On the surface companies may be reporting better than expected earnings but expectations were really low. Sales revenue is continuing to be a serious challenge and lower revenue eventually leads to lower earnings. The rising number of revenue misses is causing some investors to move to the sidelines.

Market Statistics

The AAII Investor Sentiment Survey hit a milestone this week. The proportion of individual investors that described their six-month outlook as neutral is above 45% for the second consecutive week. This is the first time in more than 26 years that has occurred. This last occurred on January 27th, 1989. Neutral sentiment has now been above the historical average of 30.5% for 15 consecutive weeks. Investors with a bullish outlook rose to 32.1% but still below its historical average of 39%. Bearish sentiment declined to 22.8% with the historical average at 30.5%.

More than 22% of respondents said events in the Middle East were affecting their market outlook. Another 19% said events in Europe were a concern with the strong dollar bothering 15% and the global economy another 11%.

Apparently the permanently bullish individual investor is reconsidering his outlook but they have not turned bearish. They are confused about where the market is headed given the geopolitical issues and the weak earnings and guidance. This is especially evident in the choppy trading and low volume.

The news today that a high frequency trader in the UK was arrested for causing the Flash Crash in May of 2010 could be a new reason for traders to fear the market again. Navinder Singh Sarao was arrested and charged with 10 counts of commodities fraud, 10 counts of commodities manipulation, wire fraud and one count of spoofing. The U.S. is requesting extradition to the USA. The CFTC also filed civil charges calling him a "very significant player in the market."

Sarao is thought to have made $40 million from his scheme to crash the futures market. The complaint say Sarao used an automated trading program to manipulate the market using the E-Mini S&P-500 futures contracts on the Chicago mercantile Exchange (CME) while trading from his home in London.

The trader used a layering strategy where his program placed multiple high volume sell orders at different prices to make it look like there was a large volume of orders being dumped on the market. This causes other traders following the market move to sell their positions and begin to short the market. His phony orders were modified or replaced 19,000 times during the crash and covered 20 million contracts. The rest of the global market only traded a total of 19 million contracts on May 6th. His multiple orders to sell were placed at several ticks under the actual market but close enough simulate actual trades when they disappeared as actual trades dipped to his spoofed price.

He has continued trading and spoofing the E-Minis over the last 5 years but with smaller volume. However, the CFTC claims he engaged in market manipulation and spoofing on about 400 days between 2010 and into 2014. Even with his lowered trade rate he was the fifth largest trader of E-Mini's in the world. Spoofing was made illegal in the 2010 Dodd-Frank legislation. The CFTC said there are probably others doing this same thing today. "If there was one, there can be hundreds. Why can't there be hundreds of people doing this same thing all over the world?" While regulators don't blame Sarao for the entire crash they do believe his spoofing caused other large institutions and high frequency trading programs to dump large orders into the market. The 2010 SEC report blamed a single large trade from Kansas's Waddell & Reed Financial for setting off the crash. After today's arrest that claim is likely to change.

Waddell & Reed's computers triggered a sale of 75,000 S&P futures contracts when the market began to crash as part of a strategy to hedge an existing equity position. The value of that order was $4.5 billion. The algorithm was programmed to sell the E-Minis so that the sell volume was only equal to 9% of the total volume, calculated over the previous minute. The high volume spoofing artificially inflated the global volume by triggering program trades globally. That rapid spike in volume allowed the Waddell & Reed program to sell the 75,000 contracts over a period of less than 20 minutes. Over the prior 12 months a sell program of that size had been triggered only twice and neither time did it cause a major market disruption. In the flash crash the rapid acceleration of the selling in the E-Minis caused the cross-market arbitrageurs to rapidly liquidate equivalent positions in the underlying equities. Selling volume increased more than 1000% in only a matter of minutes.

Since institutions and funds can own thousands of contracts of the S&P futures as part of their investment strategies, a sudden downdraft in those futures can trigger automated sell programs. One event leads to another and the crash was born.

The picture below is the "home" of "Nav Sarao Futures Limited" west of London.

Bill Gross made news today by claiming that German debt is now the "short of a lifetime." The 10-year Bund was yielding .94% on Tuesday morning, up +19.8% from Monday as a result of the Gross comments. The shorter German maturities either already have a negative yield or very close to it. Gross said it was only a matter of time before the trend would reverse. Once the ECB halts its QE program or even begins talking about halting it as the Fed did with its taper, the debt will be sold hard as money rotates back into risk assets. Gross is anticipating a 10-15% return over a 1-2 year period. Doug Kass said last week, "Near zero to negative sovereign debt yields in Europe represent the bubble of all investment bubbles, dwarfing even the Nasdaq bubble of 16 years ago. Mark my words I will make a fortune shorting these bonds at some point in time...probably much sooner than later."

The economic calendar had only one entry today and it was a lagging indicator. The regional employment report showed that unemployment declined in 23 states and Washington DC in March. Another 15 states were unchanged with 18 states showing employment increases. The states with the biggest declines had the strongest ties to the energy sector. Analysts claim more than 100,000 energy workers were laid off in Q1. For instance, Texas lost -25,400 jobs, Pennsylvania -12,700 and Oklahoma -12,900. The report was ignored.

The calendar for Wednesday has Existing Home Sales and Thursday is New Home Sales. Those are the high points for the rest of the week. The Kansas Fed Mfg Survey is of interest but likely to be ignored.

The calendar that matters for the rest of the week is the earnings calendar. There are several large cap techs and Dow components to report and continued earnings misses could sink the market.

Harley Davidson (HOG) reported earnings of $1.27 that beat estimates for $1.25. Revenue declined to $1.67 billion from $1.73 billion but still beat estimates for $1.58 billion. However, shares dropped hard after the company said shipments would decline because of heavy discounting by competitors. Harley said they were not going to compete with the strong discounts and shipment growth would grow only 2-4% in 2015, down from prior estimates for 4-6% growth. In Q2 they expect to ship between 83,000-88,000 motorcycles, down from 92,217 in the same quarter in 2014.

United Technology (UTX) reported a +20% rise in earnings to $1.58 but the strong dollar knocked them down to $1.51. Analysts were expecting $1.45. Revenue fell -1% to $14.5 billion and missed estimates for $14.9 billion. The company blamed the weakness on the continued currency headwinds. UTX reaffirmed its full-year outlook for earnings of $6.85-$7.05 and analysts are expecting $6.98. Shares initially rallied to $119 but fell back to close at $107 and a fractional gain.

Lockheed Martin (LMT) posted earnings of $2.74, down -6% from $2.87 in the year ago quarter. Analysts were expecting $2.48. Revenue of $10.11 billion missed estimates for $10.21 billion. The company said revenue was down because fewer airplanes were delivered and the impact of the dollar. Shares declined fractionally.

Under Armour (UA) reported earnings of 5 cents that matched analyst estimates. Revenue rose +25% to $804.9 million and barely beating estimates for $802 million. However, revenue from apparel, their largest product category, rose only +21% compared to +30% in the comparison quarter. The company said gross margins would be flat after previously saying they would improve. The dollar was to blame. They are projecting a 23% rise in sales in 2015 and that would be the lowest since 2009. Shares of UA declined -5%.

After the bell Yahoo (YHOO) reported a -60% drop in earnings to 15 cents that missed estimates for 18 cents. Revenue of $1.04 billion also missed estimates for $1.06 billion. CEO Marissa Myer said, "Yahoo is amidst a multi-year transformation to return an iconic company to greatness." Unfortunately she has about three more quarters to accomplish that feat or she will be replaced. The Yahoo board is not favorable to leaving a CEO in place that can't make the changes needed. She has already had 2 years and historically 3 is about the limit for troubled companies. Myer increased costs by about $500 million a year since she has been in charge.

Display advertising revenue fell -7% and the price per ad declined -17%. On the bright side search revenue rose +20% with search volume at a five-year high thanks to a partnership with Mozilla. Yahoo received 43,000 job applications in Q1. Yahoo signed a new agreement with Microsoft that allows either company to terminate the search partnership at any time starting later this summer.

After falling -15% in afterhours shares recovered to end slightly positive for the session.

Amgen (AMGN) reported earnings of $2.48 that beat estimates of $2.10. Revenue of $5.03 billion rose +11% and beat estimates of $4.91 billion. The company said strong performance of Enbrel and Prolia helped power the gains. The company raised full year revenue guidance to $21 billion. Shares of AMGN rose +$4 in afterhours.

Chipotle Mexican (CMG) posted earnings of $3.88 that beat estimates for $3.66. However, revenue of $1.09 billion missed estimates for $1.11 billion. Same store sales rose +10.4% but that was less than estimates for +11.8%. Same store sales averaged a +16.8% increase in 2014. The company only reiterated the same guidance it gave last quarter and said they were still struggling to find more pork and that was limiting sales in some areas. Shares declined about -$36 after the report.

They are probably going to have trouble finding chicken in the months ahead. More than 7.8 million chickens have been killed because of exposure to the bird flu. More are expected as the virus is transmitted by wild birds from state to state.

YUM Brands (YUM) reported earnings of 80 cents compared to estimates for 72 cents. Revenue of $2.62 billion missed estimates of $2.64 billion. Same store sales in China declined -12% but analysts were expecting -14.4%. They are still suffering from a meat sourcing issue where a supplier sent them out of date meat products. Same store sales declined an average of -16% in 2014. YUM has 6,700 stores in China, which are mostly KFC and Pizza Hut stores. Shares of YUM rallied +$3 after the report.

VMware (VMW) reported earnings of 86 cents on an 11% increase in revenue to $1.51 billion. That was the slowest revenue growth in seven quarters. Analysts were expecting 84 cents and $1.5 billion. They blamed the strong dollar for impacting overseas sales. Shares initially declined more than $2 in afterhours but rebounded to close flat.

Gilead Sciences (GILD) spiked $4.50 on a call by Bernstein for the company to buy Vertex (VRTX). Gilead has a surplus of cash but their Hep-C franchise is not going to last forever. Bernstein said buying Vertex would give them a pipeline of new drugs. Bernstein expects Gilead's cash inflows to decline 30-40% between 2017-2021 as its drugs go off patent. Vertex has a promising Cystic Fibrosis drug called Cayston and the commercial infrastructure to capitalize on it. Gilead has more experience in developing multiple drug combinations and that would be needed to take Cayston to the next level. This is another high dollar drug that sells for $250k-$300K per year for the average patient. Bernstein did their homework and pointed out several associated drugs that Gilead and Vertex could combine to create a longer lasting franchise.

Gilead only has a PE of about 10 today despite the huge inflow of cash from their new Hep-C drugs. They could easily afford Vertex even if they had to pay a hefty premium. Maxim's Jason Kolbert disagreed with the Bernstein analysis saying Vertex is already fairly valued and there are better CF drugs in the pipeline from other companies. This is what makes a market. Gilead shares rallied +$4 and VRTX +$6.65.

In other biotech news Perrigo (PRGO) said it would not accept Mylan's (MYL) $29 billion offer. Mylan offered to buy Perrigo for $205 per share in cash and stock. Perrigo said the offer was too low and did not value the company's assets correctly as well as the benefits from the recently closed Omega acquisition.

Mylan is also under attack as Teva Pharmaceuticals (TEVA) offered to pay $82 per share for Mylan. That values the company at $40.1 billion and a 21% premium over Monday's closing price. If Teva is successful in its hostile bid for Mylan it would create the dominant global generic drug company. It would be the largest in the world and be able to dramatically cut costs by demanding concessions from suppliers. In the U.S. 7 out of 8 prescriptions are filled with generics. Mylan markets more than 1,800 generic drugs.


Despite the Nasdaq's gain of +19 points thanks to the biotech news, Tuesday was not a good day in the markets. Monday's "inside day" where the highs and lows were inside the highs and lows from Friday was due purely to a short squeeze. There was no follow through today and volume was very low. In fact the volume on Monday was only 5.6 billion shares and today was 5.8 billion. Investors are definitely pulling back from the market and there are multiple reasons.

Weak earning will get most of the blame but the market technicals are still deteriorating. The market has failed to recapture the highs made in February and each attempt has resulted in a lower high. Since the October rebound culminated just after Thanksgiving at 2075 on the S&P the market has traded sideways with severe fits of volatility. Normally when there is prolonged volatility the market ends up with a directional move. Here we are five months later and today's close was only 22 points above the 2075 post Thanksgiving close.

As I wrote at the beginning of this commentary the majority of investors are confused and have turned neutral on the market. Every failed rally kicks a few more undecided traders to the curb to wait for a direction. At the risk of repeating myself we need a correction in order to clear the cobwebs and set the market up for a new move. However, a correction going into the summer doldrums risks setting us up for the same lackluster market action several months from now only at a lower level.

The S&P is struggling at the 2100-2110 level. The opening spike this morning topped out at 2109.64 and it was immediately sold with the index ending the day only 3 points off the low for the day.

Friday's dramatic drop gave us a clear support level at 2075 and the action over the last two weeks has given us a clear picture of resistance at 2100-2110. Until these levels break the market is trapped in neutral with no direction.

The Dow was dragged lower by Travelers (TRV) after they posted a -14% decline in earnings of $2.55 that match some estimates. Revenue of $6.63 billion missed estimates of $6.78 billion. The company tried to offset the negativity in the stock by announcing the addition of $5 billion to their stock buyback program. It did not help and Travelers shares declined -4.26 to knock about -32 points off the Dow.

Dupont (DD) reported earnings of $1.34 that beat estimates for $1.31 but revenue of $9.17 declined -9% and missed estimates of $9.41 billion. Their forecast worsened with the company saying the strong dollar would now knock 80 cents off full year earnings compared to the previous 60 cent forecast. They now expect earnings to come in at the low end of their prior forecast. Shares declined -$2 and knocked another -15 points off the Dow.

The index spiked to strong resistance at 18,100 at the open and it was immediately sold. The selling persisted all day to close near the lows. With another round of Dow components reporting on Wednesday the outlook is not much better. Even if they do report positive earnings there will be continued drag from those already reported including GE, GS, IBM, DD, TRV, INTC, VZ, etc.

Resistance remains 18,100 with support at Friday's lows at 17,750.

The Nasdaq Composite posted a +19 point gain thanks to the rally in the various biotech stocks. Only about 5 of the top 25 gainers were in a different sector. This enabled the Nasdaq to close back over 5000 but right in line with the highs from last week. Can the Nasdaq move to new high with only one sector contributing the gains? Yes, as long as those gains continue to be outsized moves. The instant the sector takes a rest the index could crash if there is no positive help from another sector.

Fortunately the semiconductors are starting to show life but resistance on the $SOX is right at 710 and today's high. It will be a tough job for the chip stocks to take over the leadership without a catalyst to drive them. In the biotechs we are seeing potential acquisitions almost every day but not so in the chip sector.

Resistance on the Nasdaq remains 5026 with initial support at 4950.

The small cap Russell 2000 has lost its mojo. The index has failed to recover last week's high at 1275 and today's action was lackluster with a fractional loss. They are not selling them off yet but investors have definitely quit buying. If the Russell declines below 1250 and support from Friday it would indicate the game has changed and we should begin forecasting a steeper drop.

I remain neutral on the market. I am not ready to pull the plug and turn bearish but there are far more bearish stocks than bullish stocks today. In researching for the other newsletters yesterday I looked at more than 800 individual stock charts. The vast majority were showing a bearish trend. If that majority continues to broaden and the number of stocks leading us higher begins to dwindle then we will eventually move lower.

You have to ask yourself today, "Why buy?" What reasons do investors have to be bullish on the market? Earnings are a negative. Economics are weak. The Fed meeting is next week and while they are not likely to raise rates they will definitely talk about raising rates in the near future. If they name June as a potential date the market will not react well. The market is projecting September or longer. The geopolitical events of Greece, Iran, Yemen, Russia, Ukraine, etc are still clouds over the market.

They say bull markets climb a wall of worry. If they do it over the next couple weeks it will be rock climb rather than a simple wall of worry. I continue to recommend holding a minimum number of long positions and keep your stops tight.

Remember, the market never goes in the direction you expect and when it does decide to move it moves in a hurry. Also, the market does not need a reason to correct.

Enter passively, exit aggressively!

Jim Brown

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