Friday's lackluster market traded in both positive and negative territory before a flurry of buying ahead of the close lifted it back to Thursday's highs. With China and Japan now old news, it was fear of the Fed that kept investors wary.

Market Statistics

Friday's lack of news and volume was more like a summer Friday than the middle of September. Market commentators everywhere were struggling to find something to talk about. The market call for the possibility of $20 oil by Goldman Sachs was the topic for the day because of its dramatic potential. I will cover that in depth later.

The Producer Price Index (PPI) for August gave the Fed something else to worry about at the meeting this week. Producer prices were flat compared to +0.2% in July and +0.4% gains in both May and June. Goods prices actually fell -0.6% after -0.1% in July and +0.7% in June. Core goods fell -0.2%. Intermediate goods declined -0.6% after a -0.2% drop in July. Intermediate unprocessed goods declined -4.4% after a -2.9% drop in July. Core unprocessed goods fell -10.6% after a -5.5% decline in July.

The trend is clear and inflation is dropping like a rock. Low oil prices are driving the declines but the drop in commodities in general is affecting the decline in inflation. Food prices rose or the overall numbers would have been worse. Driving food prices higher was a +23.2% jump in egg prices after the loss of more than 50 million chickens to the bird flu.

On a trailing 12 month basis producer prices have declined -0.7% because of the -4.0% decline in goods prices. Year over year prices have declined all year. With Goldman warning that $20 oil prices are possible in the coming months the Fed is fighting a losing battle to raise inflation. The Fed believes the drop in commodities is transitory but that transit period is looking longer every day.

Consumer sentiment for September declined -6.2 points from 91.9 to 85.7. Analysts expected 91.5 and this is the third consecutive monthly decline. It is also the lowest reading in 2015. Analysts believe the stock market volatility had a direct impact on the sentiment numbers.

The present conditions component declined from 105.1 to 100.3 for the third consecutive monthly decline. The expectations component declined from 83.4 to 76.4 and the third decline.

In September, 33% of respondents said their finances were worst than last year. That was an 8% increase from the prior month. This is why analysts believe the headline decline was market related. Another 46% of respondents said the U.S. was going to experience bad economic times over the next year.

There are a lot of economic reports out next week but the big news is on Thursday. The Philly Fed Manufacturing Survey is out in the morning followed by the Fed announcement and press conference in the afternoon.

The odds for a rate hike are about 50:50 if you believe the financial press. With the World Bank and the IMF warning the Fed not to hike until 2016 there is a decent chance they could pass. However, the Fed has been promising a hike for the last year and not doing it at the September meeting moves them to December in order to have a press conference after the rate hike.

The market is pricing in a hike. If there is no hike the Fed will lose a prime opportunity and have to go through the same pre meeting volatility at some point in the future. Personally, I think they will take this opportunity in order to get the first hike behind them and then target Q2-2016 for the next one.

The market may react positively since it is already factored into sentiment and getting it behind us would be a plus. This is like a child dreading a scheduled vaccination. They worry about the shot well in advance and once in the doctor's office the worry increases significantly. Once the shot is over, they are ready to run and play again. Within minutes, they have completely forgotten about the pain. The market has been kicking and dragging its feet on the way to the doctor's office for the last several weeks. Once past next Thursday the worry will be over and the market can relax again.

James Hardie Industries (JHX) announced a 5:1 stock split to be made at the close on September 21st. JHX only trades about 5,000 shares per day so this will not be a candidate for a split run. Stock Split Calendar

Early Twitter (TWTR) investor Chris Sacca, went on a twitter rant on Friday complaining about the lack of a CEO announcement. The rant was heavily pro co-founder Jack Dorsey and criticized the board for the lack of an announcement. Even before Dick Costolo resigned on July 1st the board had been looking for a new CEO. While the search drags on key employees have left, the stock has declined and the company is being left for dead. Sacca's 7-tweet rant captured a lot of attention but did not help the stock price. Shares were down 32 cents. However, we know there will eventually be a CEO named and their new products will begin to gain traction. It is only a matter of time before the stock rises or they are acquired.

Mattress Firm (MFRM) warned on guidance and the stock was crushed. The company said it now expects earnings of $2.30-$2.45 for the full year. That was down from prior forecasts of as much as $2.70. Shares fell -23% for the biggest one-day drop in its history. Shares of competitors Tempur Sealy International (TPX) fell -2.3% and Select Comfort (SCSS) fell -2.2% in sympathy. Mattress Firm blamed the slow sales on the decline in oil prices saying the 100,000 energy layoffs kept a lot of people out of stores. I think that was a convenient excuse rather than reality.

Unilever (UL) is now selling a single serve tea machine to compete with the Nestle Nespresso beverage maker. The device is called T.O. by Lipton and manufactured by Krups. The device will go on sale in France on Monday with distribution to expand in the coming months. It will not be cheap. The initial price will be about $200 with 10 tea capsules for about $5. Shares of UL were down fractionally and shares of competitor Green Mountain were up fractionally. I guess that means investors were not impressed with the new product.

Kroger (KR) shares rallied 5% after the company reported earnings of 44 cents that beat estimates for 40 cents. Revenue of $25.5 billion matched estimates. Kroger raised full year estimates from $1.95 to $1.98 per share. Kroger said it was expanding its online offerings and would be adding 20,000 workers.

Avon (AVP) lost another 15% on Friday after a -9.5% decline on Thursday. Shares spike Thursday morning on a rumor that Cerberus Capital and Platinum Equity might be taking a stake in the company. Shares briefly spiked nearly +25% on the news but immediately crashed after more details were known. The PE firms were reportedly going to inject funds through a PIPE acquisition (Private Investment in Public Equity) where the shares could be bought at a significant discount to the current market. Shares of Avon crashed because it suggested company finances were weak and they needed additional capital to survive the holiday season. Avon has been in a slump and the drop in foreign currencies has been painful. Brazil has been a serious drain on profits.

Chico's Fashion (CHS) is reportedly in talks to be acquired by a private equity firm. Reportedly, Sycamore Partners has made an offer while Chico's is still in talks with other bidders. The company hired Investment bank Peter Solomon to explore options. Sycamore has arranged $3 billion in debt financing for an acquisition. Shares spiked $2 to $17 in afterhours on Friday.

If you want a McRib sandwich, you have to look for it. The McDonalds McRib sandwich is now available for the once a year sales special. However, it will only be offered in about 8,000 of McDonald's 14,350 U.S. restaurants. That equates to about 55% compared to 75% in 2014. The McRib is only offered once a year because of the shortage of the main ingredient. The boneless McRib is a regional favorite with most of the buyers in the south. The company allows the stores to decide if they want to offer the boneless barbecue rib sandwich based on their prior sales.

In another menu change McDonalds is returning to its roots with the original egg McMuffin on an actual English Muffin. They are also replacing margarine with the real butter as a McMuffin ingredient. This is in addition to having breakfast items all day long. McDonalds is struggling to overcome the rising competition from other chains including Five Guys, Shake Shack, etc. Junk food lovers rejoiced and shares rose +$2 on the menu news.

Restoration Hardware (RH) reported earnings of 85 cents that beat estimates for 83 cents. Revenue rose +14% to $506.9 million and beat estimates. The company expects revenue to grow +16.2% for the year and earnings up +32%. The company raised guidance for the full year from $3.02-$3.15 to $3.06-$3.16. Analysts were expecting $3.11. Shares rallied +9% on the news.

Marvell Tech (MRVL) shares crashed -16% after the company said it had begun an internal investigation into its accounting and reported seeing weakening demand for personal computer parts. That was the biggest decline since 2002. The accounting review is focused on revenue recognition and whether the revenue was recognized sooner than it should have been. That would have made earnings appear better than they were. Susquehanna Financial said the stock was "unownable" during the investigation since years of earnings could be restated. The company posted a loss of $382.4 million, which included a charge of $394 million for pending litigation. Analysts were expecting a $12 million profit.

Zumiez (ZUMZ) shares fell -32% after reporting earnings of 12 cents that matched estimates. However, that was -60% below the year ago quarter. Same store sales fell -4.5% compared to +3.4% growth in the year ago quarter. Zumiez guided to a decline of 7-9% in sales in Q3 and revenue of $204 million. Analysts were expecting $224 million. They guided for earnings in the range of 27-31 cents and analysts were expecting 53 cents. The company is planning on opening 57 new stores in Q3 despite a sharp decline in sales at existing stores. Investors are running scared with revenue and profits declining.

You know you have entered the Twilight Zone when you read a headline that Microsoft may acquire Advanced Micro Devices (AMD). Advanced Micro is a failing semiconductor manufacturer that only exists because Intel needs somebody else in the market to keep from being called a monopoly. The tech site said the two companies were in serious talks about the acquisition. AMD products are seriously lagging the Intel processor family and there is almost zero hope of ever being competitive with Intel again.

Apparently, Microsoft is hoping to control the next round of Xbox development and having its own chip company could allow it to lower costs and increase the capability of the gaming console. Microsoft could also streamline the future of the Zen processors from AMD and put them in the Surface tablets.

There may actually be a growth path for AMD as a Microsoft subsidiary as strange as that idea may seem. Shares spiked 9% on the news.

Goldman Sachs (GS) created a flurry of arguments when they said crude prices could fall to $20 a barrel in the near future. Goldman's report said "Although oil prices have revisited the lows of last winter, this time both financial and fundamental metrics are much weaker. Forward demand expectations are lower as the emerging market economic outlook continues to deteriorate."

Goldman is not predicting a drop to $20 but they said that was their worst-case scenario. Goldman is expecting $45 oil for 2016, down from the prior forecast of $57. The doomsday scenario of $20 rocked the market but Goldman is known for making wild forecasts as part of its broad outlook. You may remember their $200 forecast in 2008.

Goldman said it was still unclear how the eventual supply adjustment will take place. However, we can say for certain that North American supply growth will slow down or even reverse given recent drilling and investment patterns. The U.S. has created such a backlog of drilled but uncompleted wells that future profit margins will be pressured. The drilled but unfracked wells are now called the "Fracklog."

A Reuters analyst pointed out that the top 50 U.S. producers have spent more than $200 billion in capex over the last two years and took on more than $150 billion in debt to do it. That debt will be coming due soon and they cannot pay it back on $40 oil. Shale producers rarely get the WTI price for their oil. Shale oil is superlight and very gaseous and does not produce the mix of products refiners want to sell. When combined with the high transportation expense from the various shale fields the actual price received is in the mid $30s per barrel. It is very hard to drill an $11 million well and make a profit at $35 oil.

Crude prices closed the week at $44.76, down -$1.22 for the week but they are on a downhill slide now that we are past Labor Day. Refineries are shutting down for seasonal maintenance and more than 2 million barrels per day will be offline at the peak of maintenance season. Refinery utilization has already declined from 96.1% for the week of August 7th to 90.9% today. That will continue down into the mid 80% range over the next several weeks. This means inventories will rise for the next 10-12 weeks and they are already near multi-decade highs.

From the middle of September 2014 until the peak in May 2015 crude inventories rose from 360 million barrels to nearly 490 million and 100 million barrels over the normal highs for that period. Today we are starting out that same period at 460 million and it is nearly inconceivable that we will not exceed that 490 million high from last year and possibly by a lot.

Goldman's worst-case scenario assumes we add the same 100+ million barrels as in 2014 and we run out of places to store the oil. Storage at the futures hub at Cushing Oklahoma peaked at a record 62.2 million barrels on April 17th and has only declined -5 million barrels ahead of the inventory accumulation season. Cushing has barely enough room to maintain operating capability and cannot absorb millions of extra barrels.

We may have seen a preview of things to come last week. U.S. production declined -83,000 bpd to 9.135 mbpd. That is -475,000 bpd below the June 5th peak at 9.61 mbpd. Production is suddenly beginning to decline at a rapid pace. However, because of the fracklog it will not decline quick enough to raise prices. Those wells have to be completed in a certain period of time or be plugged and abandoned.

The active rig count declined by -16 for the week ended on Friday and that was after a -13 rig decline the prior week. Active rigs at 848 are now at the cycle low and below the prior 857 low back in early July. They are also below the July 2009 low of 866. Active gas rigs declined -6 to 196 and a new 18-year low. Active oil rigs are 652 are still above the July low at 638 but a couple more weeks of decline should see that low broken.

Producers have given up on the Q3 rebound. Many put rigs back to work in July/August in expectations of a rise in prices. That rise did not happen except for the short squeeze two weeks ago and prices are now fading again. The mindset is no longer to try and squeeze a few more rigs into production but to cut every expense possible and go into conservation mode and try to live on existing cash flow until the cycle reverses. As inventory levels rise in the coming weeks I would expect to see prices decline at least back to the $40 level or lower.


Wednesday's rebound took the Dow and S&P right to resistance and those levels acted like an electric fence. The rally stopped dead on that resistance and was repelled instantly. On the negative side that showed exactly how many sellers were waiting at those key levels. On the positive side, the decline was not severe and we know exactly where to make our next trade decision. A break over those resistance levels would be a buy signal and another failure at those levels would be a sell signal.

Also positive is the pattern of higher lows on both the Dow and S&P. This suggests investors are buying the dips with an increasingly higher threshold. As long as we do not dip below the blue lines the rebound remains in play. A breakout over the red lines could attract a lot of buying interest and short covering.

For the S&P the resistance is strongest at 1,990 but last through 2,005. Support is now 1,939 followed by 1,912.

The high for the Dow on Wednesday was 16,664 with resistance at 16,666. That is almost a perfect test and failure. That is now the line in the sand for next week. A move over that level could move back over 17,000 before hitting significant resistance at higher levels.

The Dow stocks are still in the tank with only about five charts that could be considered buyable. The rest are either falling knives or they are basing in a sideways motion. However, the intraday Dow chart still shows the suggestion of a breakout in the coming days, Fed permitting.

The Nasdaq closed very near resistance at 4,835 and could be poised for a breakout as well. The Biotech sector continued to supply the gains but Amazon and Google were also leaders.

The chip sector remains weak and a drag on the tech index. Were it not for the AMD/Microsoft rumor on Friday the Semiconductor Index ($SOX) would have been negative rather than fractionally positive.

Apple (AAPL) closed at the highs of the week at $114.20 after a post announcement decline on Wednesday. The products are seeing mixed reviews but most believe the iPhone changed enough that consumers will want to upgrade. More than 70% of iPhone users are still on phones older than the iPhone 6 so there are plenty of faithful that could upgrade.

The Russell 2000 chart looks more like the Nasdaq with a close at 1,157 and just slightly under resistance at 1,165. With any positive headlines, the Russell could breakout over that resistance and possibly trigger a broader rally among the big caps.

At this point, I believe a Fed rate hike is priced in. There may be some immediate volatility if a hike is announced on Thursday but I think the market will shake it off very quickly and the next move will be higher. It will all depend on the forward guidance. If they emphasize as expected that the next hike will be well into the future then we could reach new highs before year-end. If they try to get cute and dangle the possibility of an October or December hike in the statement then all bets are off. If the market thinks there is any chance of a second hike in 2015 the bears will come out of the forest and the rest of September could be bleak.

If the Fed does not hike then the market will be left in limbo for another month. The vaccination will be postponed and the adolescent patient will continue to anguish over the eventual shot.

If the Fed were reading my comments, I would ask them to please hike this week and end the uncertainty. The market needs a firm direction rather than continuous Fedspeak that promises but never delivers.

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Random Thoughts

A year ago, ISIS warned that it could destabilize Europe by forcing 500,000 Syrians to migrate to Europe. To date more than 4.5 million Syrians and Iraqi's have fled their country to avoid the war and the terror that is ISIS. With more than one million walking into Europe the individual countries are being forced to accept more "refugees" whether they want to or not. An illegal alien that crosses borders and ends up in a country illegally receives no social service benefits. However, a refugee is immediately awarded a full slate of benefits from housing, welfare, food stamps, healthcare, etc. In Germany, this could add as many as 460,000 people to their social benefits programs. The amount of money Germany and the other European countries are going to have to spend to support this migrant flood is astronomical and this will burden an already marginal economy.

The EU Commission could mandate what benefits countries must provide to the migrants. That is the real name for them. If they were just refugees from the Syrian war they could have stayed in Turkey and be ready to go home once the fighting ends. They do not want to go home. They are looking for a new home and the rich European countries are being deluged with migrants while the poor countries with minimal social services are being avoided. If the Commission mandates a full slate of services to be provided by each country it could cause significant division between EU countries.

Several officials have proposed a "blue card" experiment. With all countries facing streams of migrants at their borders waiting for entry the government should allow everyone entry with only one catch. Anyone entering would have to sign an agreement to never be eligible for social benefits. You would immediately see how many people really wanted to migrate to seek a new opportunity and be a productive citizen and who was simply looking for the best handout. I am sure many entrance lines would evaporate once the new rules were explained.

In the U.S., about 51% of immigrant-led households receive at least one kind of welfare benefit, including Medicaid, food stamps, school lunches, housing assistance, etc. This compares to 30% for native-led households. If there are children in the household, the percentages rise to 76% for immigrant-led homes and 52% for native-born households.

This is not a defect of moral failing on the part of immigrants. Rather, unrestrained immigration, whether legal or illegal, allows a lot of less-educated immigrants to settle in the country and they only earn minimal wages and become eligible for a very generous welfare system.

Europe is facing a monstrous increase in their social service costs. This will require higher taxes and more facilities like hospitals and schools. I have not even discussed the problems of allowing another million plus Muslims into Europe and the fundamental assimilation problems that will occur.

Officials are worried that hundreds or even thousands of ISIS sympathizers and fighters are hidden in the migrant horde currently trying to infiltrate Europe. This is going to cause significant problems in the years ahead as those people spread their message to other Muslims in the communities where they settle.

Europe is facing an ISIS invasion only without guns. The migrants will drain their public coffers and cause challenges for generations to come.

Noted investor John Hussman expects a pullback in stocks of 40% to 55% to bring valuations back into line with historical levels. He is not predicting this in the next few weeks or months but at the end of the current market/economic cycle. He makes a good case for the current dip expanding into a bigger decline based on historical cycles. Don't Get Comfortable

The Energy Information Administration (EIA) is now predicting gasoline prices will decline to $2.03 per gallon by December. Gasoline has not been that low since the Great Recession in 2009. In 17 states, gasoline is already below $2 with six more states near that level. Unfortunately, low gasoline prices come with a catch. More than 86,405 jobs have been lost that are directly attributed to lower oil prices and more than 150,000 jobs have probably been lost in total because non energy jobs depend on workers employed in the energy sector. That includes waitresses, retail workers, service businesses like carpet cleaners, roofers, etc, that lose their jobs because energy workers lost their jobs and incomes.

Goldman said China spent more than $236 billion trying to support their declining equity markets. That is 3.5% of the total market value. The Shanghai Composite rallied +150% in 12 months only to lose -32% in just 18 trading sessions. The government has now declared they will prosecute short sellers and suspended new IPOs. Institutions and funds have been told to buy stocks and hold them. Selling is deemed "against the state" and will be dealt with. China will eventually learn that manipulating the market is a fool's game and it is best left to normal market forces.

Tomi Kilgore warned that a bearish "symmetrical triangle" on the Dow and S&P suggests a continuation of the decline with a target of 14,000-14,200 on the Dow. The triangles normally appear in the middle of a sharp selloff and are continuation patterns. That means the next breakout is more likely to break down and continue the decline. Personally, I view the charts differently but that is what makes a market. I also factor in the current news events and the macro picture rather than simply rely on a chart pattern. New Lows Ahead

David Bianco, chief U.S. equity strategist at Deutsche Bank, warned that earnings estimates for S&P companies might be too high. For every $5 decline in the price of oil, it reduces the net income for S&P companies by $7.5 billion or $1 per share. A 10% rise in the dollar cuts profits by about $20 billion or $2.50 per share. Every 25 basis point rise in the Fed funds rate cuts S&P earnings by 50 cents per share.

Bianco is expecting S&P earnings to come in at $128 in 2016, up from $120 in 2015. Because of the impact from oil and the dollar, earnings could decline to $125. Despite the reduction in his earnings forecast Bianco is still expecting the S&P to rise to 2,150 this year and 2,300 in 2016.

I received this from a reader. I have not heard about this in the press. Thank you Bob for the input.

Potential Drop in Microsoft Earnings

I see in the news that the Justice Department is pursuing Microsoft to access data stored on Microsoft servers in Ireland. Two judges have ruled in favor of the government, but Microsoft is appealing the rulings. If the government is prevails in the appeal, would that not send a message to all the tech companies that have data servers overseas that the data stored outside the US is now accessible? Should this occur, one could expect a serious slide in tech company earnings (and therefore stock prices) as both US and foreign investors decide they do not want US companies storing their sensitive data. Much like what happened to IBM after the Snowden revelations when companies abandoned IBM servers en masse over NSA snooping and IBM earnings took a huge hit. IBM sold their server business to Lenovo (pretty much in accordance with their plan to get out of the hardware business anyway), but Lenovo cannot sell the servers to US DoD or companies supplying servers to the US military. If companies and individuals decide they do not want the Justice Department reviewing their sensitive business data (instead of the NSA), there could be wholesale departure from large tech company products and migration to European companies, where data privacy is better protected.

This is all theoretical at the moment, but if Microsoft were to lose on appeal, I would expect a potential sell-off following a big earnings hit by not only Microsoft, but other big tech companies (Google, Amazon, et. al.) as people and companies decide they need to protect their data. Of course, if the data were encrypted, in theory it would be protected against review by the Justice Department, but one never really knows what the capabilities of real world encryption breaching algorithms are (not trying to wear a tin foil hat here, only remarking on what could be versus what is acknowledged ...). Trader's perceptions of the earnings hit, were it to occur, would constitute (let's say) a "gray swan", since a "black swan" would be by definition a totally unexpected event, while this one would be telegraphed.

We did see a major hit to IBM and other U.S. hardware manufacturers after Snowden. "Cloud" companies could be next since that information is relatively easy to obtain by a governmental spy agency. Encrypting all the information in the cloud is not practical since the higher grade encryption that would be necessary to defeat government (NSA) spying is too slow for the billions of terabytes of data stored in the cloud. It has to be encrypted going in and decrypted coming out and the computing overhead would be tremendous. Bob could be right that corporations could move away from the commercial cloud networks and into private clouds or European cloud services that ar enot subject to prying U.S. government eyes.

The AAII Investor Sentiment Survey for the week ended on Wednesday, surprised once again. Both bullish and bearish sentiment rose with neutral sentiment declining. Apparently the market is polarizing opinions but the opposite ends of the spectrum are almost dead even.


Enter passively and exit aggressively!

Jim Brown

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"There are no certainties in the markets. Otherwise, there would be no such thing as risk and no rewards. Nothing works all the time. Otherwise, it would never work in the first place."

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