The Dow closed at a 4-week low with a loss of -56 but the Nasdaq Composite rallied +9 to post a minor gain. One payroll report does not make a trend but the strong jobs gain would seem to suggest the Fed is going to get its wish for a rate hike in 2015.

Market Statistics

The yield on the ten-year treasury soared to 2.438% intraday before fading only slightly to close at 2.4%. The soaring interest rates weighed on equities as fears of a Fed rate hike increased sharply.

European indexes were all lower as the game of chicken with Greece moved into a new phase. The Greek Prime Minister said Greece could never agree to some of the conditions required by the EU Finance Ministers and Greece put off making the June 5th payment to the IMF until month end when 1.5 billion euros will be due and Greece only has 300 million. This is also when the second phase of the Greek bailout expires and the 18 billion in funding still on hold will evaporate if not dispensed. Both sides have some serious objections to a deal but both sides agree a deal must be reached by June 30th. This is a game of political chicken and whoever blinks first loses.

The Shanghai Composite broke out to a new seven-year high at 5,023 on Friday as the China bubble continues. The Chinese market is now trading at an average PE of more than 50. This is a bubble in search of a pin but that may not happen for some time because of the bullish sentiment from individual investors. Since they were allowed to invest in the market several months ago the rally has been a rocket ride. The Shanghai Index was the only positive market in Asia on Friday.

The big news in the U.S. was of course the Nonfarm Payrolls. The May number came in much hotter than expected with a gain of +280,000 and well over estimates of 225,000. The April number of +223,000 was revised down only slightly by -2,000 to 221,000 but the March number was revised significantly higher from 85,000 to 119,000 for a net revision for the two month of +32,000 additional jobs.

The internals were very strong. Leisure and hospitality added +74,000, professional and business services added +63,000, healthcare +58,000, retail trade +31,000, construction +17,000. Even government payrolls rose by +18,000. The sector that lost jobs was the energy/mining sector with a loss of -18,000.

The unemployment rate increased slightly from 5.4% to 5.5% because more people entered the workforce. The BLS said 397,000 people decided to get off the couch and look for work. This raised the labor force participation rate from 62.8% to 62.9% and a four-month high.

Before we rush out to celebrate the strong jobs numbers let's remember that 92,986,000 people are still not in the labor force. That includes everyone that are 16 years and older who are not employed and did not look for work in the prior four weeks. Obviously that includes a large number of housewives, retirees, etc, that don't want to be employed. The civilian workforce rose +397,000 in May to 157,469,000 of which 148,795,000 were employed and 8,674,000 were unemployed.

Average hourly earnings rose +2.3%, which was a significant gain and something the Fed was hoping to see. Wages rose +2.2% in April so back to back gains are Fed positive. This could be the result of Walmart giving raises to the majority of its workforce over the last two months. Starting in April Walmart gave raises to more than 500,000 workers. That raised their minimum wage from $7.25 an hour to $9.00 and Walmart said that would rise to $10 an hour by February 2016 for those that complete six months of training.

While that is still far below the national average of $24.96 for private-sector workers it still represents an additional $1 billion in wages according to Walmart. That is a pretty significant injection into the average wage calculation.

Analysts claim the strong payrolls over the last two months are concrete evidence of a rebound from the economic contraction in Q1 and that the economy is beginning to accelerate. It may take 2-3 more months to prove that out but for now the Fed should be relieved.

The broader U6 number for unemployment remained flat at 10.8% or twice the more commonly reported rate of 5.5% this month. The U6 number includes everyone out of work that would take a job if one was offered.

Overall it was a good report and it should give the Fed a reason to relax after the economic contraction in Q1. It was the second month of stronger than expected payrolls and when combined with the strong pending home sales and strong auto sales for May it would appear the economy is rebounding and the Q1 contraction will be an exception caused by weather and the port strike.

The FOMC meets on June 17th and there are no expectations for a rate hike in June. The next meeting is at the end of July and that only gives them one more month of data and it is not followed by a press conference. Analysts believe the Fed will only hike at a quarterly meeting with a press conference especially for the first time. There will be numerous questions and explanations that Yellen will have to answer. That means September is the most likely meeting for the first hike. The Fed does not have to wait but several Fed heads are being overly cautious on making sure the economy is really growing rather than just a short term rebound.

Earlier last week the Director of the IMF, Christine Lagarde, asked Janet Yellen to postpone any rate hikes until the middle of next year because of the impact on the global economy. The IMF believes the conditions that caused the contraction in Q1 will drag U.S. economic growth down to +2.5% for the full year. Previously they were expecting +3.1% for 2015. The IMF also downgraded the global growth outlook from +3.8% to +3.1% for 2015. Lagarde said the dollar was already "moderately overvalued" after a 13% gain in the last 12 months. Hiking rates would send the dollar even higher. The problem with holding off until the middle of 2016 could mean that inflation accelerates and the pace of rate hikes would need to be faster and more damaging to the economy.

Fed Vice Chair Stanley Fischer said last week the Fed was "not the central bank for the world" meaning the Fed was not responsible for what happens to the rest of the world if they raise rates. The next three months should be really interesting.

The pace of economic reports slows dramatically next week with nothing of any importance other than maybe the May Retail Sales on Thursday and Producer Price Index on Friday. Analysts are looking for a huge spike in retail sales of +0.9% after a zero rise in April. There could be a disappointment there.

Energy Transfer Equity LP (ETE) announced a 2:1 split but they are not likely to produce a split run. We are still waiting for the Netflix (NFLX) shareholder meeting on Tuesday to approve the five billion in additional shares. Once the shares are approved the company will announce the split rate and with shares at $633 they could easily do a 10:1 split and that would be a serious event.

There was almost no stock news on Friday. The payroll report overpowered the headlines and pushed the stock news out of the headlines. The big mover was Diageo Plc (DEO) a producer of premium alcoholic beverages. A Brazilian news agency said Brazilian billionaire Jorge Paulo Lemann was considering a takeover bid. Lemann's firm 3G Capital orchestrated the $52 billion buyout that produced Anheuser-Busch InBev (BUD). 3G also worked with Warren Buffett to acquire Heinz and helped combine Burger King with Tim Horton's. DEO is well off its 2014 highs at $133. With a market cap of $74 billion it would be a major deal if 3G could get it done.

Security stocks all rocketed higher after the government disclosed that a government sponsored cyberattack stole information on 4 million people that had applied for various security clearances. The hack was discovered in April and it took the government more than a month to determine which files had been stolen. The security companies helping the government track the hack and remove the code from the government computers said it was clearly a Chinese sponsored cyber attack. The code they left behind was nearly identical to other hacks that were also tracked back to China. The government stopped short of specifically blaming China but the implications were clear.

The specificity of the hack to look for people that had applied for security clearances is troubling. Investigators believe that China targeted them in order to develop some spies in America. Security applications include background checks and interviews with friends and relatives as well as financial information. Applicants with problems in their background could be leveraged or blackmailed to exchange secrets rather than have their background problems exposed to the world. The data could be used to target individuals with access to sensitive information that have financial, marital or other problems and might be subject to bribery, blackmail, entrapment and other espionage tools, according to the spokesman.

FireEye (FEYE) spiked +6.4%, Palo Alto Networks (PANW) rose +3%, Fortinet (FTNT) +4%, Cyberark (CYBR) +7.4% and Proofpoint (PFPT) +6%. The new Purefunds Cyber Security ETF (HACK) gained +3.3%. The fund includes 20 of the top security stocks.

Chinese Internet stocks were soaring on the spike in the Shanghai Composite to a seven-year high. QIHU +7.5%, SINA +7.8% and WBAI +9.9%. Sina and Weibo (WB) gained +39% and +22% respectively after the Sina CEO said on Monday he was investing $456 million in Sina.

Under Armor (UA) spiked +5% on an upgrade from DA Davidson. The broker upgraded the active wear company on strong earnings growth potential, digital health investments and sponsorship of athletes. The company upgraded shares from neutral to buy with a $91 price target. UA has had a 30% compound annual revenue growth since 2010 and "should be able to support 20-25% growth for years to come."

All the stock moves were not bullish. Zumiez (ZUMZ) shares fell -19% after the company guided for Q2 for earnings in a range of 13-16 cents on revenue of $179-183 million. Analysts were expecting 30 cents and $192.8 million. Roth Capital Partners said the forecast missed because weakness in April accelerated in May. Janney Capital said it was due to weak traffic and soft demand for men's seasonal products. Shares fell to a 52-week low.

OPEC met and agreed to do nothing. They maintained their production quota at 30 million barrels per day for the next six months but there is no penalty for pumping over the quota. OPEC produced nearly 31.58 Mbpd in May. That was the 12th consecutive month of over production. Officials expect Iran to bring another 500,000 bpd to market within 90 days of the sanctions being lifted and raise that to 1 million barrels within 6 months.

OPEC is moving to a capacity model rather than a price model. Previously they attempted to restrict production to maintain prices. That model failed as the U.S. shale fields began pouring out millions of barrels of high priced oil. With 1.5 mbpd of excess global production OPEC had the capability of supporting prices as long as Saudi Arabia was willing to be the swing producer that made the biggest cuts. As U.S. production rose from 3.8 mbpd in September 2009 to 9.6 mbpd last week the supply and demand balance was lost.

The U.S. was producing high cost oil with some shale fields as high as $70 and deepwater Gulf of Mexico as much as $100 a barrel. Multiple efforts were underway to explore the Arctic where costs would be well over $100. With the cost for Saudi Arabia at roughly $29 a barrel they decided to ramp up production and sell it for less than everyone else. Their desire today is to make up for lost revenue from lower oil prices by pumping even more oil to increase sales. In May Saudi Arabia pumped 10.38 mbpd and they claim to have the capacity for 12.5 mbpd.

After the OPEC meeting Goldman's chief commodity analyst reiterated their forecast for $45 oil by October, $50 in December and $55 in 12 months. If Libya, Iran and Iraq all increase production as expected we will be floating in oil 12 months from now. Many shale producers will either be out of business, acquired or in a holding pattern waiting for prices to increase.

The rising shale fraclog of wells drilled but not completed is thought to now be as high as 425,000 bpd of new production waiting to be turned on when prices recover. Baker Hughes said active rigs declined another -7 last week to 868, only 2 rigs above the 2009 low at 866. Oil rigs declined -4 to 642, -60% off their highs. Gas rigs declined -3 to 222 and only 5 above a 17 year low. Offshore rigs declined -2 to 27 and well below the recent peak at 60. There has been a serious decline in new offshore projects because of the high cost.

Crude prices declined slightly when the OPEC decision was announced. Apparently there were some hopeful investors wishing for a production cut. When prices did not crash the short covering began and WTI closed at $59.13 in the regular session.

Prices are expected to rise slightly into the July 4th weekend because of higher gasoline prices during the holiday period but once past that weekend I would expect a new decline to begin as demand for fuel declines and inventories begin to build again.


On the surface the markets showed a confusing picture with the Dow, S&P and Nasdaq 100 declining but the Nasdaq Composite, Russell 2000, S&P-600 and S&P-400 Midcap indexes rising. The biggest gainer was the Russell Microcap ($RUMIC) with a +1.1% gain and closing less than 1 point from a new high.

Traders looking at that mixed picture were likely confused. However, the stocks with the biggest gains were small biotechs and the Chinese Internet stocks. There were dozens upon dozens of small biotechs that exploded higher last week. The cancer conference and all the talk about M&A in the sector has built a fire under those small cap biotechs.

This powered the small cap indexes while the blue chips were still fighting problems over rising interest rates and the stronger dollar.

The Russell Microcaps have an ETF (IWC) but volume is very low at only 67,000 shares on Friday. If you want to play those stocks that is your only choice. The ETF has options but the bid ask spreads are pretty wide because of the low volume.

I mentioned over the last two weeks that I expected fund managers to put their spare cash to work before the end of June in order to window dress their midyear portfolios and corresponding statements. The best way for a manager to increase their beta to the market is with the small caps and apparently that is what they are doing. This is risky but so far it has worked out. If they happen to have a couple of those small biotechs acquired along the way that is just a bonus.

On the big cap indexes the picture is very different. On the S&P-500 the percentage of stocks under their 200-day average fell to 59.4% and the lowest level since October. This is hardly a bullish event. The advance/decline line on the S&P is at two-month lows.

The problem with the big caps is the declining earnings, the strong dollar and the potential for rising interest rates. In theory the small caps would be hurt the most by rising rates since they require more financing against a smaller asset base. A company like Apple or Boeing would not suffer the same spike in rates because they can command the best deals.

The S&P came very close to touching the 100-day average at 2083 with a low of 2085. In early May and April the 100-day served as support. I think the more likely support this time around is 2080 and the combination of that level and the 100-day could be the bottom we are looking for. However, if that level breaks we could be looking at a dip to 2040. Friday's close at a three-week low is a danger signal. Some of that was probably a negative reaction to the payroll report and expectations for the Fed but there could have been some Greek fear mixed in there as well.

The S&P is now 37 points off its high of 2129. That is less than -2% and definitely nothing to be worried about. However, that reduced its gain for the year to only 1.3%. It has been a really slow first half for the bulls even with the new highs.

We need to be concerned about the declining internals on the S&P. The chart below does not tell the entire story. The two above are the more telling and they are telling us support for individual stocks is weakening.

The Dow is in similar shape to the S&P only the Dow is up only 0.15% for the year. It will only take a few points to put it in the red and that is also a sell signal. However, there is strong support at 17,800 and 17,600 so it will take some concentrated selling to produce a major decline from here. The 100-day was broken on Thursday but the Dow is not really reactive to moving averages because of its limited 30 stock composition.

A couple weeks ago I said it was sometimes helpful to go through the charts for each of the Dow 30 stocks to see which are in an uptrend and which are in a downtrend in order to get some idea which way the Dow is headed. Unfortunately I did that exercise again this weekend and it was not pretty. Only TWO Dow stocks were in an uptrend on a 30 min chart. The majority were in a confirmed downtrend that was not hopeful. The two stocks with a positive chart were Goldman Sachs and JP Morgan. I encourage you to try this exercise at home on the 30 min chart.

This does not bode well for our chances of avoiding a continued decline early next week. Of course there is always the potential for a short squeeze Monday but we would need some major headline to provide a catalyst.

The Nasdaq Composite benefitted from the biotech rally with nearly half of the gainers in the list below from that sector. Add in the security stocks and Chinese Internets and that was the majority of the gains.

Can that continue next week? Anything is possible but any continuation in the security sector will probably be muted after the big gains on Friday. The Chinese Internets are a wild card since a new high on the Shanghai Index could easily continue producing new highs. The biotech sector had been somewhat subdued over the last week with the $BTK fading for several days before the spike on Friday. The Nasdaq Biotechnology Index (IBB) rebounded to within .64 of a point of a new closing high. The old high was 367.68. This index could breakout on Monday and that could force some more short covering and price chasing. That would be the best hope for the Nasdaq.

The overhead resistance for the Nasdaq Composite is solid at 5100. It has been solid for three weeks and odds are good that has not changed. The support at 5000 was tested on May 14th and again on the 26th. Friday's early dip did not come close at 5025. Without several sectors providing unexpected lift next week I would expect the Nasdaq to drift lower with the 5000 level again providing material support.

The Russell 2000 had a strong day on Friday and quickly recovered from Thursday's market drop. The Russell closed slightly over resistance at 1260 and the internals were strong. The rebalance trade will pick up late next week when the first official list of additions and deletions is released on Friday. Historically once the list is released it weighs on the Russell. The reason is that the stocks being deleted are still in the Russell and traders will be selling them ahead of the rebalance. The stocks being added, and therefore bought, are not yet in the Russell indexes so gains in those stocks have no impact on the index.

On the positive side the stocks are normally being dropped because they have declined to the point where they no longer qualify. That means it takes a lot of selling in a low dollar stock to make a negative impact on the index. Stocks that are being acquired and no longer qualify for inclusion are probably being acquired by another company already in the index. The selling in one and buying in the other because the weighting increased will offset each other. Confused yet?

I would not worry about the rebalance trades this week. The final list is not published until the 19th and that is when the real selling will increase. Of course a positive market can easily offset the rebalance trading. If funds are trying to window dress with Russell stocks it would have an offsetting positive impact.

Several analysts were trying to claim the rebound in the Transports was positive for the overall market. That is true to some extent but the rebound was lackluster and failed at 8525. It will take a lot more buying here to really influence the broader market. The airline sector is still out of favor because of the increased competition even though another decline in oil prices would be helpful. The railroad sector is going to take another hit if it looks like oil prices will remain low because trainloads of sand and drill pipe will slow even further. The biggest worry on the Transports would be a new decline that takes the index below 8300. A lower low would trigger additional sell signals.

I am no longer in the "cautiously long until proven wrong" camp. The research on the individual Dow stocks has poisoned my mind and until there is some improvement there I am neutral on the market. At this point I would start looking for a capitulation dip to buy. Ideally on the S&P that would be 2040 but we could get a bounce at 2080. While I really don't want to drop to the 2040 level it would clear the weak holders and give us a -4% dip to buy. Over the last year those 3-5% dips have all been bought.

Remember, June is historically the worst month for the Dow in recent years. It has been down 8 of the last 10 years. That does not mean this June will be down as well but defined trends like that tend to be traded.

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Random Thoughts

The Fed's biggest nightmare according to Citigroup is not the date of its first rate hike. The biggest nightmare is what would happen if the economic recovery dies of old age without the Fed having done anything to tighten. "If this were to occur, the dollar would probably fall faster than it rose from July to March." This could be a precursor to a loss of faith in the dollar's reserve currency status.

Normal recession recoveries last 5-7 years. This one is already 6 years old.

The second biggest nightmare is an economic rebound that rises so fast that the Fed's entire carefully planned normalization schedule collapses. "Based on current trends we will be at zero unemployment before we are at 2% inflation." Good article here

Despite the spike in the jobs numbers the Fed is not likely to raise rates until September and maybe not until 2016. Fed head Daniel Tarullo said on Thursday "the economy, moreover, appeared to lose momentum" and "our data dependent orientation is going to be particularly important." Tarullo is a Fed governor and offices in the same building as Yellen. That suggests he is more in tune with what Yellen is thinking.

Fed governor Lael Brainard said on Tuesday, "I think there is value to watchful waiting while additional data help clarify the economy's underlying momentum in the face of headwinds from abroad." James Bullard said, "I think it's very difficult to say that you are trying to normalize interest rates just at the moment where the economy looks a little bit weaker." Source

The nation's debt is roughly $18 trillion. The Fed owns $4.5 trillion or 25%. What is wrong with this picture? If it were not for the Fed's QE purchases the interest on the government debt would 2-3 times what it is today. The concept of normalization of interest rates has got to be a scary thing for the administration because normalization will cause major budget deficits.

Greece postponed its first June payment to the IMF until June 30th and said all 1.5 billion euros of debt will be paid in a lump sum. Since the don't have the money a default on June 30th is guaranteed unless the EU Finance Ministers cave in to Greek demands and release the 18 billion euros of bailout cash that is already in the bank and ready to be released. That is also not likely to happen.

Greece is likely to default because its impact on Europe has declined to almost zero. The GDP of Greece is only about 1.5% of Europe's. The equity markets in Europe have about 10 trillion euros of market cap. The capitalization of the Greek stocks is about 19.7 billion euros or about two one-thousandths of Europe. The vast majority of Greek debt is now held by the ECB or the IMF and a default will be an isolated event. There are some privately held bonds but very few and those investors knew the risk when they bought them.

A Greek default does not mean an exit from the eurozone. It may lead to that but 75% of Greek citizens don't want to leave the eurozone and the rest of the eurozone members don't want them to leave because it would set a bad precedent. Source

Bank of America warned that bond flows were likely to turn negative after the serious whipsaw in yields last week. The expectation for the Fed to hike rates is increasing and bond holders stand to lose enormous amounts of money over the next 6-9 months. BofA said "We expect high-grade fund flows to turn generally negative in line with the initial experience during the Taper Tantrum in 2013." Investors pulled nearly $70 billion from bond funds during the Taper Tantrum selling according to BofA analysts warned that if ten-year yields rose to 2.6% over the next two weeks the outflows from bond funds could rival the bloodbath during the Taper Tantrum. Yields on the ten-year closed at 2.4% on Friday. Source

Gross Says Bond Rout Scary as Hell

As of Friday the U.S. markets have gone 1,340 calendar days without a 10% correction on the S&P. That is the third longest streak on record since 1929. It is only the fifth time that the streaks have exceeded 1,000 days. The longest streak on record was a 7 year rally from October 1990 through October 1997. The second longest was a 4.5 year rally between March 2003 and October 2007. The average market rally without a correction is 357 days so we are long overdue.

The current streak has confused investors into waiting on the sidelines for a correction rather than putting money to work in the market. However, just because a streak is getting old it does not mean it will end soon. If you had exited at this point in the 1990s market you would have missed out on a further +105% gain.

Deutsche Bank warned, "We believe the probability of a 5%+ dip is high this summer." David Bianco, chief U.S. equity strategist said there are three possible sell-off triggers. "The Federal Reserve botching the timing of the first rate hike, the U.S. dollar getting too strong and the bond market -- especially the U.S. 10-year yield -- rising too fast." Source

The AAII Investor Sentiment Survey for last week still has 48% of investors neutral on the market. Bearish sentiment declined slightly to 24.6% and bullish sentiment rose slightly to 27.3% but the undecided group is by far the largest.

I know a lot of our readers don't get out much and when you do it is probably with the family. I doubt many readers have had a chance to pick up the 2015 Hooters calendar. No problem here is a link to the calendar and you can enjoy it on the privacy of your own PC. 2015 Hooters Calendar

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Jim Brown

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"In any moment of decision, the best thing you can do is the right thing. The next best thing is the wrong thing, and the worst thing you can do is nothing."

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