Those bullish analysts that were upgrading their S&P yearend estimates a month ago are probably wishing they could have their old estimates back.

Market Statistics

A sure sign of a market top is a flurry of previously bearish analysts suddenly upgrading their forecasts to higher and higher numbers. Add in the bullishness surrounding the irrationally exuberant Alibaba IPO and a market top was born.

Alibaba IPOed on September 19th and that was the exact market top with the S&P hitting 2,019 intraday. We speculated in these pages before that event that the bullishness surrounding the IPO was extreme and events like that tended to occur at market tops.

In the week just prior to the IPO multiple analysts upgraded their bearish S&P targets to bullish targets well over 2,000. Stifel Nicolaus went from 1,850 to 2,300, Wells Fargo from 1,850 to 2,100, S&P Capital from 1,985 to 2,100. The best call was Mr Belski at BMO Capital on Sept 9th when he affirmed his 1,900 estimate saying the bullish outlooks were overrated.

Obviously there are still 2.5 months left in 2014 and anything can happen but you have to think the majority of those analysts with recent bullish upgrades would love to have their old estimates back.

Shaded entries are recent upgrades.

The market is crashing for four reasons. The first is the need for some profit taking after the huge gains over the last two years. Second is a surge in earnings warnings. Third is the end of QE in three weeks. Fourth is the economic implosion in Europe with Mario Draghi talking a big game but then a no show when it comes time for him to bat.

Markets don't need a reason to correct. They operate on the herd concept. When the big guys start taking profits and restructuring their portfolios the herd sees the declines and a stampede begins. Sometimes there is an event that triggers the profit taking but once the snowball begins rolling down hill it is hard to stop.

Once that stampede begins to pick up speed every news headline adds more urgency to the selling. The correction becomes a self perpetuating event. Eventually somebody will either call a bottom OR we will get the much hoped for washout event on high volume where decliners are 10:1 over advancers and a capitulation event is formed.

We are not there yet. Everyone is pointing to the 200-day average on the S&P at 1,905 as the potential bottom. Unfortunately unless the news headlines improve it may only be a temporary pause.

Traders were trying to go home flat on Friday until S&P lowered its rating on France from stable to negative saying the economic outlook is weakening. They left the credit rating at AA but the negative rating means it could be lowered in the future. S&P said that government deficits will take up a larger portion of the country's GDP, which is only expected to grow at +2%. That is a downgrade from their prior forecast of 2.5%. When the news broke late Friday afternoon the selling accelerated into the close. The downgrade simply confirmed the negative economic headlines out of Europe that weighed on the markets all week.

China was starting to creep back into the headlines after a series of weaker than expected economic numbers. It is almost a certainty that they will be forced to lower their growth forecasts for 2015 if the weakness continues.

With Europe sinking fast, China worsening, the truce in Ukraine failing, the Persian Gulf in a war and western Africa consumed with Ebola there is little to really be bullish about. Q3 earnings are expected to grow about 6% but Q4 guidance is fading fast.

The only economic report on Friday was the Import and Export prices for September. Import prices fell for the third consecutive month with a -0.5% drop. Weakness in imported oil and gasoline prices were responsible for the majority of the decline. Ex-petroleum prices only declined -0.2%. The higher dollar is also weighing on import prices and this will force consumer prices lower in the coming months. Inflation will probably come in below the Fed's target and push their decision timeframe for rate hikes farther into 2015.

The economic calendar for next week is weighted towards the end of the week. Monday is a government holiday and there are no reports. Tuesday is also light but Wednesday and Thursday pick up the pace.

The most important reports are the Fed Beige Book on Wednesday and the Philly Fed Manufacturing Survey on Thursday.

One new split announcement this week with SYNT added to the list.

The story for next week is the beginning of the Q3 earnings cycle. This is a big week for financials with dozens reporting led by JPM, WFC, C, BAC, GS, AXP, PNC, COF, SCHW, BK, CMA, HBAN and MS. This is our best hope for a market rebound. If the financials beat the street and have positive guidance we should see the indexes recover.

Tech stocks are also prominent. INTC, EBAY, NFLX, GOOG, SNDK and IBM will report. After Friday's chip warnings by MHCP the sector was decimated. If Intel, IBM and Sandisk post positive results it could produce some dip buyers.

Microchip Technology (MCHP) warned that sales for Q3 would be in the range of $546 million compared to July 31st guidance of $560-$576 million. They blamed weakness in demand from China. September is normally a strong month overall and especially from China. This year the CEO said those sales in China did not appear. Since China is where the majority of electronic consumer goods are manufactured the decline in chip orders suggests a drop in the global demand for consumer goods.

MCHP did not just warn about its slowing sales. They issued a much stronger warning that the industry was moving into a correction. Here is the text from their press release.

Microchip often sees the turn of the industry ahead of others in the semiconductor industry. First, in contrast to many others in the industry, we report sales from distribution on a sell-through basis worldwide. We built a significant amount of inventory in the distribution channel in the September quarter. If, like many others in the industry, we recognized sales on a sell-in basis to our distributors, our sales would have been significantly higher for the September quarter. Second, Microchip does business with over 80,000 customers worldwide, most of whom are small and nimble and are able to adjust their demand in real time. We believe that another industry correction has begun and that this correction will be seen more broadly across the industry in the near future.”

Citigroup translated the warning like this. "In semiconductor speak, an inventory correction occurs whenever demand drops off for a moderate period of time and can occur during economic expansion or contraction. Inventory corrections typically last 2-3 quarters with a step-down in demand and reduced visibility. The economic impacts are lower sales and margins."

MCHP declined -12% to $40 but the impact of the warning was felt all across the sector. The Semiconductor Index ($SOX) fell -7% to levels not seen since April.

Chip stocks not related to China were also hit. High flyer Ambarella (AMBA) a major producer of video chips for things like the GoPro camera was knocked for a -13% loss even though their demand is very strong. This MCHP warning in a bearish market produced a flush reaction to everything chip related. When the smoke clears there will be plenty of bargains.

Bucking the market trend was Exact Sciences (EXAS) after Medicare said it would cover the Cologuard diagnostic test effective immediately. The test uses DNA from stool samples to spot potentially deadly tumors and growths. Medicare coverage is key since the majority of patients in need of the test are elderly and on Medicare. Colon cancer is the second leading cause of death in the USA with 50,000 expected this year.

Also in the biotech sector Gilead Sciences (GILD) said the FDA had approved its new Hep-C pill called Harvoni with a $94,500 price tag for a 12-week treatment to cure Hep-C. The pill combines the drug Sovaldi with another drug, Ledipasvir that eliminates the need for two older side-effect-laden treatments that needed to be taken along with Sovaldi. Hepatitis C is a viral disease that infects 3.2 million Americans and up to 100 million globally and leads to liver failure. If you don't take the drug you either die or have a liver transplant. Both of those outcomes are more expensive than the $94,500 price tag. Another treatment produced by Johnson & Johnson combines the drug Olysio with Sovaldi costs $130,000 for 12 weeks. Gilead is expected to sell $12 billion in Hep-C drugs in 2015 and that will go up in 2015. It is the highest first year sales ever for any drug. Shares of GILD declined slightly on price backlash and the weak market.

Darden Restaurants (DRI) found out what happens when they go against shareholder wishes. Activist investor Starboard Value won all 12 seats on the board in a shareholder vote. A board sweep is extremely rare especially when there were incumbents in the company recommended slate. However, there have been two other occasions recently with the ALCO board and the Morgan Hotel's board.

Darden operates Olive Garden, LongHorn Steakhouse and several other chains. The company said it was going to sell its Red Lobster chain last year and it produced an immediate shareholder backlash. Darden went ahead and quickly sold the Red Lobster chain at a bargain price despite the uproar from shareholders demanding they hold off on the sale until other alternatives were considered. The quick sale including thousands of prime real estate parcels caused a shareholder revolt that was completed when Starboard gained all 12 seats to replace the entire board. The Darden CEO that forced the sale of Red Lobster is clearly on his way out. The CEO of Starboard showed up at the shareholder meeting and introduced himself saying there would be a seamless transition in management. Starboard has an 8.8% stake in Darden. They are planning on spinning off the Capital Grille and Yard House chains.

Darden shares were slightly lower on the news but it was a bad market.

Earnings guidance has not been good. Since October 1st twice as many companies have given negative guidance (26) than positive guidance (13). In the same period 23 companies have guided in line with prior estimates. In the month of September there were 32 companies with positive guidance, 80 with inline guidance and 41 companies issued negative guidance. We are just now starting the real earnings parade and it will be interesting to see how many warn on Q4. The initial results have not been good.

October Guidance


There is definitely a lot to analyze this weekend. The return of volatility has been huge. Since the September 19th high the Dow has had 11 directional moves totaling 3,559 points. The total loss for that period has only been -805 points from the high. That is a -4.5% decline and hardly a significant correction. It is the back to back 200+ point moves that make it seem like a really ugly market.

Everybody is focused on the 200-day average on the S&P-500 but the Dow closed -48 points below its 200-day at 16,544. There was not even a blip in the direction when it passed the 200-day at 16,592. The Dow is not really sensitive to moving averages but it is still important to watch from a sentiment perspective.

The next support point on the Dow is 16,368. The Dow has gone negative for the year with a -0.2% decline.

The S&P crashed right at the close with $800 million in stocks for sale on the NYSE and it settled at 1,906 and the low for the day. That is a two month low and below the 1,909 low from August but above the 1,904 intraday low. The 200-day is 1,905 and the convergence of all these numbers should at least slow the decline temporarily. However, it has been 685 days since the S&P tested the 200-day average. We were well overdue. The 125 day average has been good support since late 2012 and it was broken last week.

The advance-decline line on the S&P is in free fall and approaching the August and June lows. This is confirmation of an increasingly oversold condition.

Only 24% of the S&P-500 stocks are currently trading over their 50-day average. This is also approaching the 2014 lows at 23% and the November 2012 low at 21.8%. Over the last three years the S&P rarely remained this oversold for more than a few days at most. While it is entirely possible we could become more oversold we are testing the recent support levels on the A/D. Nothing prevents us from becoming significantly more oversold. In August 2011 when the debt ceiling battle was underway the number of stocks trading over their 50-day average fell to only 2 out of 500.

The Nasdaq suffered its first 2% back to back losses in 3 years to put it at a four month low. The tech index has given back all its gains for the year and is in danger of going negative for the year with only a +2.39% YTD gain as of Friday's close.

All the near term support levels have been broken and the next material support is 4,250 followed by 4,040. Only 16.4% of the stocks on the Nasdaq are above their 50-day average. That is the smallest amount since the August 2011 debt ceiling decline when only 5% were over their 50-day.

The Nasdaq is in crash mode. The warning from Microchip Technology on Friday that "We believe that another industry correction has begun and that this correction will be seen more broadly across the industry in the near future" crushed the tech sector and has the potential for further significant damage. It is one thing to say your sales were down but to say an industry correction has begun is a much more drastic warning. For this reason I believe the Nasdaq has more weakness ahead.

The Nasdaq A/D line is in free fall and at the lowest point in 2014.

The Russell 3000 broad market index ($RUA) has broken below the 200-day and rapidly approaching its last level of major support at 1,110. If this level breaks we could easily see a drop to 1,050 or below. This is the 3,000 largest stocks in the market so in reality it IS the market.

The Russell 2000 has imploded. It broke below multiple prior support levels and is now in uncharted wilderness. It is -12.8% below its 1,208 high in July. It has passed correction levels and appears headed for bear market levels at 966. There is no material support between Friday's close at 1,053 and that level other than possible round number support at 1,000. This is as bearish as it gets for the small caps. They continue to lead the broader market lower.

As I wrote this commentary I vacillated back and forth from expecting a rebound to expecting further declines. The indexes are very oversold on a relative perspective. With the Dow and S&P down -4.5% from their highs it is hard to say they are very oversold but relatively speaking they are on a short term basis. On a long term basis they could be just getting started. The Russell 2000 appears to be headed for bear market territory and there is no reason to believe the big cap indexes will not follow the Russell at least to correction territory.

Volume has been increasing over the last week from a low of 6.3 billion shares on Monday to a high of 9.1 billion on Friday. The A/D ratio was 6:1 decliners over advancers on Thursday but only a little over 3:1 on Friday. That would seem to suggest we are starting to see some dip buyers in the market. However, light buying on a Friday after a big drop could only be shorts covering positions before the weekend. There is also the matter of the $800 million in order on close orders to be sold on Friday. It is very unusual to have large block sell orders of that size on a Friday close. Where they afraid of the weekend events? I doubt it. I would bet they are afraid of the market overall and they were hoping to sell into the normal short covering that occurs on Friday afternoons.

For the market to close at multi month lows and on its lows for the week on a Friday is very bearish. There is nothing to prevent a rebound next week and we are oversold enough that any positive headline could cause a bounce. I believe that bounce would be sold.

The odds of the 200-day average on the S&P being broken next week are very high but that is not the end of the world. It would be positive for us to have a break below that 1,905 level by just a few points for a couple days and then rebound back over it. However, a major breakdown by 20 points or so would probably mean a retest of 1,850-1,865. We don't want to go there but we are not in control.

Keep those stop losses in place and be very picky about buying this dip. The end of every QE to this point has caused significant declines and this time we have Europe, China, Russia and the Middle East all in economic decline. The U.S. may still be the best house on the block but the other houses are on fire.

Random Thoughts

More than 200 years ago the United States declared war on Muslims after more than one million Americans and Europeans were captured by the Barbary states led by Tripoli and sold into slavery. Tripoli, the largest city in Libya, along with Algiers, Tunis and Morocco, commonly called the Barbary Coast, were the scourge of the Mediterranean. Capturing merchant ships and enslaving or ransoming their crews provided the Muslim rulers of those cities with wealth and naval power. The scourge was so bad that many nations and powers were forced to make annual payments to those countries to ensure the safety of their ships.

When the U.S. became independent they no longer fell under the protection of Spain or England. U.S. merchant ships immediately fell prey to the Muslim pirates and their crews held for ransom. In 1785 each of the four coastal states demanded $660,000 each as ransom and for protection against future attacks. In 1795 Algiers was paid over $1 million for the release of 115 American sailors. That amounted to one-sixth of the entire U.S. budget. They demanded annual tribute to prevent any future attacks.

The number of attacks and ship seizures were so bad that the U.S. was forced to form the U.S. Navy in 1798 to prevent future attacks and end the demand for tribute from the Muslim states.

In 1785 Thomas Jefferson and John Adams went to London to negotiate with Tripoli's envoy, Ambassador Sidi Haji Abdrahaman. When they asked the ambassador from the Barbary States why they made war on nations that had done them no injury and the ambassador replied:

It was written in their Koran, that all nations which had not acknowledged the Prophet were sinners, whom it was the right and duty of the faithful to plunder and enslave; and that every mussulman (Muslim) who was slain in this warfare was sure to go to paradise."

Jefferson and Adams returned to the U.S. and after conferring with congress decided to continue paying more than $1 million a year for the next 15 years for the safe passage of American ships and the return of American hostages. During this period the U.S. Navy rapidly increased its shipbuilding, training and provisioning with the intent of taking the war to the Muslims in the Barbary States. When Jefferson was inaugurated as president in 1801 the Pasha of Tripoli demanded an additional payment of $225,000 per year from the new administration. Jefferson refused and sent the new navy to wage war against the Barbary States.

One of the many battles around Tripoli in 1805 caused the phrase "From the shores of Tripoli" to be memorialized in the Marine Hymn. Marines aboard the navy ships wore heavy leather collars when they went into battle to prevent the Muslim pirates from beheading them with their scimitars when they boarded their ships. Thus the term "leathernecks" would be applied to the Marines.

The U.S. Navy along with the Swiss Navy blockaded Tripoli and eventually forced them to surrender in June 1805. After they withdrew from the region Algiers immediately began taking American ships and seamen hostage again under the same pretense given by the Tripoli Ambassador in 1785 and demanding annual tribute to the Muslim nation. The Navy went back to Algiers in 1815 and ended the practice with multiple naval victories that decimated the Algiers fleet.

Link to Description of the First Barbary War

I included this bit of history to show that the ISIS problem is not new. We have been fighting their religious intolerance for hundreds of years. It is a death by a thousand cuts. In America the Muslims have brought about women-only classes and swimming times at taxpayer-funded universities and public pools; that Christians, Jews, and Hindus have been banned from serving on juries where Muslim defendants are being judged, Piggy banks and Porky Pig tissue dispensers have been banned from workplaces because they offend Islamist sensibilities. Ice cream has been discontinued at certain Burger King locations because the picture on the wrapper looks similar to the Arabic script for Allah, public schools are pulling pork from their menus, and on and on. I firmly believe that every Muslim has the right to live in peace wherever he chooses. However, I believe everyone else has a right to live in peace as well and free from the constant onslaught of complaints.

America has freedom of religion. Every person is free to worship as they choose. This freedom should not be seen as the right to force your views on everyone else around you. This political correctness in every form has got to stop.

U.S. Southern Command warns about the potential for Ebola in Central and South America. The commander of the U.S. Southern Command warned last week that if the disease gets into Central American countries like Haiti, Guatemala, Honduras or El Salvador the results will be dramatic. They will not know what it is or how to combat it and they will not have the resources to prevent its spread.

Once it begins spreading and people are dying "they will run away from Ebola, or if they suspect they are infected, they will try to get into the United States for treatment" according to General John Kelly. "There will be a mass migration to the United States."

He warned about transnational criminal networks that smuggle people and those people can be carrying Ebola. Kelly spoke of visiting the border of Costa Rica and Nicaragua with U.S. embassy personnel. At that time there were groups of men "waiting in line to pass into Nicaragua and then on their way north" he recalled. "The embassy personnel asked who they were and they told him they were from Liberia and they had been in transit for about a week. They met up with the network in Trinidad and now they were on their way to the USA," illegally of course. Kelly said "those men could have made it to New York in another week and still be in the incubation period for Ebola."

This is an even bigger reason for securing the southern border. Not only are the border patrol agents catching ISIS travelers according to California Representative Duncan Hunter, a member of the House Armed Services Committee, but a mass migration of people fleeing Ebola will easily overwhelm existing border agents. Hunter said at least ten ISIS fighters have been apprehended by border patrols but that agents have been prohibited from discussing it publically. The Dept of Homeland Defense issued a statement on Thursday saying that claim was "categorically false" but Hunter is sticking by his claims.

The Ebola patient in Dallas died but it appears to be spreading to other cities. In Spain 7 more people turned themselves in to an Ebola isolation unit in Madrid after coming down with the symptoms to bring the total to 14. A French national has contracted the disease from travel in Africa. Brazil has its first case with a 47-year old man originally from Guinea.

Germany will need a miracle to avoid a recession after exports fell by 5.8% and the largest decline since January 2009. The German economy posted a -0.2% decline in GDP in Q2 and the odds are very good the Q3 numbers will be dramatically worse. Imports also declined by -1.3%. Germany is the strongest economy in the euro zone and this is a bad omen for the future of the EU.

IMF director Christine Lagarde warned that Europe is in danger of a Japan-style "lost decade" unless EU members pull together to fend off the threat of recession. The IMF said there was a 40% chance of an EU recession, the third since 2008.

Global shipping rates on the world's busiest route from Asia to Europe fell -10.2% to $738 per container. This is the fourth weekly drop and the lowest level since October 2013. The Baltic Dry Index of shipping rates declined to $963 and well below the $2250 high for the year. This is a period when holiday shipping should be in full swing but demand is very light.

China has its own epidemic of Dengue Fever, which is transmitted by mosquitoes. The unseasonably warm weather has pushed the mosquito population to five times the normal level. More than 27,200 people have been infected thanks to hot humid weather and the dense population. The disease thrives in the tropical mega cities and it may only be getting started with more than 1,000 new infections per day. This is the worst outbreak in more than two decades and it is spreading. Japan reported its first outbreak in 70 years with most people catching it at the popular Yoyogi Park in Tokyo.

According to Bloomberg and Dow Jones the S&P-500 companies are poised to spend $914 billion on share buybacks and dividends in 2014. That is roughly 95% of earnings. Money distributed to shareholders exceeded profits in Q1 and are poised to do it again in Q3. Share buybacks have doubled over the last decade while capital investments have shrunk. Eventually these companies are going to be forced to increase profits because you can only buyback so many shares to improve earnings per share.

The market rallied last Wednesday after the FOMC minutes contained the following statement. "a number of participants noted that economic growth over the medium term might be slower than they expected if foreign economic growth came in weaker than anticipated, structural productivity continued to increase only slowly, or the recovery in residential construction continued to lag.

Traders immediately thought that meant it would be a very long time before the Fed raised rates. There was even talk of QE4. By the next day with economic data coming out of Europe continuing to be negative, that Fed worry suddenly turned into fear of a European recession dragging the USA back into recession and stocks plunged. You can't have it both ways. Either the economy is improving and rates will rise or the economy is starting to weaken and stocks may crash.

The Defense Dept is going to request up to $40 billion a year to fight ISIS. This is after they spent $4-$6 trillion for the Iraq and Afghan wars. Currently the DoD is spending about $10 million a day but rapidly increasing. The Afghan war totals will continue to rise after Joe Biden's pledge to get out of Afghanistan "come hell or high water by 2014" died when President Obama signed a deal last week to leave troops in the country until "at least" 2024. The DoD has spent more than $100 billion more than expected in 2014 so far.

Tyrel Oates, an employee at Wells Fargo, emailed the CEO John Stumpf asking for a raise. He copied more than 200,000 other employees on the email. Tyrel said Wells Fargo should give every employee a $10,000 raise to show they care about their employees. In his email he said employees should not ask for a raise but demand the raise. Tyrel has been with WFC for 7 years and makes $15 an hour. As of Friday afternoon he was still employed.

For the number junkies out there here is a good article that explains all the bad economic news from around the world last week. Gloom Spreads Over Markets

The U.S. Forest Service is finalizing plans on requiring permits to take pictures on public lands. Permits would cost up to $1,500 even if you are only using your smartphone. Fines for taking a picture without a permit would be as high as $1,000. I am not kidding. Forest Service $1,500 Picture Permits

Mutual fund performance is going to be lousy for Q3. Expect a disappointment when you get your fund statements. Expect Disappointment

Kim Jong-un failed to show up for a key celebration last week and further triggered speculation he may no longer be in power. He failed to show up for the 69th anniversary of the founding of the Korean Workers Party. He was last seen in public on Sept 3rd. The government now says he injured his leg doing a military drill with his troops. That has the majority of reporters rolling on the floor laughing. Severely overweight, chain smoking, Kim, doing combat field exercises with the troops? Not hardly.

The State Dept upgraded their warning over a possible ISIS attack.

The Department of State remains concerned about the continued threat of terrorist attacks, demonstrations, and other violent actions against U.S. citizens and interests overseas. On September 22, 2014, the United States and regional partners commenced military action against the Islamic State of Iraq and the Levant (ISIL), a designated terrorist organization in Syria and Iraq. In response to the airstrikes, ISIL called on supporters to attack foreigners wherever they are. Authorities believe there is an increased likelihood of reprisal attacks against U.S., Western and coalition partner interests throughout the world, especially in the Middle East, North Africa, Europe, and Asia.

Extremists may elect to use conventional or non-conventional weapons, and target both official and private interests. Examples of such targets include high-profile sporting events, residential areas, business offices, hotels, clubs, restaurants, places of worship, schools, public areas, shopping malls, and other tourist destinations both in the United States and abroad where U.S. citizens gather in large numbers, including during holidays.

U.S. citizens are reminded of the potential for terrorists to attack public transportation systems and other tourist infrastructure. Extremists have targeted and attempted attacks on subway and rail systems, aviation, and maritime services. In the past, these types of attacks have occurred in cities such as Moscow, London, Madrid, Glasgow, and New York City.

Canadian authorities recently broke up plans to attack a crowded shopping mall. The terrorists had done walkthroughs and planned on how they were going to mow down shoppers on escalators and in the food courts.

I would plan my holiday shopping in the off hours if you have to go to a mall and try to do most of it online.

Only 74 shopping days until Christmas.

Enter passively and exit aggressively!

Jim Brown

Send Jim an email

"There are no secrets to success. Don't waste your time looking for them. Success is the result of perfection, hard work, learning from failure, loyalty to those for whom you work, and persistence."

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