Multiple negative earnings reports were ignored and the market rallied anyway. We are officially in the Twilight Zone.

Market Statistics

A flurry of Dow components reported earnings today and the results were not good. Despite some sharp declines from those stocks the market rallied anyway and another short squeeze was born. The futures began to rally Monday night after CMG beat earnings by a mile and Netflix failed to disappoint. Hopes for a strong earnings cycle rose and futures rallied. The Dow spiked for the first 40 minutes of trading before flat lining into the afternoon. However, attempts to sell it off into the close eventually failed.

It was a heavy day for economics and most of the data was positive. This added to the premarket futures rally. The Consumer Price Index (CPI) headline number rose +0.3% for June, compared to +0.4% in May. The core rate excluding food and energy rose only +0.1% and in line with estimates. Higher gasoline prices were the major driver of the headline number with a +1.6% rise. Food prices only rose +0.1% and a dramatic decline from the +0.4% average over the last four months.

The core rate of inflation for the last 12 months is +1.9% and the Fed is targeting up to 2.5%. The headline rate is 2.1%, food +2.4% and energy +3.1%. Overall this report substantiates Janet Yellen's claim that the higher inflation earlier in the year was just noise. Longer term inflation is definitely contained.

Existing home sales rallied +2.6% to an annualized rate of 5.04 million units. This is up from 4.91 million in May. This is the fastest pace since October and the severe weather dip has been erased. Home prices are up only +4.3% over the last 12 months. The number of homes for sale are increasing slowly at a +2.2% rate as current owners realize they may not be able to qualify for a loan on a replacement house. Home price appreciation slowed to +4.3% compared to +13% on a trailing 12 month basis for June 2013.

Distressed sales are dropping rapidly as are foreclosures. The share of distress sales dropped to 11% of the total in June, down from 15% in June of 2013. Lower priced homes are shrinking with higher priced homes making up the majority of the homes available on the market. Investor buying is slowing now that prices have firmed and supply of inexpensive homes shrinks.

The separate FHFA Purchase Only House Price Index showed home prices rose +0.5% in May and +5.5% over the trailing 12 month period. This includes new homes as well as existing homes.

The Richmond Fed Manufacturing Survey rose from 4 to 7 for July. The components were mixed and the gain came from the shipments component rising from 1 to 3 and employment rising from 4 to 13. New orders were flat at 5 and backorders rose from contraction territory at -4 to flat at zero. The average workweek declined from 5 to 3 and inventories rose from 8 to 12. Rising inventories suggest consumers are not increasing purchases. The lack of backorders shows a weak order flow and the shrinking workweek suggests part time workers are seeing their hours cut and new hires are coming in under the 30 hour level where health insurance has to be provided under Obamacare. One interesting component was supplier delivery time, which rose from 2 to 12. With all the slack in the economy why is the delivery time rising?

The Richmond Services Survey rose from 9 to 12 for July. The main driver was retail sales revenues. Expected demand for the next six months rose from 10 to 24 and retail demand was expected to rise from 1 to 21. This was a strong report.

The calendar for the rest of the week is light with the Kansas Fed Survey and Durable Goods the only material reports. Of the two the Durable Goods will be the most important because it has a direct impact on the Q2 GDP estimates.

Next week is the FOMC meeting and the next cut in QE. After a tame CPI report there is little worry the Fed will do anything but stay the course and the statement should not contain anything to roil the markets.

Earnings are front and center this week with 12 Dow components and 133 S&P 500 components reporting. Tuesday through Thursday is the most active three days for the earnings cycle.

Dow components were making the biggest headlines and most were not good. Travelers (TRV) reported earnings of $1.93 compared to estimates of $2.07. Revenue rose +2% to $6.79 billion. However, catastrophe losses rose +28% to $436 million. Also today a federal appeals court ruled Travelers had to pay more than $500 million to settle some asbestos related claims stemming from policy holder Johns-Manville.

Travelers does not provide guidance but comments from the CEO seemed to suggest earnings would be pressured for the rest of the year. Shares fell -4% for the day.

McDonalds (MCD) posted earnings of $1.40 compared to estimates for $1.44. Global same store sales were flat with U.S. sales down -1.5%. The company said July comps were expected to be negative. McDonalds is fighting growing competition from places like Five Guys and the addition of sandwiches to the Starbucks menu to name just a couple.

McDonalds warned on Monday a supplier in China shipped them beef and chicken that was out of date and they had to remove some items from the menu and sales were expected to decline as consumers went elsewhere for fast food.

Coca-Cola (KO) reported earnings that declined -3% to 64 cents that beat estimates by a penny. North American volume was flat and global volume rose only +3% thanks to growth in carbonated beverages. U.S. consumers are drinking less carbonated beverages and more water and juices. Sales were actually better because the date for Easter fell favorably into the quarter. That means Q3 could be even worse for sales. The lack of hot weather so far this summer suggests sales could be light.

Diet Coke sales are declining with a drop of up to -2% for the quarter according to JP Morgan. Diet carbonated beverages are declining for everyone as the health negatives become better known. On the conference call the company said consumer skepticism about the safety and quality of artificial sweeteners was weighing on sales. Higher commodity costs related to the juice beverages also weighed on earnings.

DuPont (DD) reported adjusted earnings of $1.17 that were in line with estimates. Revenue declined -1.4% to $9.71 billion and missing estimates for $10.02 billion. The company said weak sales as a result of a wet spring were continuing into Q3. The company warned operating earnings at the agricultural unit would be down -11% in Q3. Sales were expected to decline to $9.71 billion compared to analyst estimates of $9.79 billion. The company said farmers were concentrating on soybeans instead of corn and soybeans made up only 14% of DuPont's 2013 sales.

Altria Group (MO) reported earnings of 65 cents compared to estimates of 66 cents. Tobacco volume declined -5%. The stock declined only fractionally on the earnings miss because they announced a $1 billion stock buyback.

Kimberly Clark (KMB) reported earnings that declined -3.2% to $1.49 per share and in line with estimates. Revenue rose +1.4% to $5.34 billion and slightly better than the $5.31 billion expected. The company narrowed full year guidance to the low side from $6.00-$6.20 to $6.00-$6.15. shares declined -3% on the report.

Harley Davidson (HOG) reported earnings of $1.21 compares to estimates for $1.46. The company also cut full year guidance to 270,000-275,000 bikes compares to prior guidance for sales of 279,000-284,000 bikes. The company blamed the weak Q2 performance on the lingering winter weather that kept people out of the showrooms early in the quarter. However, they sold 58,225 bikes in the quarter compared to 58,241 in Q2-2013. That is not much impact from weather. Shares fell -5.4% on the report.

I think it is strange that they had an 18.7% jump in sales in Q1 when the weather was the worst and blowout earnings of $1.21 compared to estimates for $1.07. So why did Q2 weather hurt them so badly? Can you say, "Convenient excuse."

At the same time Harley was suffering from the cold Polaris (PII) was selling everything in stock. I know it is an unfair comparison since Polaris makes snowmobiles and four-wheelers as well as motorcycles but I could not resist the comparison.

Polaris reported earnings of $1.42 which rose +26% and beat estimates by +3 cents. Revenue rose +20% to $1.014 billion and slightly ahead of consensus. They also raised full year guidance to $6.48-$6.58 per share up from $6.30-$6.45, an increase of 21% on revenue growth of 17%. Analysts were expecting $6.49. North American sales rose +15% in Q2.

Lockheed Martin (LMT) profits rose +3.5% to $2.76 compared to estimates for $2.66. The company also raised full year guidance from $10.50-$10.80 to $10.85-$11.15. Total revenue declined -1% to $11.31 billion due to a decline in U.S. spending. Shares rallied +3% to $168 and the prior resistance high.

After the bell Microsoft (MSFT) reported adjusted earnings of 66 cents compared to estimates for 60 cents. Those comparisons may not be apple to apples. Some analysts did not factor in the impact of the Nokia acquisition and some did. Microsoft said their actual earnings were 55 cents after subtracting 8 cents for Nokia and 3 cents on restructuring charges. Revenue rose +18% to $23.4 billion with $2 billion coming from Nokia. This was slightly ahead of the $23 billion expected.

Microsoft said it was cutting up to 18,000 jobs and would take charges over the next two quarters between $1.1 to $1.6 billion. The new cloud services and software effort produced $4.4 billion in revenue. The company is also benefitting from the end of Windows XP, an OS version that lasted 12 years. They sold $409 million in Surface tablets, 1.1 million Xbox consoles, and 5.8 million Lumia smartphones and 30.3 million lower priced non-Lumia models it is discontinuing.

Shares rose 50 cents in afterhours.

Apple (AAPL) reported earnings that rose +12% to $1.28 and beat estimates of $1.23 on a 6% rise in revenue to $37.43 billion. Revenue missed estimates for $37.99 billion. The rumor of a 4.7 inch iPhone 6 plus a 5.5 inch model probably weighed on iPhone 5 sales in the quarter that totaled 35.2 million. That was a +13% rise in volume but Apple said it would have been more but the leaks from suppliers on the new products ahead restrained sales. If the bigger screens appear as expected it could be an explosive quarter for Apple sales.

iPad shipments totaled 13.3 million and a -9% drop. That is the second consecutive quarter for declining iPad sales. Apple hopes the newly announced partnership with IBM will provide a boost to tablet sales. Apple was granted a patent this week for a "touch screen device to be worn on the wrist" and it will be called iTime rather than the iWatch. This patent makes it even more likely the iTime product will be announced in Q3.

Shares of Apple declined -44 cents in afterhours.

Electronic Arts (EA) announced adjusted earnings of 19 cents compared to estimates for a loss of -4 cents. Shares initially rallied strongly in afterhours but then fell back to earth to close down -30 cents. The company said on the call it had delayed the launch of the next version of "Battlefield" until early 2015. Previously it was expected before the holiday shopping season and this will hurt Q4 sales. The company did reaffirm full year revenue of $4.1 billion and earnings of $1.85 despite the delay in Battlefield. CFO Blake Jorgensen said the company was seeing strong headwinds on sales of products for the older Xbox console while sales for the new Xbox and Sony PlayStation were running 90% ahead of the older models.

Chipotle Mexican Grill (CMG) reported blowout earnings Monday night and the stock rallied +12% today. Chipotle's earnings are a slap in the face to McDonalds. The company sells higher priced fast food and sales are booming. If you have the right menu consumers will beat a path to your door.

The company's same store sales rose +17.3% and they opened 89 new stores so far this year. They currently have about 1,700 stores on their way to 4,000 in the U.S. alone. They expect to open up to 195 stores in 2014. Revenue is expected to rise +25% from the current $4.5 billion to more than $5.5 billion in 2015. Revenue in Q2 rose +26% to $1.05 billion. Earnings increased +24% to $3.50 per share. For comparison YUM Brands reported a 2% increase in Taco Bell's sales and McDonalds reported a -1.5% decline in U.S. sales. Chipotle is showing everyone else how to run a fast food chain.

So far this earnings cycle 23% of the S&P have reported, prior to today, and 66.1% beat on earnings while 22.6% missed estimates. The earnings growth so far has been close to 7% and well over the revised estimates of 3.3% just a couple weeks ago. However, 77 companies have warned on guidance so there are still some problems in earnings world.

Earnings due out on Wednesday include Facebook, Boeing and Gilead with Facebook probably the most watched. Thursday is another big day with numerous high profile reporters and then the announcement calendar begins to fade next week.

Walmart (WMT) said it was cutting back-to-school (BTS) prices by another 10% and increasing the number of BTS products on its website by 30% to 75,000. Walmart is suffering from five consecutive quarters of sales declines and they are pulling out all the stops for this BTS season. Teachers who shop there are eligible for e-gift cards for 10% cash back on 15,000 products. It is the first time Walmart has offered a cash back program. The company estimates teachers spend about $1,000 preparing their classrooms for the fall semester. Half of that comes from their own pockets. WMT shares were down fractionally.

Pershing Square Capital Management's Bill Ackman had a very public humiliation today. On CNBC on Monday he said he was giving a presentation today that would be a death blow for Herbalife (HLF). Ackman has a $1 billion short on Herbalife with an average cost of $40. He has been battling the company in high profile appearances since 2012 and the stock refuses to die.

Yesterday the stock fell -12% after Ackman promised the death blow in his presentation today. He said it will be the most important presentation of his career. Unfortunately he over promised and under delivered. There was no death blow and investors rushed back into Herbalife while he was speaking and pushed the stock up 25.4% for the day. In the middle of his three hour presentation he was told the stock was spiking and he tried to blame it on Herbalife's stock buyback program and the company trying to make him look bad. Shares rallied +14 to $68 and a five-month high.

Trading volume was the most since February 2013 at 98.1 million shares. That is hardly a buyback program in progress. It was a massive short squeeze after Ackman promised on Monday the stock was going to zero. So many people believed him that stock lost -$9 immediately after his CNBC appearance. All of those shorts and probably a lot that were already short were scrambling to exit the stock on the rocket ride higher. Ackman shot himself in the foot with his bragging on Monday and it was a very expensive lesson. In addition to his $1 billion short position he spent more than $50 million on private investigators and undercover operatives to study Herbalife methods. More than 10,000 man hours were involved. All this and no death blow?

Apache (APA) spiked today after Jana Partners said they had acquired a stake worth more than $1 billion and wanted to talk to the board about options. Jana wants Apache to sell off its international holdings and drill only in North America. Apache has sizeable holdings in Egypt, Australia and the Kitimat LNG project in Canada. Apache is already working on selling off non-core assets so this could be a match made in heaven. Shares rallied 4.6% to a new high on the news.

The markets rallied today but it all came in the first 40 minutes of trading. It was a futures related short squeeze and once the indexes hit their highs around 10:10 the volume died and no further progress was made. Total volume was light at 5.2 billion shares and only slightly more than the 4.9 billion on Monday.

The S&P rallied to 1,986 intraday and just a point over the 1,985 level analysts are claiming as strong resistance. That was the high close back on July 3rd. As we move farther into the Q2 earnings cycle and more stocks begin to experience "post earnings depression" after their reports the harder it will be for the markets to move higher. Once a company reports earnings and any short squeeze fades the excitement is over. Traders exit the stock and move to some company that has not yet reported. The prior stock is left to settle to a point where fundamental investors are comfortable adding shares. This post earnings depression can last from a few days to a few weeks and the declines can be substantial.

Since this is the summer doldrums earnings cycle the post earnings depression typically lasts longer because investors are on vacation and not focused on the market. We need to watch carefully for the S&P to weaken. If it is successful in breaking out to a new high the 2,000 level is a natural round number selling point so any forward progress may be limited.

The 62 day streak without a 1% move ended on Thursday.

Support remains 1950-1960 with resistance 1985-2000.

The Dow may have rallied +80 points at the open but that was the high of the day at 17,133. The index moved perfectly sideways until a minor sell program hit about 2:15 but that dip was bought. The Dow remains in its uptrend channel with resistance now the prior high at 17,138 and 17,200.

It was a miracle the Dow rallied at all with the negative earnings events from multiple Dow components. We need to thank Goldman, IBM and Visa for offsetting losses in DD, KO, MCD, UTX and TRV. The gains in the winners came at exactly the right time.

The Nasdaq 100 ($NDX) broke out to a new high but it all happened in the first 30 min of trading. There was no forward progress after 10:AM. This is a new 14-year high but it may be difficult to maintain since Microsoft and Apple both failed to rally after their earnings tonight.

The Nasdaq Composite finally punched above short term downtrend resistance but the gain was a struggle. Initial resistance is 4,465 with the 4,485 closing high from July 3rd the next target. I don't have a lot of faith in the Nasdaq Composite today. There are some high profile tech earnings due out on Thursday but the MSFT/AAPL results tonight may be the equivalent of jumping the shark for those familiar with the Happy Days analogy.

If the Nasdaq Composite falls back into the congestion range around 4,420 it may have a difficult time breaking out again. This current breakout needs to continue tomorrow or investors are going to become discouraged and head for the beach.

The Russell 2000 is struggling. The +9 point gain today failed at the 1,160 resistance level and this would be a good place for the index to roll over and retest the lows from Thursday at 1,131. The Russell rebound from those Thursday lows has been lackluster and we need to see some more excitement here or the index is going to drag the broader market lower.

I have been recommending buying the dips for the last several months. I am starting to worry we may be coming to the end of that trend of successful rebounds. This is summer and the indexes are struggling at the highs. Once the earnings excitement fades we could be in for a slow, choppy decline into August. The next two months are typically the worst two of the year for the markets and while a rally is always possible we need to be on alert for an alternate reality. Markets don't go up forever and it has been more than two years since a 10% correction. Tiptoe lightly through the coming minefield. Reduce your long positions to only those with the best relative strength. We don't want to run from the market but simply manage our risk in case a decline does appear.

Enter passively, exit aggressively!

Jim Brown

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