor improvement. However, if you exclude retail services the headline number declined to -3 and contraction.

The Richmond Manufacturing Survey has a rocky and highly volatile past. Until a new trend develops I would not apply too much importance to the monthly moves.

Existing Home Sales for March declined for the third month to 4.59 million, down from 4.60 million. Sales are running at the slowest rate since June 2012 and are down -7.5% from March 2013. The conditions impacting sales are higher mortgage rates, higher home prices, very tight credit rules and the severe weather in Feb/Mar.

On the bright side the months of supply rose from 5.0 to 5.2 with the number of homes up +3.1% over the same period in 2013. Average prices are up +7.9% over March 2013 but that is down from +9% in February. The average sales price rose from $188,300 to $198,500. Distress sales are slowing and are not having the same impact on the market as they did in 2012-2013.

The calendar for the rest of the week is light and headlined by the New Home Sales on Wednesday and Kansas Fed Manufacturing on Thursday. The real attention will be on earnings.

More than 31% of the S&P 500 reports earnings this week. So far 20% of the S&P has already reported with 63% beating estimates, 15% meeting estimates and 22% missing expectations. The big names for Wednesday are Apple, Facebook and Boeing. Thursday is the busiest day of the week with more than 250 reports.

Netflix (NFLX) surprised last night with subscribers rising to nearly 49 million and shares rose +$24 today to close at $373. Earnings of 86 cents beat estimates by +3 cents. Revenue rose +24%. Netflix added 4.0 million subscribers in the quarter. The company said it was going to raise prices $1-$2 on new subscribers in selected regions in Q2.

Harley Davidson (HOG) posted earnings that rose +18.7% to $1.21 compared to analyst estimates of $1.07 and the comparison quarter at 99 cents. Revenue rose +11% to $1.57 billion. Motorcycle sales rose +3% to 35,730 and this was a very bad quarter for test driving motorcycles in snow, ice and rain. They reiterated guidance for shipments to rise between 7-9% for the year. Q2 shipments are expected to rise 9-15% to 92,000-97,000, up from 84,606 in Q2-2013.

Pentair (PNR) said earnings more than doubled to 73 cents and that was in line with estimates. However, revenue declined -3% to $1.73 billion and -9% in their largest division. Shares of PNR declined -7%.

After the bell Juniper (JNPR) reported earnings of 29 cents that met analyst estimates. Revenue rose +10% to $1.17 billion. The company said carrier orders were rising to accommodate an increase in Internet traffic. Phone service providers provide more than 65% of Juniper's revenue. The CEO said the company was accelerating out of the recession and "the best days are ahead of us." Shares were flat after the report.

Amgen (AMGN) reported earnings after the close that declined -25% on higher costs. Earnings of $1.87 missed estimates of $1.94. Total operating expenses rose +13%. Revenue rose +7% to $4.52 billion. Marketing costs rose sharply while prices received for drugs declined as copycat "biosimilar" drugs invade their marketplace. Research and development costs rose +17%. Sales of Enbrel, their number 2 drug, declined -5%. Shares fell -$2 after the report.

Gilead Sciences (GILD) posted earnings of $1.48 that beat estimates by 56 cents. Revenue was $5 billion including $2.27 billion for their new drug Sovaldi. Analysts were only expecting $1.13 billion for that drug. The 12 week course of treatment costs $84,000 or roughly $1,000 per pill. However, the drug cures Hep C in almost 100% of cases. About 30,000 patients have already started on the medicine. This is the fastest launch of any drug in history. It was approved for sale in December. This suggests the full year sales could be huge. Analysts now expect full year sales of Solvaldi could be near $12 billion. Chronic Hep C affects 3.2 million Americans. Investors had expected earnings to beat so the stock only gained $2 in afterhours after a +1.26 gain in regular trading. It was halted for trading for most of the afterhours session. Analysts now expect Gilead to earn close to $10 in 2015 so any reasonable PE puts the stock well over $100.

YUM Brands (YUM) posted strong earnings that rose +18% to 87 cents compared estimates of 84 cents. The company reiterated its forecast for earnings growth of at least 20% in 2014. Same store sales in China rose +9%. Sales at KFC rose +11% and Pizza Hut rose +8%. China is their largest market. This compares to McDonalds sales in China rising +6.6%. The conference call will be Wednesday morning. Shares rose +$3 to $80.20 and a new 52-week high in afterhours.

Dow component AT&T (T) reported earnings after the close and the market was disappointed. The company reported earnings of 70 cents compared to estimates of 70 cents. Revenue rose +4% to $32.5 billion. AT&T added 1,062,000 wireless subscribers. AT&T has been pushing wireless subscribers into higher end plans with larger data limits but at reduced prices. Investors were not excited. Shares declined $1 in afterhours.

Wynn Resorts (WYNN) rallied +11.65 after credit numbers from Macau suggested affluent VIP gamblers were getting around the government regulations limiting cash play in Macau. Visitation is up +8% QTD compared to 4.4% in 2013. WYNN will report earnings after the bell on Thursday.

The market rallied sharply at the open on the merger and acquisition news and a decent short squeeze was triggered. That lasted until about noon and buyers evaporated. The S&P rallied to strong resistance at 1,885 and came to a dead stop at 1,884.89. In theory we should expect to see a minor decline before we take another run at that resistance. Buyers will want to see how the market reacts to that dead stop at resistance before they add to positions.

Support is now 1,870 and 1,865 so a minor dip will find support really quickly. If we do move over 1,885 it should trigger significant short covering and that should immediately test the prior high resistance close at 1,890.90. We are very close to either a new high or a dramatic climax to the rally ahead of the sell in May cycle.

The Dow is showing a similar pattern only the January highs are at the same level as the April highs. This produces even stronger resistance at that 16,580 level. The Dow has rebounded +500 points from the April 11th low at 16,016 and that is a huge stretch for buyers to keep the rally going through strong resistance.

A triple-top reversal pattern is three equal peaks created over a 3-6 month period followed by a failure of support. All three highs should be relatively equal and well spaced to clearly define the resistance level. After the third high volume should increase to the downside as traders throw in the towel.

While nobody can ever predict in advance the potential is certainly there for the Dow. With the seasonal "sell in May" cycle only a week away we have the potential for a triple top failure. I would be very cautious on any further gains until the Dow moves well over that resistance. Support is now 16,400.

The Nasdaq benefitted greatly from the biotech rebound and acquisition speculation in the sector. The $64 question is how much higher can the biotechs push the index with solid resistance ahead. Despite the strong rebound from the 3,950 low last week the Nasdaq is still well below the relative levels seen in the Dow and S&P. The Nasdaq and the Russell 2000 are still the weakest links. Both have significant resistance well below their prior highs.

In the biotech list below ISRG was up +$11.22 at the close. After the close they reported earnings are declined from $422 to $387 and that will drag on the Nasdaq at the open. Earnings declined -77% and they cut their forecast for growth in robotic procedures. Adjusted earnings were $2.67 compared to estimates of $3.29.

Gains at the close

Real-time aftermarket numbers

After all the earnings hits and misses after the close were netted out the S&P futures are down only -1 point. I would have expected the futures to decline a little more given the hard stop at resistance but we did have more positive surprises than negative in the post close earnings.

I was surprised with the rally so far this week. I thought the charts over the weekend were bearish and evidently others did too since the short squeeze this morning was a surprise. I would remain cautious until the Dow and S&P make new highs. We could very easily rally up to those levels this week thanks to earnings and then collapse as we near May 1st.

Enter passively, exit aggressively!

Jim Brown

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