Falling oil prices, negative economics and a head fake by the Bank of Japan combined to kill the historical pre Fed rally.

Market Statistics

The big oil rebound is fading after investors began to realize that Iran was not going to play along unless they got an exemption that allowed them to add 1.4 million barrels to their daily production. The production freeze is beginning to thaw even before an official agreement is reached. With the current month WTI futures scheduled to expire on Monday those still holding longs and hoping for a freeze agreement are going to have to sell.

The Bank of Japan failed to issue new stimulus to push their rates even further into negative territory. The BOJ left rates unchanged but said its assessment of inflation expectations had "weakened recently" which suggests they may increase stimulus again at some point in the future. However, they removed the language from the statement they used last time that warned further rate cuts were possible. This confusion over the potential BOJ moves caused Asian and European markets to decline.

In the U.S. the Retail Sales for February fell -0.1% after a -0.4% decline in January. Unfortunately, January sales were originally thought to have risen +0.2% but were revised to that -0.4% drop in this report. Declines were broad based including auto dealers, electronics and appliance stores, furniture stores, department stores and grocery stores. Sales at gasoline stations declined -4% because of the drop in fuel prices. Gains came from building supply stores, sporting goods stores and restaurants.

Sales compared to February 2015 levels are still showing gains. Sales are up overall +3.1% over the last 12 months. If you exclude autos that declined to +2.1% but if you exclude autos and gasoline it rises to +4.3%. Obviously, that is because falling gasoline prices skew the comparisons. The numbers are also impacted by extreme winter storms in February 2015 that depressed sales and producing an unfair comparison.

The Producer Price Index for February declined -0.2% after a +0.1% rise in January. Prices have declined 5 of the last 7 months. Goods prices declined -0.6%, services were flat at zero and core goods rose +0.1%. The year over year comparison was flat at zero on the headline number with goods prices declining -2.8%. Any version of goods relating to energy was off the scale in comparisons with intermediate unprocessed goods down -16.7% and core goods -25.8% all due to oil price declines.

Analysts believe the decline in inflation has reached a turning point and prices will rise from here. Commodity prices reached a level where it is unprofitable to mine or produce them and that has reduced production quantities and prices will rise. The same is true for oil prices. The rebound may be slow but the bottom in prices is behind us.

The NAHB Housing Market Index came in at 58 for March. That is the same level as February and the lowest level since last May. Buyer traffic rebounded from 39 to 43 and the biggest gain since June. The six-month expectations component declined from 64 to 61.

The biggest economic positive for the day was the NY Empire Manufacturing Survey. The headline number for March came in at +0.6 compared to estimates for -10.0 and the February reading of -16.6. That was the largest monthly gain in five years. That is the first positive reading for the headline number since July with a -19.4 reading as the low in January.

New orders rose from -11.6 to +9.6 and backorders rose slightly from -6.9 to -4.0. Employment declined slightly from -1.0 to -2.0. Analysts claim global recession fears appear to be fading despite continued weak economic growth. Also, the strong job gains in February have improved sentiment after the sharp drop in January that was also revised higher.

The two big events remaining for the week are the FOMC decision and press conference on Wednesday and the Philly Fed Manufacturing Survey on Thursday. The Fed is the most important because of their guidance for the June meeting. While nobody expects a rate hike tomorrow there is a growing army of analysts that expect one in June. How Yellen phrases her guidance will be critical.

The disaster of the day was Valeant Pharmaceutical (VRX). The company reported adjusted earnings of $2.50 that missed estimates for $2.61. Revenue of $2.79 billion beat estimates for $2.75 billion. However, the company guided lower for the full year. They cut prior revenue guidance from $12.5-$12.7 billion to $11.0-$11.2 billion. They now expect to earn $9.50 to $10.50 a share. While that was troubling, there were other problems. In the actual earnings release, they projected adjusted EBITDA of $6.2 to $6.6 billion. On the conference call, they said it would be $6.0 billion. When questioned about the difference between the press release and the numbers on the call the company said, "It must have been a typo." They immediately put out a corrected press release.

The problem here is that the right hand does not know what the left hand is doing. Their constant restatement of numbers and downplaying the future has created a severe lack of confidence by investors. Also, they warned that "accounting problems" could force them to miss the deadline on their SEC filings and put them into technical default. A failure to file by the Tuesday deadline means that holders of at least 25% of any series of debt instruments could deliver a notice of default. That could cause lenders to accelerate the debt and place restrictions on future borrowing ability.

This is material because Valeant has more than $30 billion in net debt after allowing for cash on hand. Valeant said it was planning to pay down $1.7 billion in 2016, but that was also lower than the $2.25 billion they had previously guided. Valeant's market cap has fallen to $11 billion and now has a 3:1 debt to equity ratio. Valeant is also under investigation by the SEC for accounting irregularities and by several state agencies over high drug prices.

Shares declined another 51% on the news. This stock is down from $263 to $33 in only 7 months. Bill Ackman increased his stake in Valeant two weeks ago with a 14 million-share purchase. He now holds 30.7 million shares at an average price of $142.99 or $4.389 billion, which is now worth only $1.028 billion. He sent out a letter to shareholders this afternoon saying he was going to take a much more active role on the board and he still believes the company is worth several times its current valuation. That may be but it could take years to recover given the extreme blow to investor confidence.

The drop in Valeant caused biotech investors everywhere to run for the exits in nearly every biotech stock. The Biotech Index ($BTK) dropped -4% and succeeded in dragging the Nasdaq and the Russell 2000 down with it. The BTK has strong resistance at 3,000 and the support at 2,800 is likely to be broken with a retest of 2,600. This could continue to weigh on the major indexes and the market in general.

The one pharma stock that did not react to the news was Celator Pharmaceuticals (CPXX). After the close on Monday, Steve Cohen of Point72 Asset Management disclosed an 8.3% ownership position of 2.8 million shares. Shares rocketed +432% higher to $8.94 in trading on Tuesday. That increased the value of Cohen's stake by $20.7 million. With the stock trading at an average of about $1.75 over the last month, that stake was probably worth about $5 million before the spike. Bill Ackman, read it and weep.

Mead Johnson (NYSE:MJN) shares rose 11% on reports Danone and Nestle were interested in acquiring the nutrition specialist. Among other products, Mead makes Enfamil infant formula. Reports claim Mead is working with Lazard on a possible buyout. Danone and Nestle are locked in a price war and both lowered prices over the last year. That makes it tougher for companies like Mead to compete. Mead was spun off from Bristol Meyers in 2009. The good news is a bidding war between those two giants could push Mead's price higher.

Children's Place (PLCE) reported earnings of $1.19 that beat estimates for $1.11. Revenue of $498.5 million beat estimates for $497.2 million. They guided for the current quarter to earnings of $1.00-$1.06 and analysts were expecting 93 cents. The company also raised its quarterly dividend from 15 cents to 20 cents. Shares rallied +8.2% on four times average volume.

Redbox DVD kiosk owner Outerwall (OUTR) said it was exploring strategic alternatives and other financial options. A month ago a major shareholder, Engaged Capital LLC, urged the company to explore options including going private. The company also increased its quarterly dividend by 100% to 60 cents to give an implied yield of 7% in hopes of lifting its stock price. With streaming video replacing DVD rentals and phone companies giving tradeins on cell phones working or not, the company's DVD rental business is fading and the cell phone kiosks are losing money. Redbox is just one generation behind Blockbuster in obsolescence.

Terex Corp (TEX) rallied +7.4% after China's Zoomlion Heavy Industry Science & Technology Co Ltd raised its bid to $3.4 billion and added a special dividend of $1 to its prior $30 per share cash offer. Terex responded by asking for $32.75 in cash to terminate an existing merger agreement with Finland's Konecranes. It is unclear what Terex will do because some major shareholders have asked that it continue negotiations with Zoomlion in hopes of getting a higher price.

After the bell, Oracle (ORCL) reported earnings of 64 cents that beat estimates for 62 cents. Revenue of $9.012 billion missed estimates for $9.125 billion. Those numbers were down from $9.33 billion in the same period last year.

Oracle blamed the dollar for a significant impact on its results saying revenue would have been 1% higher on a constant currency basis. Revenues from cloud computing rose +40% to $735 million but software revenue declined -4% to $6.3 billion. Gross margins for the high growth cloud business are nearing 80% and that will help Oracle in the years to come. The company guided for earnings in the current quarter of 84-87 cents and analysts were expecting 82 cents.

With quarterly revenue falling for the fourth consecutive quarter the company is resorting to buybacks to lift the stock price. They authorized an additional $10 billion in their buyback program. Oracle is struggling to grow with old enemies Microsoft and IBM still around and Google, Salesforce and Amazon becoming an even greater threat. Shares rose $2 in afterhours trading.

Morgan Stanley (MS) strategists are becoming increasingly worried about a global recession and slashed their targets for the S&P from 2,175 to 2,050. They also said there was no reason to believe the current rally would continue. "Weaker growth forecasts and rising political risk lead us to close our positive tactical stance and lower exposure in global equities," the analysts said in the note. "The probability of a global recession has risen." They are putting the risk today at 30%.

Morgan Stanley sees the U.S. economy growing by 1.7% with the Eurozone growing 1.5%. Those estimates are down from 1.9% and 1.8% respectively. Emerging market growth expectations were cut from 4.4% to 4.0%. They believe the U.S. market is the safest port in the potential storm but a full-blown recession will cause all assets to be sold equally. They recommend consumer discretionary, utilities and financials as the best places to hide. To turn this into a positive comment there is a 70% chance there will be no recession.


What we have here is a failure to communicate. The Fed has failed to communicate in the many appearances by Fed speakers, a coherent strategy for future rate policy. One speaker says the Fed should exercise patience and the next one on the schedule says the Fed should accelerate its rate hike process. Several times a week we get these conflicting views and now nobody knows what to expect from the Fed this week.

The market is confused and traders have no conviction. While nobody expects a hike this week there is always the potential for a surprise. Instead of producing the normal pre Fed rally on Tuesday, investors moved to the sidelines. Decliners were 3:1 over advancers but conviction was sorely lacking. Volume on Monday of 6.3 billion shares was the second lowest of the year and today at 6.5 billion was only marginally better. Nobody was trading and it appeared even the high frequency traders were going dormant.

The S&P continues to hold just under the confluence of resistance at 2,020 with a 2,015 close. While there is no conviction to push it higher the opening dips on both days were bought. The Dow declined -108 at the open and ended with a gain of +22. The S&P and Nasdaq were negative because of the -4% crash in the biotech sector.

If Yellen puts on her dove costume and placates the market on Wednesday afternoon, we could move higher. However, there is significant risk in the guidance. If she pulls a Mario Draghi and develops foot in mouth disease, we could easily retest 1,990 or even 1,950. With Q1 earnings still four weeks away there is room to move to the upside if traders could develop some confidence in the future. A break through 2,020 could test 2,075 but that would likely be the spring high ahead of the sell in May season.

The Dow managed a gain thanks to Apple's $2 boost. Morgan Stanley upgraded the tech giant saying iPhone sales were being underestimated and they reiterated their $135 price target. The Dow is holding the recent gains thanks to stocks like Home Depot, Johnson & Johnson, Procter & Gamble and Microsoft. They are seen to be somewhat recession proof and are considered safe havens.

Financials are up one day and down the next so support from that sector has been unreliable. The Dow is holding over 17,135 and approaching resistance at 17,300. A breakout on some positive Fedspeak could take it to 17,775.

The Nasdaq is suffering under the burden of the biotech crash. In the losers list below the vast majority of the big losers are biotech and pharma stocks. Until the biotechs find a bottom the Nasdaq will be weak.

The Nasdaq Composite is wandering around at the 50% retracement level of 4,691 and cannot seem to move too far away in either direction. There is major resistance at 4,806 and the 61% retracement level, which is also the 100-day average. Any breakout from the current congestion is going to find a ceiling there. Support is the 4,600 level and just over the 38% retracement level.

The Russell is building quite a solid top at the 1,078 level. The Russell is being pressured by the decline in energy stocks and biotechs. We have seen several spikes above 1,078 but each is immediately sold. The 1,064 level has emerged as initial support but that may only be temporary. Note that the RSI is weakening and the MACD is rolling over.

Our fate rests in the words from Janet Yellen at 2:30. She can make or break the market for the rest of the week. Just remember that the initial move after the 2:PM announcement is typically a head fake. The real direction will come after she speaks at 2:30.

There may also be a market reaction to the results of the Tuesday primaries. As I write this Trump appears to be ahead everywhere but Ohio and Rubio has suspended his campaign.

I would recommend holding off on adding new positions until Thursday. There is no reason to jump into traffic when the direction can change every 5 minutes. There is always another day to trade if you have money in your account.

Enter passively, exit aggressively!

Jim Brown

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